March 28, 2017 / 4:07 PM / a year ago

Fitch Rates Omega Healthcare's Senior Unsecured Notes 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, March 28 (Fitch) Fitch Ratings has assigned a 'BBB-' rating to the senior unsecured notes due 2025 and 2027 being issued by Omega Healthcare Investors, Inc. (NYSE: OHI). A full list of Fitch's ratings for OHI follows at the end of the release. KEY RATING DRIVERS The affirmation and 'BBB-' ratings are based on Omega's strong credit metrics (low leverage, high fixed-charge coverage and ample liquidity) providing a sufficient buffer against the potential effects of tenant-related operating headwinds. OHI focuses on skilled nursing (SNFs) and assisted living facilities (ALFs) wherein tenants' capacity to honor lease obligations are closely influenced by changes to government reimbursement and regulatory / licensing risk. Operating headwinds faced by skilled nursing operators have been a focal point after announcements related to fourth quarter 2015 (4Q15) performance at some of the industry's largest operators. Healthcare REITs, including OHI, responded throughout 2016 and amended leases or provided debt capital to tenants in certain instances (e.g. Genesis HealthCare). We do not believe these headwinds will materially affect OHI's credit given the capacity to provide relief and maintain strong metrics should it choose to do so. However, tenant headwinds could cause the price at which OHI can issue debt and equity to become more expensive. LOW LEVERAGE WITH SUFFICIENT CUSHION OHI has consistently maintained leverage between 3.9x - 5.1x since 2011, with leverage at 4.8x and 5x for the quarter and year ended Dec. 31, 2016. Fitch views quarterly leverage as more meaningful than trailing 12 months for OHI given the lack of seasonality in reported earnings and timing effects of acquisitions. Fitch expects leverage will remain between 4x - 5x over the next 12-to-24 months. Fitch's projections indicate OHI has a cushion of 0.5x - 1x to the negative leverage sensitivity of 5.5x. We view it as unlikely that tenant issues could in and of themselves cause OHI to breach the 5.5x sensitivity. Under a simple analysis where the rent was reduced for tenants having coverage below 1x (7.6% of 4Q15) back to 1.4x (as measured by EBITDAR), leverage would only increase 0.2x. Tenants with coverage below 1x declined to 3.9% as of Sept. 30, 2016. Were OHI to change its financial policies and operate with leverage closer to 5.5x, Fitch would then consider the adequacy of the cushion. FCC is strong for the rating at 4.5x for the year ended Dec. 31, 2016 based on interest expense and 5.3x based on cash interest paid. This compares to FCC of 4.2x, 3.7x and 3.6x for 2015, 2014 and 2013, respectively. Fitch expects OHI's FCC will continue to improve, driven by contractual rental escalators and reduced fixed charges as the interest savings from the refinancing is realized. STRONG LIQUIDITY & APPROPRIATE CONTINGENT LIQUIDITY OHI's near-term liquidity is strong pro forma for this issuance which provides it time to manage through the tenant-related headwinds. Should proceeds be used to repay the amounts outstanding on the revolving line of credit ($190 million at Dec. 31, 2016) and some amount towards the $500 million of term loans maturing in 2019, OHI will have no debt maturities until 2021. OHI's primary sources of liquidity are the $1.25 billion revolving credit facility due 2018 and extendable to 2019, proceeds from issuance and retained cash flow from operations. Uses are relatively manageable beyond the $320 million of remaining development and renovation commitments. COMMONALITY OF TENANT REVENUE SOURCES MITIGATES OPERATOR DIVERSIFICATION BENEFITS Fitch views skilled nursing real estate (and by extension pure-play REITs) as having more risk than other real estate subsectors due to the potential for legislative or regulatory changes (including the annual changes to reimbursement amounts by the Center for Medicare and Medicaid Services). These unilateral actions can impact the profitability of most tenants, thus partially mitigating the benefits of tenant and geographic diversification. The operating environment for tenants has been eventful beginning with weak results being announced by some of the largest operators in 2016. SNF margins are being pressured by increasing coverage under Medicare Advantage, Department of Justice investigations potentially influencing billing practices, and pilot programs for bundled payments and coordinated care. While the Trump administration appears to be in favor of slowing the growth of bundles and making participation voluntary, we believe the long-term demographic and economic factors will continue to drive the market towards these programs over the long run. We view these as long-term headwinds that stronger operators should be able to manage given they are fairly well-telegraphed. Another limiting factor on the rating (but inherent to the strategy) is OHI's exposure to private, unrated operators, which limits the extent to which Fitch can assess their creditworthiness. Fitch views most for-profit post-acute operators to be 'B' category credits, where capacity to meet debt obligations is vulnerable to deterioration in the business and economic environment. Rent coverage, as measured by EBITDARM (EBITDAR before management fees) and EBITDAR were 1.7x and 1.3x, respectively, at Sept. 30, 2016, which reflects the deterioration from prior periods but still implies some cushion to sustain annual rental increases and/or unforeseen changes to reimbursement rates. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for OHI include: --Operator headwinds persist and pressure coverage levels but do not result in wholesale bankruptcies or rent renegotiations; --Contractual rental escalators of 2%-2.5% per year through 2018; --Acquisitions of $500 million per year through 2018 at 8.5% cap rates; --$300 million of equity being issued in both 2017 and 2018 to fund acquisitions. Should OHI's equity trade at levels where it is unable or unwilling to transact, Fitch assumes OHI would reduce acquisition volumes. RATING SENSITIVITIES Fitch does not expect management will operate the company consistent with the metrics that could otherwise result in positive momentum in OHI's ratings and/or Outlook, such as: --Increased scale and diversification; --Fitch's expectation of net debt-to-recurring operating EBITDA sustaining below 4x; --Fitch's expectation of fixed-charge coverage sustaining above 3.5x. The following factors may result in negative momentum in OHI's ratings and/or Outlook: --Further pressure on operators through reimbursement cuts; --Fitch's expectation of leverage sustaining above 5.5x; --Fitch's expectation of fixed-charge coverage sustaining below 2.5x. FULL LIST OF RATING ACTIONS Fitch currently rates Omega Healthcare Investors, Inc. as follows: --Long-Term IDR 'BBB-'; --Unsecured revolving credit facility 'BBB-'; --Senior unsecured notes 'BBB-'; --Senior unsecured term loans 'BBB-'; --Subordinated debt 'BB+'. Contact: Primary Analyst Britton Costa, CFA Senior Director +1-212-908-0524 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Caitlin Blalock Associate Director +1-512-215-3732 Committee Chairperson Stephen Boyd, CFA Senior Director +1-212-908-9153 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: Additional information is available on Date of Relevant Rating Committee: March 18, 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 and include operating income from discontinued operations; --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $1 million of cash for working capital purposes that is otherwise unavailable to repay debt. 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