September 20, 2017 / 8:00 PM / a year ago

Fitch Revises WPG's Outlook to Negative; Affirms IDR at 'BBB-'

(The following statement was released by the rating agency) NEW YORK, September 20 (Fitch) Fitch Ratings has affirmed the ratings of Washington Prime Group, Inc. (NYSE: WPG) and its operating partnership, Washington Prime Group Limited Partnership at 'BBB-'. The Rating Outlook has been revised to Negative from Stable. A full list of rating actions follows at the end of the release. KEY RATING DRIVERS The Negative Outlook reflects Fitch's view that WPG has weaker access to capital (secured and unsecured debt and equity) than most other investment grade REITs. However, Fitch views positively the company's more recent access to the unsecured bond market to extend debt maturities. Market sentiment across most capital providers for 'B' malls generally has eroded given the challenges to ascertaining the long-term productivity and financeability of this asset class. The company has adequate unencumbered asset coverage of unsecured debt when applying a stressed capitalization rate reflective of less productive retail assets, although the financeability of the company's community center portfolio is less certain. In addition, property-level performance has been uneven, with relatively flat occupancies and SSNOI growth, due primarily to a more challenging leasing environment. Over the short term we believe that portfolio operating metrics will be stable to down slightly, but long-term 'B' malls fundamentals will likely decline. These factors are balanced by Fitch's expectation of investment-grade leverage and fixed-charge coverage (FCC) metrics. Further, while 'B' malls are less financeable in the mortgage market than most traditional real estate assets, they are considerably more financeable than niche asset classes such as casinos, data centers and hospitals. PROPERTY-LEVEL FUNDAMENTALS UNEVEN The company's operating performance has been negatively affected by weakening retailer trends, in particular tenant bankruptcies and closures. For the 12 months ended June 30, 2017, the company's stabilized mall same-center tenant sales per square foot was $368, down from $376 a year earlier, total portfolio occupancy declined approximately 70bps to 92.3% and same-store NOI declined 1.3% for the six months ended June 30, 2017. Fitch expects some stabilization in operating metrics as the company backfills vacant space; however, we expect only modest same-store NOI growth during the projection period. EVOLVING ACCESS TO CAPITAL Fitch views WPG's access to most forms of debt and equity capital to be at the lower end of the investment-grade REIT spectrum and it has weakened since the time Fitch initiated ratings. Mortgage availability for 'B' malls is less plentiful and more discriminating than it was in prior years and has weakened over the last year. Similarly, Fitch views WPG's access to non-bank unsecured debt capital as weak compared to investment-grade peers when measured by bond issuance spreads, attributable to its asset class, market sentiment around less-productive malls and being a less-seasoned issuer. In particular, the company's August 2017 bond offering priced at a spread indicative of a below-investment-grade issuer. WPG's ability and willingness to issue unsecured debt in August 2017 was a credit positive on the margin. However, the widening in spreads for WPG's issuances juxtaposed against REIT spreads tightening may reflect deteriorating capital markets access. WPG's common equity is trading at a 38% discount to consensus net asset value which is one of the largest discounts in Fitch's rated universe (the REIT index is at a 1% discount). Fitch attributes the discount to the wide bid-ask spread for 'B' malls generally as the market struggles to ascertain the long-term viability and value of less productive malls. By extension, thinner investor demand for B-malls limits the extent to which WPG can raise equity through asset sales, and thus the company has resorted to contributing assets to joint ventures as a way to extract equity from these assets. Fitch believes that some of the company's stronger assets were contributed to these ventures, resulting in adverse selection towards unsecured bondholders. INVESTMENT-GRADE CREDIT METRICS Fitch expects that WPG's leverage will migrate towards the mid-6.0x range driven by (re)development NOI coming on line and minimal SSNOI growth over the projection period. WPG's leverage was 6.2x for the quarter ended June 30, 2017 and 5.7x for the TTM ended June 30, 2017. Leverage has declined over the past year due primarily to the company contributing assets to a joint venture and repaying debt with the proceeds. When treating 50% of WPG's preferred stock as debt, leverage would be approximately 0.2x higher. Fitch forecasts FCC will sustain in the high-2.0x range through 2019. Over the past three years FCC has been consistent at 3.1x on a TTM and calendar year basis for both 2016 and 2015. FCC fell to 2.8x for the quarter ended June 30, 2017 as lower rental revenues from dispositions failed to be offset by correspondingly lower interest expense. Fitch attributes some of the deterioration in the quarter to seasonality in revenues, but FCC will likely decline due to the higher cost of newly issued debt versus the retired term loans. ADEQUATE UNENCUMBERED ASSET COVERAGE OF NET UNSECURED DEBT Unencumbered asset coverage of June 30, 2017 over net unsecured debt was 2.1x when applying a stressed 9.0% capitalization rate to unencumbered NOI. This ratio is appropriate for the current rating and is driven in part by over 80% of the company's unencumbered NOI being derived from Tier 1 and community center properties, although the depth of secured financing for these assets as a form of contingent liquidity is less certain. NEGATIVE RATING OUTLOOK The Outlook revision to Negative principally reflects Fitch's expectation that the company's access to several forms of capital (common equity, unsecured and secured debt) will remain challenged, below that of investment-grade peers and increasingly more comparable to that of below-investment-grade REITs. Further, Fitch expects property-level fundamentals will remain under pressure due to a difficult retail environment, placing pressure on the company's ability to grow cash flow. Fitch believes it is unlikely there will be positive revision in investor sentiment and therefore property liquidity and financeability will be challenged. Regardless of investor perception, REITs' need for consistent access to capital heightens the implications of investor sentiment on such access. Moreover, while liquidity is adequate through the rating horizon, we believe negative retail headlines will continue and thus 'B'-mall sentiment is unlikely to improve. DERIVATION SUMMARY Relative to the broader mall REIT sector, WPG's levels of occupancy, SSNOI growth, leasing spreads and tenant quality are weaker than Simon Property Group (IDR of A) and similar to 'B'-mall peer CBL & Associates, Inc. (IDR of BBB-). In addition, the company has weaker access to capital, given its ~38% equity trading discount to NAV and wide spreads at which its bonds trade relative to the broader peer set. Further, secured lender sentiment for the 'B'-mall asset class has declined to a level that Fitch believes is below that of many other retail commercial real estate asset classes. WPG has lower leverage than CBL, although Fitch expects leverage for both to center in the low-to-mid 6.0x's range during the projection period. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: -Annual SSNOI growth of approximately 1.0% for 2017-2019; -Annual development/redevelopment spend of $125 million for 2017-2019. The weighted average initial yield on cost for projects coming online is approximately 6%, ramping to approximately 8%; -Total non-core asset sales of approximately $300 million, none beyond 2017; -Annual recurring capital expenditures of $70 million. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Fitch Revising the Outlook to Stable at a 'BBB-' IDR: -Improved capital markets sentiment regarding 'B'-malls, specifically enhanced insurance company lending to the sector, bond issuance pricing closer to investment-grade peers, or a lower NAV discount for the company's common stock which may result in the company raising equity; -Fitch's expectation of leverage sustaining below 6.0x -Fitch's expectation of fixed charge coverage sustaining above 2.5x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Should Fitch's opinion of WPG's access to debt and equity capital fail to improve from current levels; -Sustained deterioration in operating fundamentals or asset quality (e.g. sustained negative SSNOI results or negative leasing spreads); -Fitch's expectation of leverage sustaining above 7.0x; -Fitch's expectation of fixed charge coverage sustaining below 1.8x; -Failure to maintain unencumbered asset coverage of unsecured debt (based on a stressed 9% cap rate) at around 2.0x. LIQUIDITY Liquidity is not a concern given the lack of unsecured debt maturities over the next few years, although access to attractively priced debt and equity capital is a key rating consideration for REITs given their distribution requirements. The company ended the 2Q17 quarter with $76.8 million of cash and equivalents and has a $900 million revolver with no outstanding borrowings and $0.3 million of letters of credit outstanding. The revolver matures in 2018 with two six-month extension options through 2019. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Washington Prime Group, Inc. --Issuer Default Rating (IDR) at 'BBB-'; --Preferred stock at 'BB'. Washington Prime Group Limited Partnership --IDR at 'BBB-'; --Senior unsecured revolving credit facility at 'BBB-'; --Senior unsecured term loans at 'BBB-'; --Senior unsecured notes at 'BBB-'. The Rating Outlook is Negative. 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 Stephen Boyd, CFA Senior Director +1-212 908-9153 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 and Fitch's estimate of recurring cash distributions from joint venture operations; --Fitch has included 50% of the company's cumulative perpetual preferred stock as debt in certain ratios. 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