Fitch Ratings assigns a credit rating of 'BBB-' to the $250 million aggregate principal amount 3.625% senior unsecured notes due 2023 issued by Highwoods Realty Limited Partnership, a subsidiary of Highwoods Properties, Inc. (NYSE: HIW). The notes are due Jan. 15, 2023, were issued at 98.9% of par and priced to yield 3.752%.
Highwoods expects to use the net proceeds to reduce amounts outstanding under the Company's $475 million revolving credit facility and for general corporate purposes.
Fitch currently rates Highwoods Properties as follows:
Highwoods Properties, Inc.
--Issuer Default Rating (IDR) 'BBB-';
--Preferred stock 'BB'.
Highwoods Realty Limited Partnership
--Long-term IDR 'BBB-';
--Unsecured revolving credit facility 'BBB-';
--Unsecured term loans 'BBB-';
--Senior unsecured notes 'BBB-.'
The Rating Outlook is Stable.
The 'BBB-' IDR reflects Highwoods' improved asset portfolio that is well-positioned in its core markets, a granular, strong credit quality tenant base, and manageable lease expiration and debt maturity schedules. These strengths are tempered by challenging office operating fundamentals in many of these markets, which have resulted in stagnant same-store NOI growth and difficult leasing conditions. This is evident by elevated capital expenditures and sustained negative cash rent spreads.
However, Fitch expects Highwoods' leverage and coverage metrics to remain appropriate for the rating over the next 12-to-24 months. The Stable Outlook considers Highwoods' adequate liquidity and access to capital and solid unencumbered asset coverage of unsecured debt, partially offset by Fitch's expectation of soft property-level fundamentals.
The economic recovery remains fragile, with the high unemployment rate continuing to adversely impact business prospects of many of Highwoods' current tenants, and general office space users. Highwoods' portfolio is focused primarily in the Southeast region, with the top four markets represented by Raleigh (16.3% of annualized cash revenue), Atlanta (15.2%), Tampa (12.8%) and Nashville (11.9%). The company has also continued to grow in the Pittsburgh market, which Fitch views favorably. The recent acquisition of EQT Plaza is consistent with management's strategy to expand the company's footprint in downtown Pittsburgh, which is expected to see above-average demand and robust fundamentals over the near to medium-term.
Highwoods' geographic focus, with exposure to some weaker markets with lower barriers to entry, has resulted in same-store NOI declines of 0.6%, 2.9% and 2.8% for 2011, 2010 and 2009, respectively. Operating performance has seen positive momentum more recently, however, with 5.4% same-store NOI growth in first quarter-2012 (1Q'12), 1.8% in 2Q'12 and 2.7% in 3Q'12. This was driven by an increase in same-store occupancy, which has seen sustained improvement to 90.4% at 3Q'12 from 90.0% at 3Q'11.
Occupancy improvement has been partially offset by continued rent declines. Office cash rollover rents declined 6% in 1Q'12, 6.3% in 2Q'12 and 9.7% in 3Q'12. This follows significant declines in 2010-2011 that ranged from 5% to 12.4%. Despite the decline, average cash rental rates for all in-place leases were flat year-over-year. This was driven by contractual rent escalators and recent acquisitions and dispositions, which have had a higher net effect on in-place rents.
Highwoods' portfolio benefits from solid tenant diversification. The top 10 tenants represent 21% of annual base rent (ABR) as of Sept. 30, 2012. In addition, the US Federal Government is the largest tenant, contributing 7.2% of ABR as of Sept. 30, 2012 (down from 8.9% at Sept. 30, 2011). Highwoods also has a well-laddered lease expiration schedule, with an average of 12% of annual base rent expiring in each of the next five years. This should mitigate the impact of further rent declines.
From 2006 - 2011, Highwoods underperformed in comparison to a selected group of office REIT peers by 40bps in same-store NOI performance and 130 bps in occupancy rates. However, Highwoods outperformed its markets on an average NOI basis (as followed by Property & Portfolio Research (PPR)) by nearly 100 bps for the same timeframe. Highwoods competes in markets with more private developers. This enables Highwoods to utilize its stronger liquidity and access to capital to attract and retain tenants. Few of the selected REIT peers own properties in the same markets as HIW.
Highwoods has solid fixed charge coverage levels despite same-store NOI deterioration since early 2009. Fixed charge coverage has declined to 2.1x for the twelve months ended Sept. 30, 2012 from 2.2x for full year 2009, but remains appropriate for the 'BBB-' rating. Fitch defines fixed charge coverage as recurring operating EBITDA less recurring capital expenditures, less straight line rent adjustments, divided by interest expense, capitalized interest, and preferred dividends.
Leverage (measured as net debt to trailing twelve months recurring operating EBITDA) was 5.7x as of Sept. 30, 2012, compared with 6.7x and 5.4x at Dec. 31, 2011 and 2010, respectively. Highwoods has made ample progress in de-levering since executing debt-financed acquisitions in Pittsburgh and Atlanta in late 2011. Leverage is appropriate for the 'BBB-' rating and is expected to remain so during the forecast period. Highwoods uses a prudent combination of asset sales, common equity and unsecured debt to finance growth and repay debt maturities.
Fitch views Highwoods' elevated adjusted funds from operations (AFFO) payout ratio as a credit concern given it has paid out more than 100% of AFFO in common dividends since 2010. Highwoods maintained the dividend level through the downturn while also electing to pay the common dividend entirely in cash, rather than utilize a combination of cash and stock.
Additionally, difficult leasing conditions in HIW's markets have led to elevated recurring capital expenditures, which have pressured AFFO. This high payout limits Highwoods' ability to generate internal liquidity. In turn, it will result in Highwoods needing to draw on its credit facility or source other forms of liquidity to fund a portion of the common dividend. An AFFO payout ratio in excess of 100% is inconsistent with an investment-grade rating and could have negative rating implications.
The Stable Outlook reflects Fitch's view that Highwoods' credit metrics will remain in an acceptable range for a 'BBB-' rating. The Outlook also takes into account Fitch's expectation that Highwoods will maintain adequate liquidity and appropriate coverage of unsecured debt by unencumbered assets.
Pro-forma for the bond issuance, sources of liquidity (unrestricted cash, availability from Highwoods' unsecured revolving credit facility, projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (pro rata debt maturities and projected recurring capital expenditures) result in a liquidity coverage ratio of 1.6x for the period from October 1, 2012 through Dec. 31, 2014.
If Highwoods refinanced 80% of its secured debt due in the period, its liquidity coverage would be a strong 3.0x. In addition, Highwoods has a well-laddered debt maturity schedule with no unsecured debt maturities until the revolver in 2015. However, this facility may be extended at Highwoods option to 2016.
Highwoods has historically maintained strong coverage of unsecured debt by unencumbered assets. The implied value of unencumbered assets (calculated as unencumbered NOI divided by a stressed capitalization rate of 9%) covered unsecured debt by 2.1x as of June 30, 2012. Fitch deems this adequate for a 'BBB-' rating, though it has fallen since 2009 (when it was approximately 2.9x).
The two-notch differential between Highwoods IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch research on 'Treatment and Notching of Hybrids in Nonfinancial Corporates and REIT Credit Analysis' dated Dec. 15, 2011, these securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in a corporate default.
Fitch does not anticipate positive rating momentum over the near term. That said, the following factors may result in positive momentum on the ratings or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining above 2.25x (fixed charge coverage was 2.1x for the 12 months ended Sept. 30, 2012);
--Fitch's expectation of leverage sustaining below 5.5x (leverage was 5.7x as of Sept. 30, 2012);
--Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining above 2.5x (implied unencumbered asset value calculated as annualized unencumbered property NOI dividend by a 9.0% capitalization rate);
--Demonstrated consistent access to the unsecured bond markets;
--Maintaining a healthy liquidity surplus.
Conversely, the following factors may precipitate negative momentum on Highwoods' ratings and/or Outlook:
--Fitch's expectation of fixed charge coverage declining below 1.75x;
--Fitch's expectation of leverage increasing above 6.75x;
--A sustained decline in unencumbered asset coverage of unsecured debt below 2.0x;
--An AFFO payout ratio exceeding 100%.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug 8, 2012);
--'Recovery Ratings and Notching Criteria for Equity REITs' (May 3, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012);
--'Treatment and Notching of Hybrids in Nonfinancial Corporates and REIT Credit Analysis' (Dec. 15, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis