Fitch Rates Corporate Office Properties, L.P.'s Senior Unsecured Notes
NEW YORK -- May 15, 2014
Fitch Ratings has assigned the following debt obligation rating to Corporate
Office Properties, L.P.:
--$300 million 3.7% senior unsecured notes 'BBB-'.
The notes mature in June 2021 and were priced at 99.739% of their face amount
to yield 3.742%, a 165 basis point spread to the benchmark treasury rate. The
notes are obligations of Corporate Office Properties, L.P. and fully and
unconditionally guaranteed by Corporate Office Properties Trust (COPT, NYSE:
COPT will use net proceeds from the offering to repay borrowings under the
company's unsecured revolving credit facility and a portion of the 2015 term
loan, to redeem its series H preferred stock, and for general corporate
Fitch currently rates the company as follows:
Corporate Office Properties Trust
--Issuer Default Rating (IDR) 'BBB-';
--Preferred Stock 'BB'.
Corporate Office Properties, L.P.
--Senior unsecured line of credit 'BBB-';
--Senior unsecured term loans 'BBB-';
--Senior unsecured notes 'BBB-';
--Senior unsecured exchangeable notes 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Strong Franchise/Defense-Driven Portfolio
COPT generates 73% of net operating income (NOI) from its strategic tenant
niche, which includes properties occupied primarily by government agencies or
defense contractors. As a result, COPT's assets are generally located near
strategic defense locations (i.e. Fort Meade), which drives geographic
concentration in the Washington, D.C. and Baltimore region. These strategic
locations drive strong tenant investment in the assets and create tenant
stickiness, as retention rates have averaged approximately 70% since 2007.
Tenant missions also center on R&D and high-tech areas that are critical to
national cyber-security in the United States. Together with COPT's
long-standing relationships with the federal government and contractors, these
strategic locations create meaningful barriers to entry.
Portfolio Realignment Largely Complete
COPT completed its Strategic Reallocation Plan (SRP) commenced in 2011 via the
sale of non-core assets (reduced Baltimore County footprint by 2 million
square feet), exiting the Colorado Springs market, and improving its balance
sheet to levels consistent with an investment-grade office REIT. Key remaining
transactions include the expected conveyance of a $150 million portfolio
(based on outstanding CMBS balances) to the special servicer during 2014 and
the redevelopment/expected sale of the company's Blue Bell portfolio. These
transactions will further improve financial flexibility and facilitate capital
recycling in the company's strategic niche properties.
Improved Credit Profile; Addition by Subtraction
The company sold its 15-asset Colorado Springs portfolio for $133.9 million
and conveyed 14 properties to the CMBS special servicer for $146.9 million in
December 2013, reflecting the value of in-place debt and accrued interest.
These transactions drove leverage lower to 6.7x at March 31, 2014. Fitch
anticipates that COPT will convey a separate $150 million portfolio to the
special servicer in 2014 following vacancies by Northrop Grumman and CSC in
April 2014, which will facilitate further de-levering. Fitch is not concerned
about potential franchise risk at this time; however, additional conveyances
would be viewed negatively given the potential for weakened access to mortgage
Appropriate Credit Metrics
Pro forma leverage is 6.7x, a decline from 7.0x and 8.7x at Dec. 31, 2012 and
Dec. 31, 2011, respectively. Fitch expects leverage will approach 7.0x in 2014
as COPT funds its development pipeline, before declining to the low-6.0x range
over the longer term, driven by low single-digit same-store net operating
income (SSNOI) growth and incremental cash flow from development completions.
Projected leverage is appropriate for the 'BBB-' IDR. Fitch defines leverage
as net debt-to-recurring operating EBITDA.
Fixed charge coverage (FCC) was 2.2x for the trailing 12 months (TTM) ended
March 31, 2014, an improvement from 2.1x in 2013 and 1.8x in 2012. Fitch
expects that FCC will approach 2.5x over the next 12-24 months, driven by
recurring operating EBITDA growth and continued access to debt capital at
favorable rates. Projected coverage is relatively strong for the rating. Fitch
defines FCC as recurring operating EBITDA, less recurring capital expenditures
and straight-line rent adjustments, divided by total interest incurred and
Uneven Operating Fundamentals
Same-store occupancy increased 80 basis points year-over-year to 89.9% at
March 31, 2014; however, part of the gain was attributed to the sale of lower
occupancy assets (i.e. Colorado Springs) and asset foreclosures. Fundamentals
remain uneven across markets - the Baltimore/Washington Corridor, which makes
up 47% of square feet, has seen encouraging leasing indicators evidenced by
improving cash leasing spreads and lower tenant improvements. However,
Northern Virginia and Greater Baltimore (collectively 34% of square feet)
remain under pressure and have been characterized by cash rent roll down in
the high single digits with elevated capex requirements. Favorably though,
GAAP leasing spreads continue to be generally positive across the portfolio,
though 1Q'14 renewal growth decelerated to 1.6% from 4.6% in 2013. Fitch
expects that occupancy will increase marginally in 2014 as contractors
finalize real estate rationalization plans.
Informed Demand Mitigates Development Risk
COPT's growth strategy centers on new development given informed demand from
the U.S. Government for new space requirements. The pipeline totaled $376
million at March 31, 2014 and was 55% pre-leased to both government agencies
and defense contractors supporting these entities. The cost to complete the
pipeline has grown to 5% of gross assets from 3% at Dec. 31, 2013, but
development risk is mitigated by COPT's unique relationships that provide
implicit pre-leasing. The company remains well-positioned to capture future
demand from cyber-driven growth, which should offset weakness in regional
markets and potential future downsizing from defense contractors. COPT leased
approximately 900,000 square feet of first-generation development and
redevelopment space in 2013, which follows a record 1.2 million of square feet
Adequate Financial Flexibility
COPT has a strong liquidity profile with pro forma sources of liquidity
covering total uses of liquidity by 2.7x through 2015, strong for the rating.
Fitch defines liquidity coverage as sources of liquidity divided by uses of
liquidity. Sources of liquidity include unrestricted cash, availability under
the unsecured revolving credit facility, and projected retained cash flow from
operating activities after dividends. Uses of liquidity include pro rata debt
maturities, expected recurring capital expenditures, and remaining development
Financial flexibility is also supported by improved access to capital - COPT
has now issued $900 million of unsecured notes since receiving
investment-grade ratings in 2013 at a 4.2% weighted average interest rate -
and a growing unencumbered asset pool, which covered pro forma net unsecured
debt by 1.9x using a stressed 9% capitalization rate. The decline from 2.2x at
Dec. 31, 2013 was driven by the Dec. 2013 sale of the unencumbered Colorado
Springs portfolio and timing of development (i.e. incurring debt to finance
the construction without recognizing the NOI to date). Fitch expects that the
company's unencumbered asset coverage will improve to 2.0x over the next 12-24
months as these projects stabilize.
Conservative AFFO Payout Ratio
COPT's AFFO payout ratio was 70% in 2013, which allows the company to generate
approximately $45 million of internal liquidity to fund growth and repay debt.
Fitch expects the company to increase the dividend over the next 12-24 months;
however, Fitch expects the AFFO ratio will remain below 80%.
The following factors may have a positive impact on COPT's ratings and/or
--Fitch's expectation of net debt-to-recurring operating EBITDA sustaining
below 6.0x (pro forma leverage is 6.7x);
--Fitch's expectation of FCC maintaining above 2.5x (FCC ratio was 2.2x for
the TTM ended March 31, 2014);
--Fitch's expectation of unencumbered asset coverage of net unsecured debt
(UA/UD) maintaining above 2.5x (pro forma coverage is 1.9x).
The following factors may have a negative impact on the company's ratings
--Fitch's expectation of leverage sustaining above 7.0x;
--Fitch's expectation of FCC sustaining below 1.8x;
--Fitch's expectation of UA/UD sustaining below 1.8x;
--Material macroeconomic weakness affecting the defense industry, such that a
larger portion of COPT's portfolio would consist of standard suburban office
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Equity REITs and REOCs (Sector Credit Factors) (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Recovery Ratings and Notching Criteria for Equity REITs
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
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