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Fitch Rates American Assets Trust's $250MM Sr. Unsecured Notes and $50MM Unsecured Term Loan 'BBB'
March 6, 2017 / 9:08 PM / 5 months ago

Fitch Rates American Assets Trust's $250MM Sr. Unsecured Notes and $50MM Unsecured Term Loan 'BBB'

(The following statement was released by the rating agency) NEW YORK, March 06 (Fitch) Fitch Ratings has assigned a 'BBB' rating to the $250 million, senior guaranteed notes, series D private placement due March 1, 2027 issued by American Assets Trust, L.P., the operating partnership of American Assets Trust, Inc. (NYSE: AAT). Fitch has also assigned a 'BBB' rating to AAT's $50 million term loan C due March 1, 2023. 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, appropriate leverage achieved through organic delivering and appropriate for the 'BBB' rating, good unencumbered asset coverage of unsecured debt, and 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 the 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 6.2% of retail rent and 2.6% of total rent in 4Q2016. In addition, while AAT continues its evolution towards a more unsecured funding model, it has issued only four series of private placement bonds (inclusive of this $250 million issuance) since its 2011 IPO. High Barrier-to-Entry West Coast Focus At Dec. 31, 2016, AAT's portfolio included 104 retail buildings (11 properties) totalling 3.1 million square feet, 28 office buildings (seven properties) totaling 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 San Diego (32% of 4Q2016 cash NOI), Oahu, Hawaii (23%), the San Francisco Bay Area (17%), Portland, Oregon (13%) and Bellevue, Washington (8%). Fitch has a more favorable view toward companies that own properties in high-barrier-entry markets such as San Francisco when compared with other markets, due to consistently strong asset liquidity and leveragability. Growing Fixed Charge Coverage AAT's fixed-charge coverage was 2.8x for the trailing 12 months ended Dec. 31, 2016, compared to 2.5x in 2015 and 2.3x in 2014. Fixed-charge coverage has improved due to steady cash basis SSNOI growth (5.1% in 2016, 7.7% in 2015 and 1.9% in 2014), cash flow from completed developments and lower interest incurred. 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 was 6.1x for the trailing 12 months ended Dec. 31, 2016, 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. 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. Transition to Unsecured Funding Profile To date, the company has only issued four series of private placement unsecured notes. Other unsecured borrowings include the $250 million revolver and three unsecured term loans with a combined principal amount of $250 million. As of Dec. 31, 2016, the company's implied value of unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 2.7x. Fitch projects that unencumbered asset coverage should remain in the 2.5x to 3.0x range through 2018, which is strong for the rating. Offsetting the quality of the unencumbered pool is the fact that 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 Dec. 31, 2016, 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 totaled $23.7 million as of Dec. 31, 2016, 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. The historical argument for focused REITs assumes shareholders ascribe a discount to diversified REITs akin to a conglomerate discount. AAT is currently trading at a 7.3% discount to median consensus net asset value. However, Fitch observed a premium in price/NAV in diversified REITs index. According to SNL Financial, as of March 2, 2017 the share prices of diversified REITs are currently trading at a 5.1% premium to median consensus net asset value compared to retail and office REITs, whose common share prices are trading at a discount of 9.4% and 4% respectively. Exposure to Select Weak Credit Tenants AAT is materially exposed to below investment grade rated and unrated tenants, and its largest tenant ending in 2016 was salesforce.com, representing 7.9% of 4Q2016 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 2.6% of total rent in 4Q2016, and the top 10 retail and office tenants represented 10.5% and 23.6% of annualized based rent, respectively. Only one of these 20 tenants is rated investment grade by Fitch: Nordstrom ('BBB+'/Outlook Stable, 1.1% of total rent). It is possible that certain weak credit tenants will elect not to renew leases upon expiration or default during the lease term, which could provide AAT with the opportunity to push rents given that in-place retail and office rents are below market rents. However, the company would be exposed to downtime and capital expenditures during the vacancy period. Stable Outlook The Stable Outlook reflects Fitch's expectation that AAT will operate within its targeted metrics through the rating horizon and the issuer will have sufficient capacity to address any potential tenant credit issues. 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 6.1x for the year ended Dec. 31, 2016 and Fitch expects it will sustain in the 5.8x - 6.3x range over the next 12 - 24 months); --Fitch's expectation of fixed-charge coverage sustaining above 2.5x for several quarters (fixed charge coverage was 2.8x for the year ended Dec. 31, 2016). 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. 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'; --$350 million unsecured notes 'BBB'. Fitch has also assigned a 'BBB' rating to AAT's $250 million, senior guaranteed notes, series D private placement due March 1, 2027 and to the $50 million unsecured term loan C due March 1, 2023. The Rating Outlook is Stable. Contact: Primary Analyst Steven Marks Managing Director +1-212-908-9161 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Ronald Nirenberg Director +1-212-612-7747 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. 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As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed. The information in this report is provided “as is” without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. 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