February 10, 2017 / 6:12 PM / 10 months ago

Fitch Affirms Mack-Cali at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, February 10 (Fitch) Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Mack-Cali Realty Corporation (NYSE: CLI) and its operating partnership, Mack-Cali Realty, L.P. (collectively, Mack-Cali), at 'BB+'. A full list of rating actions follows at the end of the release. Fitch has also affirmed the Rating Outlook at Stable. KEY RATING DRIVERS Fitch's ratings for CLI reflect the company's weaker credit metrics and capital markets access relative to other low investment grade rated REITs, as well as challenging fundamentals in many of its core northeast suburban office markets. Fitch expects CLI's credit metrics to remain appropriate for a 'BB+' rated REIT through the 2019 projection period. CLI's turnaround plan considers bondholders but favors equity holders. The company has used the proceeds from asset sales and secured property financings and bank term loans to help fund its large (re)development platform and refinance debt maturities, primarily unsecured bonds. The company could reduce leverage below Fitch's 7.0x rating sensitivity for positive rating momentum with the proceeds from planned asset sales. However, CLI plans to use the proceeds for acquisitions and asset stabilization; repositioning and development capex, particularly in the context of its manageable debt maturity profile; and adequate access to unsecured bank term loan and secured mortgage debt. Incremental net operating income (NOI) from developments could also lead to lower leverage; however, Fitch expects the company to continue to start new developments as existing projects are delivered and stabilized. Longer-term, Fitch expects CLI to adopt financial policies that are consistent with a low investment grade rating, including leverage sustaining in the mid-to-high 6x range. The company has publicly discussed a plan de-lever during 2018 with the proceeds from flex office sales ($600 million to $700 million company-estimated market value). Fitch has not included this in its rating case projections given the high degree of uncertainty with respect to NJ flex office property values and liquidity, as well as management's commitment to this strategy. Public equity issuance as another possible avenue for future deleveraging, assuming successful execution of the company's turnaround plan narrows the net asset value (NAV) discount for its shares. SPECULATIVE GRADE CREDIT METRICS Fitch expects Mack-Cali's leverage will sustain in the mid-7.0x range through 2019, which is appropriate for a 'BB+' rated REIT with Mack-Cali's asset profile. Mack-Cali's portfolio is principally comprised of capital intensive suburban office properties in select New Jersey and, to a lesser extent, New York and Connecticut suburbs. These markets are generally characterized by stubbornly high vacancy rates and weak same-store NOI growth prospects. The company's leverage for the annualized quarter ended Sept. 30, 2016 was 7.5x. Fitch defines leverage as recurring operating EBITDA, excluding non-cash above and below market lease adjustments, over total debt net of readily available cash. Fitch expects CLI's fixed-charge coverage (FCC) to improve to roughly 3.0x in 2019 through a combination of SSNOI growth, incremental NOI from development stabilizations and lower interest costs due to refinancing. The company's FCC was 2.2x for the quarter ended Sept. 30, 2016. Fitch defines FCC as recurring operating EBITDA, excluding non-cash revenues and including recurring cash distributions from joint ventures (JVs), less maintenance capex over cash interest incurred. FEWER CAPITAL AVENUES AVAILABLE Fitch views CLI's access to attractively priced public equity and debt as limited, based on the 4% market implied discount to NAV and yield for its shares and unsecured bonds. However, Fitch believes the company retains adequate access to competitively priced debt capital from unsecured bank term loans, as well as mortgage debt capital for select higher value unencumbered assets. During January 2017, CLI refinanced and extended its $600 million unsecured revolving credit facility, entered into a $325 million delayed draw unsecured term loan and placed a $100 million mortgage on one of its multi-family communities located in Revere, MA. The company also redeemed the remaining $135 million of its outstanding bonds scheduled to mature in August of 2019 and repaid a series of loans totaling approximately $200 million of high rate mortgage debt. CLI has a handful of illiquid, legacy non-income producing assets that the company could monetize. However, successful execution and/or timing is uncertain, as is the use of proceeds. Fitch has not included these as sources in its base case liquidity analysis. The company's land/parking lot at 4 Harborside in Jersey City is a key example. CLI is pursuing a development JV with SJP Properties to build a 1.2 million office property on the site. This assumes the JV can attract an anchor tenant. CLI's equity contribution to the JV would likely be limited to its $75 million land basis. The company could also raise capital through the sale of its subordinated JV interests, primarily legacy positions inherited through its acquisition of multifamily developer Roseland. CLI has been unwinding its subordinated JV interest through sales and conversions to "participating" interests whereby the company received a share of the ongoing cash flows. However, the latter could result in a use of capital, depending on how the deal is structured. CLI expects units owned through subordinated interests to decline to 1,235 during 2018. As of Sept. 30, 2016 RRT's subordinate interest portfolio was reduced to 1,963 apartments (a 35%reduction). RRT will continue to focus on this objective with a target year-end 2016 goal of 1,235 apartments (representing a year over year reduction of 59%). In addition to operating conversions, CLI increased ownership to 100% across five parcels in Port Imperial and in East Boston. RECENT FINANCINGS IMPROVE LIQUIDITY CLI's sources of liquidity fall short of uses by approximately $400 million resulting in 0.7x liquidity coverage under Fitch's liquidity analysis for the period from Oct. 1, 2016 to Dec. 31, 2018. The company's liquidity coverage improves to 1.0x on a pro forma basis for the company's post 3Q'16 financing discussed above. Fitch's base case assumes that CLI funds its liquidity shortfall with $150 million of third-party equity raised at its Roseland Realty Trust subsidiary and incremental asset sales and asset encumbrances. CLI's pro-forma liquidity coverage improves to 1.5x assuming it refinances 80% of its secured mortgage maturities through 2017. The size and quality of CLI's unencumbered asset pool has arguably decreased during the last year. The majority of properties CLI sold during 2016 were unencumbered, including some of the portfolio's better quality assets located in non-core markets, including its Manhattan and two Washington, D.C. properties. The company has acquired new unencumbered assets in core markets, such as Metropark and Hoboken, NJ. CLI's secured debt as a percent of total debt increased to 43% at Sept. 30, 2016 from 34% at Dec. 31, 2015. Mack-Cali has a low 38.5% dividend payout ratio of its adjusted funds from operations (AFFO) for the quarter ended Sept. 30, 2016, resulting in approximately $60 million to $80 million of retained cash that supports the company's liquidity position. CREDIBLE PLAN FACES HEADWINDS CLI has narrowed its office portfolio focus to include primarily four New Jersey markets, including the Jersey City Waterfront, Metro Park, Short Hills and Monmouth County. These markets generally sustain above average occupancy rates, rents above $35 per square foot (sq. ft.) for Class A space and access to mass transit, characteristics that support continued strong performance relative to all New Jersey office markets. CLI plans to winnow down its office portfolio to 20 million sq. ft. (including 5 million sq. ft. of flex office space) from 25 million sq. ft. The company has sold $465 million of assets as of Sept. 30, 2016, including its holdings in Manhattan, Washington, D.C. and suburban Maryland, as well as a handful of non-core New Jersey office assets and one apartment property in Andover, MA. CLI had contracts out for $265 million of additional office sales at the end of 3Q'16. It has reinvested a portion of the proceeds from asset sales into new office assets in core markets, including purchases in Hoboken and Metro Park New Jersey. CLI has also strengthened its multifamily rental residential platform starting new, predominantly wholly-owned developments and exiting and/or replacing complex subordinate JV interests with "heads up" participating partnership interests. In January 2016, the company consolidated its residential holdings into a new subsidiary REIT called Roseland Residential Trust. Challenging New Jersey office market fundamentals provide execution risk to CLI's repositioning plan, recent progress notwithstanding. Fitch expects New Jersey office fundamentals will remain a headwind given the state's relatively inhospitable business environment that includes high labor and living costs, as well as regulatory and tax burdens. Employment growth has been lackluster in New Jersey during the past decade, partly due to consolidation in the telecom and pharmaceutical industries, which has caused some jobs to be eliminated or leave the state. Nevertheless, Fitch's ratings case projections assume the company's GAAP SSNOI increases at mid-to-low single digit rates between 2017 and 2019, based on occupancy gains and strong double digit positive GAAP leasing spreads. Fitch is also less optimistic regarding some of the plan's underlying assumptions. Amenity enhancements at select suburban office properties should allow CLI to take leasing market share and help stabilize portfolio occupancy, resulting in higher property operating income. However, the agency lacks conviction that tenants will pay premium rents for greater amenities given high submarket vacancy rates and an uncertain competitive response from other New Jersey office landlords. Separately, Fitch views the company's goals for the retail at its New Jersey waterfront office assets as ambitious relative to the $25 million estimated capital investment. SOME OPERATIONAL GREEN SHOOTS CLI's portfolio operating metrics during the three and nine months ended Sept. 30, 2016 showed improved occupancy rates and rent spreads. Same-store NOI grew by 2.9% and 5.5% year-over-year on a cash and GAAP basis, respectively during the third quarter. Revenues rose 5.8%, helped by a 100 bps improvement in same-store occupancy. Expenses grew by 6.3%. Same-store NOI grew by 4.3% and 8.6% year-over-year on a cash and GAAP basis, respectively during the nine months ended Sept. 30, 2016. Revenues rose 3.8%, helped by a 100 bps improvement in same-store occupancy. Expenses declined by 2.7% during the period. GAAP office leasing spreads were positive 9.1% during 3Q'16, based on 16.2% spreads on new leases and 8.3% for renewals. Comparable metrics for the nine months ended Sept. 30, 2016 were 19.3%, 8.4% and 20.2%, respectively. KEY ASSUMPTIONS Fitch's key assumptions within its rating case for the issuer include: --CLI's office platform GAAP SSNOI grows at a mid-single digit rate through 2019 based on a combination of occupancy gains and positive double digit GAAP rent spreads; --The company successfully stabilizes its multifamily developments on schedule and at yields in the mid-6% range; --CLI re-loads its multifamily development pipeline with a similar amount of new development starts as communities under construction are delivered and stabilized through the 2019 projection period; --The company continues to encumber properties to help fund its development and refinancing requirements; --Fitch has not assumed that CLI sells its flex office/industrial portfolio during 2018 and uses the proceeds to de-lever, a possibility that CLI management has publicly discussed. RATING SENSITIVITIES Although Fitch does not anticipate positive rating actions in the near to medium term, the following factors could result in positive rating momentum: Fitch's expectation of leverage sustaining below 7x (leverage was 7.5x for the annualized quarter ended Sept. 30, 2016); Fitch's expectation of fixed charge coverage sustaining above 2x (coverage was 2.0x for the TTM ended Sept. 30, 2016); Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining above 2x, assuming no material change in the quality of the unencumbered pool due to sale of best relative assets. The following factors may result in negative rating momentum: --A sustained liquidity shortfall and/or deterioration in the breadth and depth of capital access; --Fitch's expectation of leverage sustaining above 8x; --Fitch's expectation of fixed charge coverage sustaining below 1.5x. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Mack-Cali Realty Corporation --IDR at 'BB+'. Mack-Cali Realty, L.P. --IDR at 'BB+'; --Unsecured revolving credit facility at 'BB+'/'RR4'; --Senior unsecured term loans at 'BB+'/'RR4'; --Senior unsecured notes at 'BB+'/'RR4'. Fitch has also assigned a 'BB+'/'RR4' rating to Mack-Cali Realty, L.P.'s $325 million delayed draw unsecured term loan due 2020. The Rating Outlook is Stable Contact: Primary Analyst Stephen Boyd, CFA Senior Director +1-212-908-9153 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Ronald Nirenberg Director +1-212-612-7747 Committee Chairperson Steven Marks Managing Director +1-212-908-9161 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. 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