Fitch Ratings has assigned a 'BBB-' rating to the $200 million term loan
due 2019 entered into by Healthcare Realty Trust Incorporated (NYSE:
HR). The loan bears interest at LIBOR plus 145 basis points. Loan
proceeds will be used to repay borrowings on the unsecured revolving
Fitch currently rates HR as follows:
--Issuer Default Rating (IDR) 'BBB-';
--Unsecured line of credit 'BBB-';
--Senior unsecured notes 'BBB-'.
KEY RATINGS DRIVERS
The ratings reflect the expectation for improving leverage and fixed
charge coverage metrics, offset in large part by weak contingent
liquidity and an adjusted funds from operations (AFFO) payout ratio near
The ratings also reflect the company's geographically diversified
portfolio, positive medical office fundamentals, strong liquidity and
manageable debt maturity schedule.
The Stable Outlook is based on Fitch's expectation that credit metrics
will continue to improve; however, positive momentum is restrained by
weak unencumbered asset coverage of unsecured debt. Thus, the overall
credit profile will remain consistent with a 'BBB-' rating.
STRENGTHENING CREDIT METRICS
Leverage was 6.9x and 6.6x for the year and quarter ended Dec. 31, 2013
as compared to 7.0x and 8.4x at year-end 2012 and 2011, respectively.
Fitch forecasts leverage will improve towards 6.5x through 2015, which
may be consistent with a higher rating all else being equal. Fitch
defines leverage as net debt to recurring operating EBITDA.
Fixed-charge coverage was 2.2x for the year ended Dec. 31, 2013,
compared with 1.9x and 1.6x during full years 2012 and 2011 and is
forecast to improve towards 2.4x through 2015. The amount and pace by
which leverage and fixed-charge coverage improves will be dictated in
large part by the lease-up of properties in stabilization. Fitch defines
fixed-charge coverage as recurring operating EBITDA less Fitch's
estimate of routine capital expenditures less straight-line rent
adjustments, divided by total interest incurred.
STRONG LIQUIDITY AND MANAGEABLE MATURITY SCHEDULE
Healthcare Realty's liquidity coverage ratio is strong for the rating
pro forma for the term loan at 5.9x for the period Jan. 1, 2014 to Dec.
31, 2015 and a key credit strength. The ratio is driven primarily by
HR's manageable and long-dated debt maturity schedule which does not
have a recourse debt obligation maturing until 2017. Fitch calculates
liquidity coverage as sources of liquidity (unrestricted cash,
availability under its unsecured revolving credit facility, projected
retained cash flows from operating activities after dividend payments)
divided by uses of liquidity (debt maturities, projected routine capital
expenditures and development and construction mortgage funding
The company's portfolio of predominantly on-campus, medical office
buildings (MOBs) is geographically diversified save for its exposure to
Texas (which comprised 29.6% of square footage at Dec. 31, 2013).
Following Texas were Tennessee (10%), Virginia (7.3%), Indiana (5.7%),
North Carolina (5.6%) and Colorado (5.2%), with no other state exceeding
5% of the total portfolio. The portfolio is also well diversified by
tenant with the top 10 tenants making up less than 31% of leased square
footage. Healthcare Realty's portfolio positions the company to benefit
from increasing demand for health care services, given Fitch's
expectation of continued growth in the health care industry due to
WEAK CONTINGENT LIQUIDITY
Offsetting these credit strengths is weak contingent liquidity.
Unencumbered asset coverage of net unsecured debt was 1.4x at Dec. 31,
2013. Fitch has previously stated that maintenance of unencumbered asset
coverage below 1.5x may result in negative momentum in the ratings
and/or Outlook. However, Fitch notes that incremental EBITDA from the
stabilization-in-progress (SIP) portfolio should improve the ratio
towards 1.6x, all else being equal. Ftch calculates asset coverage as
unencumbered trailing 12 month (TTM) EBITDA, divided by a stressed 9%
capitalization rate, divided by unsecured debt.
ELEVATED LEASE EXPIRATIONS
Over the past few years, several expiring master leases were converted
to operating leases with underlying tenants, driving a near-term
reduction to occupancy as the company became responsible for leasing up
the vacancy in those properties. Further, HR also faces significant
lease expirations in 2014 when 21% of revenues expire. Elevated lease
expirations reduce the certainty and durability of the cash flows that
support the rating. However, the development portfolio continued to make
progress leasing, ending 2013 at 80% leased (63% occupied), up from 46%
and 28%, respectively at the first quarter of 2012 (1Q'12).
AFFO PAYOUT RATIO ABOVE 100% IMPEDES CASH RETENTION
The aforementioned leasing challenges (i.e. development lease-up and
master lease expirations) have resulted in an AFFO payout ratio
consistently above 100%, which is a credit concern. Although HR modestly
covers its dividend on a funds from operations (FFO) basis (Fitch
adjusted) with a payout ratio of approximately 94% in 2013 and 92% in
2012, the dividend is not covered when based on Fitch's estimate of
AFFO. Fitch calculates AFFO as funds available for distribution less
certain adjustments and Fitch's estimate of recurring capital
expenditures (tenant improvements, leasing commissions and maintenance
capital expenditures). The payout ratio based on AFFO was approximately
107% in 2013 and 113% in 2012.
The earnings drag from the slow lease-up of properties in stabilization
contributes to this high payout ratio and limits Healthcare Realty's
ability to generate internal liquidity. In turn, HR needs 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
CREDIT METRIC VOLATILITY
The company has periodically funded acquisitions and development
initially with debt, prior to deleveraging over time principally through
equity issuances and/or the lease-up of development properties. As such,
leverage may periodically remain high and coverage may remain low. This
has increased risk, as the capital markets may be expensive or difficult
to access when needed or fundamentals may be challenging when
development properties need to be leased-up.
The Stable Outlook is driven by Fitch's expectation that HR's forecasted
improvements in leverage and fixed-charge coverage in excess of Fitch's
rating sensitivities are offset by weak contingent liquidity and
maintenance of an AFFO payout ratio above 100% (two rating sensitivities
that could result in negative momentum).
The following factors may have a positive impact on HR's ratings and/or
--Fitch's expectation of leverage sustaining below 7.0x (leverage was
6.9x as of Dec. 31, 2013);
--Fitch's expectation of fixed-charge coverage sustaining above 2.0x
(coverage was 2.2x for the TTM ended Dec. 31, 2013);
--Fitch's expectation of unencumbered asset coverage of unsecured debt
sustaining above 2.0x (coverage was 1.4x as of Dec. 31, 2013).
The following factors may have a negative impact on HR's ratings and/or
--Unencumbered asset coverage of unsecured debt sustaining below 1.5x;
--An AFFO payout ratio sustaining above 100%;
--Fitch's expectation of leverage sustaining above 8.0x;
--Fitch's expectation of fixed-charge coverage sustaining below 1.5x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors,' Feb. 26,
--'Recovery Ratings and Notching Criteria for Equity REITs,' Nov. 19,
--'Corporate Rating Methodology,' Aug. 5, 2013.
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage
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