Fitch Affirms Health Care REIT's IDR at 'BBB'; Outlook Stable
by Business Wire
Fitch Ratings has affirmed the credit ratings of Health Care REIT, Inc. (NYSE: HCN) as follows:
--Issuer Default Rating (IDR) at 'BBB';
--$2.25 billion unsecured revolving credit facility at 'BBB';
--$754 million senior unsecured term loans at 'BBB';
--$5.4 billion senior unsecured notes at 'BBB';
--$494 million senior unsecured convertible notes at 'BBB';
--$1 billion preferred stock at 'BB+'.
The Rating Outlook is Stable.
The affirmation reflects HCN's broad healthcare real estate platform that generates largely predictable cash flow predominantly from private pay sources in markets with strong demographics. The company has projected fixed charge coverage and leverage that are appropriate for a 'BBB' rated healthcare REIT. HCN also has good access to capital and a solid liquidity position, including contingent liquidity from unencumbered assets, and a strong management team. Credit concerns center on operational volatility associated with the company's REIT Investment Diversification and Empowerment Act of 2007 (RIDEA)-related investments and modest operator concentration.
Predictable Cash Flow
Limited lease rollover risk and structural protections embedded in HCN's management agreements underpin portfolio cash flow stability. HCN's lease expiration schedule is well-laddered with fewer than 7% of leases expiring annually (excluding the seniors housing operating portfolio). In addition, master leases and/or cross-collateralization arrangements with seniors housing and healthcare facility operators minimize operators' ability to selectively renew management agreements for higher performance assets. Approximately 80% of the portfolio is in coastal markets and the top 31 metropolitan statistical areas based on data from The National Investment Center for the Seniors Housing & Care Industry.
Same-store net operating income (NOI) growth has been solid in a range from 3.5 on a quarterly basis since fourth quarter 2010 (4Q'10). Growth was 3.6% in 3Q'12, led by the seniors housing operating portfolio at 7.0%. The senior housing triple-net portfolio represents 29.2% of NOI as of 3Q'12, skilled nursing represents 27.0%, seniors housing operating 18.1%, medical office 17.1%, hospital 6.3%, and life science 2.1%. However, subsequent to the closing of the Sunrise Senior Living, Inc. portfolio acquisition (Sunrise), seniors housing operating is expected to rise above 30% of NOI.
Fixed-charge coverage for the trailing 12 months ended Sept. 30, 2012 was 2.5x, which is appropriate for the rating, compared with 2.4x in 2011 and 2.8x in 2010. Fitch defines fixed-charge coverage as recurring operating EBITDA including Fitch's estimate of recurring cash distributions from unconsolidated entities less recurring capital expenditures divided by total interest incurred and preferred dividends. Fitch projects that coverage will surpass 3.0x over the next 12-to-24 months, driven by solid projected mid-single-digit same-store performance for the seniors housing operating portfolio and low-single-digit average growth for the rest of the portfolio through 2014, coupled with incremental cash flow from new investments. In a more adverse case than anticipated by Fitch, coverage could decline below 2.5x, which is more commensurate with a 'BBB-' rating for a healthcare REIT.
Leverage Expected to Rise
Net debt to trailing 12-month recurring operating EBITDA was 5.0x as of Sept. 30, 2012. However, leverage is expected to rise toward 6.0x on a normalized basis, which is appropriate for the 'BBB' rating, as proceeds from the November 2012 bond offering and January 2013 term loan were used to fund acquisitions, including a portion of the Sunrise portfolio acquisition in January 2013. In a more adverse case than currently anticipated by Fitch, leverage could rise above 6.5x, which is more appropriate for a 'BBB-' rating for a healthcare REIT.
Strong Access to Capital and Adequate Liquidity
HCN raised approximately $6 billion of capital in 2012 including unsecured bonds, unsecured term loans, follow-on common equity and preferred equity. The company also upsized its credit facility while increasing the term and lowering the rate, attesting to solid lender support. HCN's liquidity position pro forma for recent capital transactions and the closing of a portion of the Sunrise acquisition is adequate, with total sources of liquidity exceeding uses by 1.2x for the period Oct. 1, 2012 to Dec. 31, 2014. Sources of liquidity include unrestricted cash, unsecured credit facility availability and projected retained cash flows from operating activities after dividends and distributions. Uses of liquidity include debt maturities including put options on senior unsecured convertible notes, projected recurring capital expenditures and projected development expenditures. Liquidity coverage would improve to 1.7x if 80% of secured debt is refinanced.
The company benefits from a staggered debt maturity schedule. Pro forma for recent capital raises, the company has only 15.2% of total debt maturing through 2014 and no more than 20% of total debt maturing in any given year through 2018. HCN also has good contingent liquidity. Unencumbered assets (unencumbered annualized 3Q'12 NOI divided by a stressed 9% cap rate) to unsecured debt centered on 2.2x, which is appropriate for the 'BBB' rating.
RIDEA Exposure and Limited Reimbursement Risk
The portfolio exhibits the potential for increased cash flow volatility from recent acquisitions in RIDEA operating partnerships. RIDEA NOI represented 18.1% of total annualized 3Q'12 NOI, but is expected to exceed 30% of NOI subsequent to the closing of the remainder of the Sunrise acquisition in July 2013. Fitch views the increase as a moderate credit concern, as increased cash flow volatility is partially mitigated by the quality of the assets and the favorable near-to-medium term fundamental outlook for seniors housing.
Approximately 80% of portfolio NOI is derived from private pay sources, pro forma for the Sunrise acquisition. Therefore, the company faces limited reimbursement and regulatory risk, exemplified by the 11.1% reimbursement cut to skilled nursing facilities mandated by the Centers for Medicare and Medicaid Services (CMS) in fiscal 2012. The reimbursement cut was the primary reason for cash flow coverage of skilled nursing facilities tenants to drop to 1.84x for the nine months ended Sept. 30, 2012, from 2.22x in FY2011. Healthcare operators will continue to face reimbursement challenges, especially given government budget issues.
Moderate Tenant Concentration
As of Sept. 30, 2012, Genesis HealthCare, LLC was the largest tenant, representing 15.4% of invested capital, evidence of moderate tenant credit risk. However, this is mitigated by the solid performance of the Genesis portfolio, which is located in attractive high barrier-to-entry Northeast and mid-Atlantic markets, and the cross-collateralized lease structure.
Strong Management Team
HCN's management team has successfully managed the rapid growth of the company while maintaining solid credit metrics and portfolio performance. The company has demonstrated a commitment to pre-funding acquisitions in a leverage neutral manner for the benefit of unsecured bondholders.
The Stable Rating Outlook centers on HCN's normalized credit metrics that are appropriate for the rating coupled with strong liquidity and access to capital. In addition, Fitch expects healthcare real estate to continue to benefit from positive demographic trends and limited new supply.
Preferred Stock Notching
The two-notch differential between HCN's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB' IDR. These preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
What Could Trigger a Rating Action
The following factors may result in positive momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (3Q'12 coverage was 2.5x);
--Fitch's expectation of leverage sustaining below 5.5x (3Q'12 leverage was 5.0x, but is expected to normalize in the high 5.0x range);
--Fitch's expectation of unencumbered assets to unsecured debt based on a 9% capitalization rate sustaining above 3.0x (this metric was 2.2x as of Sept. 30, 2012).
The following factors may result in negative momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.5x;
--Fitch's expectation of unencumbered assets to unsecured debt sustaining below 2.0x;
--Base case liquidity coverage sustaining below 1.0x (this metric was 1.2x as of Sept. 30, 2012).
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:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012);
--'Recovery Rating and Notching Criteria for REITs' (Nov. 12, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012).
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis