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Fitch Rates American Assets Trust's $100MM Sr. Unsecured Notes 'BBB'
May 26, 2017 / 7:06 PM / in 5 months

Fitch Rates American Assets Trust's $100MM Sr. Unsecured Notes 'BBB'

(The following statement was released by the rating agency) NEW YORK, May 26 (Fitch) Fitch Ratings has assigned a 'BBB' rating to the $100 million, senior guaranteed notes, series E private placement due May 23, 2029 issued by American Assets Trust, L.P., the operating partnership of American Assets Trust, Inc. (NYSE: AAT). A full list of Fitch's current ratings for AAT follows at the end of this release. KEY RATING DRIVERS The rating and Stable Outlook are based on AAT's credit strengths, which include a portfolio focus on high barrier-to-entry U.S. West Coast markets that Fitch expects will result in growing cash flow in excess of fixed charges. Other strengths include appropriate leverage for the 'BBB' rating achieved through organic de-levering, good unencumbered asset coverage of unsecured debt, and a long management track record. While most REITs tend to eschew property type diversification, AAT has aggregated a portfolio of retail, office, multifamily and mixed use assets in markets that have historically demonstrated strong property-level fundamentals. Further, AAT's retail and office segments have outperformed the company's public office and retail REIT peers due to sustained demand for AAT's properties, combined with limited supply. Credit concerns include the company's exposure to below-investment grade and unrated tenants, including the largest retail tenant, Kmart, which represented 6.6% of retail rent and 2.8% of total rent in 1Q2017. High Barrier-to-Entry West Coast Focus: At March 31, 2017, AAT's portfolio included 104 retail buildings (11 properties) totalling 3.1 million square feet, 28 office buildings (seven properties) totalling 2.7 million square feet as well as 1,579 multifamily units (seven properties) and Waikiki Beach Walk, a retail/hotel mixed-use property in Honolulu. The company's core markets include Southern California (32% of 1Q2017 cash NOI), Hawaii (21%), Northern California (17%), Oregon (13%) and Washington (9%). Fitch has a more favorable view of companies that own properties in high-barrier-entry markets such as San Francisco than in other markets, due to consistently strong asset liquidity and leveragability. Growing Fixed Charge Coverage: Fitch projects that fixed-charge coverage will sustain in the 2.5x to 3.0x range over the next several years as AAT continues to refinance higher coupon debt with lower cost unsecured notes. Other drivers of improving fixed charge coverage should be positive releasing spreads that should drive same-store NOI growth and the lease up of in-process development. Appropriate Leverage: AAT's leverage for the quarter ending March 31, 2017 was 5.8x, an improvement compared to 6.5x and 6.6x for the years ended Dec. 31, 2015 and 2014, respectively. Fitch expects leverage to sustain around 6.0x over the next 12 to 24 months, primarily due to organic EBITDA growth and cash flow from development, as opposed to via de-levering equity offerings. This level is appropriate for the 'BBB' rating. In Fitch's stress case, leverage would be in the 6.5 to 7.0x range, which would be on the weaker end for a 'BBB' rating, and could result in negative rating action. Reported metrics may be weaker due to the timing effects of acquisitions, dispositions and debt issuance. Transition to Unsecured Funding Profile: As of March 31, 2017, the company's implied value of unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 2.6x. Fitch projects that unencumbered asset coverage should remain in the 2.5x to 3.0x range through 2018, which is strong for the rating. A meaningful portion of the unencumbered properties (including Waikele) are subject to a tax protection agreement that may limit the company's willingness and/or ability to sell certain assets. As such, realizing value from these properties may be limited to the mortgage market. Long Management Track Record and Development Discipline: The company's CEO and Chairman founded the company's predecessor, American Assets, Inc. in 1967, and the company's Chief Financial Officer has been with the company and its predecessor since 1998. AAT has successfully overseen development and re-development projects over the past several years including the redevelopments of Del Monte Center in Monterrey and Carmel Mountain Plaza in San Diego, and the development of Waikiki Beach Walk in Honolulu. As of March 31, 2017, the development pipeline included one in-process development (the Torrey Point office project in San Diego, which took 17 years to obtain entitlements and permits for construction) and four pipeline projects. Cost-to-complete development totalled $21.6 million as of March 31, 2017, representing only 1% of undepreciated assets. Property Type Diversification: AAT's portfolio strategy runs counter to those of the largest REITs in all major sectors that have eschewed property type diversification in the name of specialization. The argument in favor of focused REITs is predicated on the view that specialization provides opportunities for operational outperformance and that optimal portfolio allocations and diversification can be achieved more efficiently at the shareholder's portfolio level. Significant Lease Expirations Through 2018: Including expiring leases and leases with tenant renewal options, AAT has approximately 30% of its annualized base rent expiring between now and the end of 2018 including over one third of its retail square footage. The majority of the 2017-2018 lease expirations are in the retail and office sectors, which historically have had renewal rates in the low 90% range and low 80% range, respectively, mitigating renewal risk. Exposure to Select Weak Credit Tenants: AAT is materially exposed to below investment grade rated and unrated tenants, and its largest tenant was salesforce.com, representing 7.9% of 1Q2017 annualized base rent. Salesforce.com has a growing presence in San Francisco, and Fitch expects it will to continue leasing at AAT's The Landmark at One Market with significant rent bumps on upcoming lease expirations. The largest retail tenant, Kmart Corporation (rated 'CC' by Fitch), represented 2.8% of total rent in 1Q2017, and the top 10 retail and office tenants represented 10.8% and 22.8% of annualized based rent, respectively. DERIVATION SUMMARY The rating and Stable Outlook are based on AAT's credit strengths, which include a portfolio focus on high barrier-to-entry U.S. West Coast markets that Fitch expects will result in growing cash flow in excess of fixed charges, appropriate leverage for the 'BBB' rating achieved through organic de-levering, good unencumbered asset coverage of unsecured debt, and a long management track record. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for AAT include: --3% same-store NOI growth through 2018; --G&A to maintain historical margins relative to total revenues; --Development expenditures of approximately $30 million in 2017-2018 annually with development yields ranging from 6.75% to 8.75%; --No acquisitions or dispositions; --Secured debt repayment with the issuance of new unsecured bonds; --Recurring capital expenditures to remain around 20% of recurring operating EBITDA through 2018; --No equity issuance and an AFFO payout ratio of approximately 75% through 2018. RATING SENSITIVITIES The following factors may result in positive momentum in the ratings and/or Rating Outlook: --Continued access to the unsecured debt markets, in particular execution of public unsecured debt offerings; --Fitch's expectation of leverage sustaining below 5.5x for several quarters (leverage was 5.8x for the quarter ended March 31, 2017, and Fitch expects it will sustain around 6.0x over the next 12 - 24 months); --Fitch's expectation of fixed-charge coverage sustaining above 2.5x for several quarters. The following factors may result in negative momentum in the ratings and/or Rating Outlook: --Fitch's expectation of leverage sustaining above 6.5x for several quarters; --Fitch's expectation of fixed-charge coverage sustaining below 2.0x for several quarters. LIQUIDITY AAT's organic liquidity is moderate as its AFFO payout ratio was 74.3% in 2016, compared to 73.8% in 2015 and 74.7% in 2014. This payout ratio is consistent with the broader equity REIT universe. Based on the current payout ratio, AAT retains approximately $20 million annually in organic liquidity. FULL LIST OF RATING ACTIONS Fitch currently rates American Assets Trust as follows: American Assets Trust, Inc. --Long-Term Issuer Default Rating (IDR) 'BBB'; American Assets Trust, L.P. --Long-Term IDR 'BBB'; --$250 million unsecured credit facility 'BBB'; --$100 million unsecured term loan A 'BBB'; --$100 million unsecured term loan B 'BBB'; --$50 million unsecured term loan C 'BBB'; --$600 million unsecured notes 'BBB'; Fitch has also assigned a 'BBB' rating to AAT's $100 million, senior guaranteed notes, series E private placement due May 23, 2029. The Rating Outlook is Stable. Contact: Primary Analyst Christopher G. Pappas Director +1-646-582-4784 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Steven Marks Managing Director +1-212-908-9161 Committee Chairperson Michael Paladino Managing Director +1-212-908-9113 Date of Relevant Rating Committee: July 6, 2016 Summary of Financial Statement Adjustments: Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock-based compensation. --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $20 million of cash for working capital purposes, which is otherwise unavailable to repay debt. Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com. 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