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Fitch Rates CoreCivic's Unsecured Notes 'BB+'; Outlook Stable
October 11, 2017 / 1:13 PM / in 7 days

Fitch Rates CoreCivic's Unsecured Notes 'BB+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, October 11 (Fitch) Fitch Ratings has assigned a 'BB+' rating to the unsecured bonds issued by CoreCivic, Inc. (NYSE: CXW). The Rating Outlook is Stable. A full list of ratings follows at the end of this release. KEY RATING DRIVERS Fitch's rating reflects the U.S. Immigration and Customs Enforcement's (ICE) reaffirmation of its reliance on private detention facilities and CXW renewing or signing new contracts with all three federal detention/correction bodies since the August 2016 Department of Justice recommendation to reduce future reliance on privately-operated prisons, which was ultimately withdrawn in February 2017. The rating further incorporates CXW's good credit metrics offset by steadily declining occupancy rates. CXW's revenues remain reliant on short term three- to five-year contracts with federal and state government entities that have the ability to dissolve agreements with the company at any time without cause, with funding often dependent on annual budget approvals. Good Financial Metrics: CXW has leverage which is low relative to Fitch's rated U.S. REIT universe, but in-line with broader corporates at the same rating level. Leverage has risen to 3.5x for the quarter ended June 30, 2017 as the full impact of the South Texas Family Residential Center (STFRC) renegotiated contract is negatively affecting top-line revenues. Fitch anticipates leverage will remain in the mid-3x through 2019 as the reduction of inmate populations due to California's Proposition 57 is largely offset by additional contracts at the state level and with ICE. CXW maintains a high level of fixed charge coverage at 6.8x for the TTM ended June 30, 2017, and Fitch projects that coverage will remain strong through the rating horizon. This metric is also amongst the strongest in Fitch's rated U.S. REIT universe and well above the average of broader corporate credits at the same rating level. Coverage has remained strong in recent years despite additional unsecured bond issuances as a result of relatively high drawn balances on the company's revolving credit facility. Falling Occupancies; Margins Stabilize: Average compensated occupancy has declined every year from 2007 to 2016 and was 79% at June 30, 2017. Occupancy has remained well below the company's target range despite CXW desiring a certain level of vacancy in order to meet demand. Vacant beds have grown by approximately 6,500 since 2012 even as CXW's average available capacity has fallen by more than 9,000 beds. CXW has lost multiple contracts in the last several years, some by choice, and it has been unable to recoup the occupancy losses. Expanded ICE operations throughout the country have prevented a steeper decline in CXW's revenues and ICE activity has held occupancy steady in recent months, but longer-term trends are shifting away from imprisonment of non-violent offenders and toward rehabilitation and re-entry for minor drug offenses and other misdemeanors. Fitch expects margins to decline due to the late-2016 renegotiation of the STFRC contract. Margins had been trending lower in recent years but levelled off during 2016 at 28% for all facilities and have remained in that range to-date in 2017. Solid Competitive Position: Public prisons are generally overcrowded, and the supply of new public prisons has been modest over the past five years. The cost for states to build or repair facilities remains significantly higher than those of the private operators. The private sector accounts for approximately 10% of the U.S. prison market. CXW, the market leader, controls 42% of all private prison beds while its largest competitor, The GEO Group (GEO), controls 37% of private prison beds. Relatively high barriers of entry exist for other potential competitors essentially forming a duopoly for private prison contracts. Despite slight declines in federal prison populations in three consecutive years for the first time in over 40 years, Fitch expects that U.S. private correctional facilities will likely continue to be a necessary part of the correctional system while federal bodies like ICE and the U.S. Marshals operate few to none of their own facilities. Limited Real Estate Value: CXW's real estate holdings provide negligible credit support. There are limited to no alternative uses of prisons and the properties are often in rural areas. The company has never obtained a mortgage on any of its owned properties, exhibiting a lack of contingent liquidity. However, the facilities do provide essential governmental services, so there is inherent value in the properties. Additionally, prisons have a long depreciable life of 50 years with a practical useful life of approximately 75 years. CXW has a young owned portfolio with a median age of approximately 18 years. Limited Secured Debt Market: The secured debt market for prisons remains undeveloped and is unlikely to become as deep as that for other commercial real estate asset classes, providing little contingent liquidity provided by CXW's entirely unencumbered asset pool. Fitch would view increased institutional interest in secured lending for prisons throughout business cycles as a positive credit characteristic. Fitch expects that the company will retain strong access to capital through the bank, bond and equity markets. High Tenant Concentration: CXW's customer base is highly credit worthy but concentrated as evidenced by the top 10 tenants accounting for 85% of total revenues through June 30, 2017. Three of the company's top tenants are large federal correctional and detention authorities, which have collectively made up 48% of revenues through 2Q17. ICE accounted for 26% due primarily to the STFRC contract and elevated detention of undocumented individuals in the last year. The United States Marshals accounted for 15% of revenue and the Bureau of Prisons accounted for 7% of revenue. Tennessee, California, and Georgia are the three largest state customers and together accounted for 22% of 1H17 revenue. Secured Credit Facility and Term Loan Notching: Fitch currently rates the secured credit facility and term loan 'BBB-'/RR1, one notch above the IDR, as they are effectively senior to the unsecured bonds. CXW's accounts receivables are pledged as collateral and were $207 million at June 30, 2017. Equity in the company's domestic operating subsidiaries and 65% of international subsidiaries are also pledged as collateral. The long-term fixed assets are not pledged. DERIVATION SUMMARY The lack of alternative uses and limited secured debt financeability of CXW's assets results in Fitch analyzing the company as a traditional corporate entity, as opposed to an asset-rich equity REIT, despite the tax election. Mid-3x leverage and over 6x fixed charge coverage are not sufficient for investment grade ratings despite being the strongest in Fitch's rated U.S. REIT universe. Fitch does not view the asset class as conducive to an investment grade IDR absent consistent, through-the-cycle mortgage financing of correctional assets. CXW's only other public U.S. competitor is GEO Group, Inc. (GEO) for which Fitch has a credit opinion of 'bb-*'/stable. Fitch's differential in viewpoints is related to GEO's less conservative financial policies specifically related to leverage under which the company often operates in the mid- to high-4x's range. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for the issuer include: --Revenues and margins deteriorate in 2017 due to full year impact of STFRC renegotiated contract. Modest single-digit revenue growth follows in 2018 and 2019 as revenue from contract gains slightly outpace losses; --Modest acquisitions annually through the forecast period; --No equity issuance through the forecast period. RATING SENSITIVITIES Although Fitch views positive rating momentum as unlikely in the near to medium term, future developments that may, individually or collectively, lead to positive rating actions include: --Increased privatization of the correctional facilities industry; --An acceleration of market share gains and/or contract wins; --Adherence to more conservative financial policies (2x leverage target; 4x minimum fixed charge coverage); --Increased mortgage lending activity in the private prison sector. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Fitch's projection of leverage sustaining above 3.5x coupled with continued fundamental business headwinds. Should operating fundamentals improve, indicating current operating weakness is more cyclical than secular in nature, leverage sustaining above 4.0x would be considered for downward pressure on the IDR/Outlook; --Increased pressure on per diem rates from customers; --Decreasing market share or profitable contract losses; --Material political decisions negatively affecting the long-term dynamics of the private correctional facilities industry; --A holistic change in the Federal government's sentiment towards privately operated prisons. LIQUIDITY Strong Liquidity Profile: Fitch estimates CXW's sources of liquidity (unrestricted cash, retained cash flow from operating activities, and availability on the company's $900 million secured revolver) cover its uses (debt maturities, development expenditures, and recurring maintenance capex) by 4.9x which is strong for the rating. CXW benefits from having just $30 million in debt maturity payments related to its incremental term loan through 2019. Fitch viewed positively the company's willingness to protect its liquidity profile from an unsustainable dividend payout ratio by reducing its quarterly dividend payment to 42 cents/share from 54 cents/share following the renegotiation of its STFRC contract. The company reduced the dividend to target an approximate 80% AFFO payout ratio. Excess cash flow supports prison construction, debt reduction, and other corporate activities. FULL LIST OF RATING ACTIONS Fitch currently rates CoreCivic, Inc. as follows: --IDR 'BB+'; --Senior secured revolving credit facility 'BBB-'/RR1; --Senior secured term loan 'BBB-'/RR1; --Senior unsecured notes 'BB+'/RR4. Contact: Primary Analyst Steven Marks Managing Director +1-212-908-9161 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Christopher G. Pappas Director +1-646-582-4784 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 Date of Relevant Rating Committee: Feb. 17, 2017 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: --Fitch adds back non-cash stock-based compensation to EBITDA and includes operating income from discontinued operations; --Fitch assumes the issuer requires $15 million of cash for working capital purposes which is otherwise unavailable to repay debt; --Fitch treats the depreciation and interest expenses associated with the company's STFRC contract as operating expenses and deducted from EBITDA. Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Criteria for Rating Non-Financial Corporates - Effective from 27 September 2016 to 10 March 2017 (pub. 27 Sep 2016) here Recovery Ratings and Notching Criteria for Equity REITs - Effective from 16 November 2016 to 16 June 2017 (pub. 16 Nov 2016) here Additional Disclosures Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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