NEW YORK--(BUSINESS WIRE)--Fitch Ratings has revised the Rating Outlook for Forest City Enterprises, Inc. (NYSE: FCEA, NYSE: FCEB, collectively FCE) to Positive from Stable. Fitch has also assigned ratings to the newly formed Forest City Realty Trust, upgraded the secured bank revolving credit facility to 'BB', and assigned Recovery Ratings as detailed at the end of the release.
KEY RATING DRIVERS
The Positive Outlook reflects Fitch's expectation that while Forest City's expected real estate investment trust (REIT) conversion and subsequent distribution requirements will reduce corporate liquidity, completed and forecast deleveraging has been significant and will be consistent with a 'BB' Issuer Default Rating (IDR) over the next 12-to-24 months. The ratings also consider the quality and durable operating performance of FCE's portfolio, offset in part by its structural complexity and significant development projects which weigh on corporate liquidity.
REIT CONVERSION REDUCES LIQUIDITY; INSTILLS LEVERAGE CONSERVATISM
Fitch generally views the REIT structure as a credit negative relative to an identical real estate operating company (REOC) because distribution requirements limit the extent to which an issuer can retain operating cash flow, and thus reliance on consistent access to the capital markets is a more important rating factor. As such, the conversion in and of itself is a credit negative. However, Fitch attributes FCE's recent and expected deleveraging and simplifying efforts to the conversion and believes the REIT structure will be a catalyst for conservatism for the issuer, relative to past years.
Forest City has meaningfully reduced its leverage over the past three years. Fitch calculates leverage was 8.1x for second quarter 2015 (2Q15) on a consolidated basis, down from 12.9x for fiscal year (FY) 2011 (trailing 12 months ended Jan. 31, 2011). The improvement has been driven in large part by the exchange of senior unsecured debt for common stock, a sizable common stock issuance and equity raised through the contribution of assets to joint ventures. Unsecured debt totaled only $272 million at June 30, 2015 pro forma for the exchange of convertible notes subsequent to the end of the period, compared to $1.1 billion at Jan. 31, 2013.
Given the issuer's increasing use of consolidated and unconsolidated joint ventures and the fact that the issuer monitors its leverage on a pro-rata basis, Fitch will increasingly look to pro-rata metrics rather than consolidated. Pro-rata leverage was 9.3x at June 30, 2015 pro forma, down from 11.6x for FY 2011. The issuer has publicly targeted reducing leverage by another 1x-2x, and Fitch's forecasts indicate leverage stabilizing at least at the current levels is likely and further improvement is achievable. While FCE's headline leverage is below Fitch's sensitivity for positive momentum, Fitch is awaiting stabilization, because metrics tend to be volatile given the fluidity of assets in and out of the consolidated financial statements and timing given the magnitude of realized and planned asset sales.
Fixed-charge coverage (FCC) has also made similar improvements to 1.6x for 2Q15 on a pro-rata basis up from 1.1x, 1.2x and 1.5x for the years ended Jan. 31, 2013, Dec. 31, 2013 and Dec. 31, 2014. Fitch does not project as meaningful improvements in FCC as FCE has historically had high maintenance capital expenditures that reduced FCC. Nonetheless, FCC is and is expected to remain appropriate for a 'BB' IDR. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA. Fitch defines FCC as recurring operating EBITDA less maintenance capital expenditures and straight-line rent to total interest.
HIGH-QUALITY, IDIOSYNCRATIC PORTFOLIO DRIVES PERFORMANCE
Since its founding, FCE has grown its expertise in developing large, mixed-use master planned communities, notably those in densely populated markets. Net operating income (NOI) was well-diversified by segment (35% office, 27% retail, 27% multifamily, and the remainder military housing and land) and located in strong markets (35% in New York City with Washington, D.C., Denver, Los Angeles, Boston, San Francisco and Chicago each comprising 3%-10%).
FCE's operating performance has been strong both on an absolute basis and relative to its underlying markets and select public peers, evidencing durable operating cash flows. The segment diversification further enhances the durability of FCE's overall cash flows. FCE's same store (SS) NOI growth averaged 2.3% from 2003 through 2014 and FCE weathered the recent downturn with only a single-year decline of 0.8% in 2009. SSNOI growth accelerated in 2014 to 4.8% and has sustained there YTD. Fitch expects SSNOI growth will be in the mid-single digits over the next 12-24 months driven by positive leasing spreads and incremental occupancy gains.
JOINT VENTURES REDUCE DEVELOPMENT RISK
The company has a proven capacity to acquire, aggregate and entitle adjoining plots of land and to work with local municipalities, community groups and government agencies to receive requisite approvals and tax credit financings. Since Fitch assigned initial ratings, FCE entered into two joint ventures that materially reduce the company's funding requirements for development going forward. In the fourth quarter of 2012 (4Q12), FCE entered into a partnership with the Arizona State Retirement System (ASRS) for a $400 million equity fund that invests in multifamily development projects.
In 4Q13, FCE entered into an agreement to develop the remainder of Pacific Park Brooklyn (fka: Atlantic Yards) through a joint venture (JV) with Greenland Group (70% ownership). The use of a JV to complete this project is largely a credit positive as it materially reduces FCE's share of remaining equity requirements. Further, FCE will be responsible for a smaller aggregate amount of non-recourse construction financing than if developed 100% on balance sheet. However, Fitch notes that only 'Special Major Decisions' need be approved by at least one member from both Greenland and Forest City, potentially limiting FCE's control over the project.
MANAGEABLE DEBT MATURITIES DRIVE SUFFICIENT LIQUIDITY
Liquidity coverage of 1.0x is adequate for the rating for the period July 1, 2015 through Dec. 31, 2016. A corporate default is highly unlikely given full availability under the $500 million line of credit, $280 million of unrestricted cash pro forma for the subsequent conversion of portions of the convertible notes, and assuming a $25 million reserve for working capital purposes.
FCE's debt maturities are somewhat concentrated but appropriate for the rating with 28.6% of total debt maturities including pro rata share of non-recourse debt coming due in 2017. By design, recourse debt maturities are limited over the foreseeable future with less than $2 million (which is convertible) maturing before 2018.
Fitch defines liquidity as sources (unrestricted cash assuming $25 million is unavailable for working capital purposes, drawn but unspent construction financing, and availability under the $500 million revolving credit facility pro forma for the convertible note exchanges, the NS&E capital call and announced property sales) to uses (total debt maturities, recurring maintenance capital expenditures, completion of in-progress developments and an estimated E&P dividend for the REIT conversion). Fitch has not assumed FCE will retain any cash flow from operating activities after dividends as the company has not established its REIT dividend policies but notes that the issuer could retain some cashflow should its dividends be closer to the minimum required rather than to adjusted funds from operations.
UPNOTCHING AND RECOVERY RATINGS ASSIGNMENT
In accordance with Fitch's updated Recovery Rating (RR) methodology, Fitch is now providing RRs for issuers with IDRs in the 'BB' category. The RR of '2' for FCE's bank credit facility supports a rating of 'BB', or one notch above the IDR, resulting in the upgrade of the facility from 'BB-'. The 'RR2' reflects that it is structurally senior to the convertible notes and that despite being structurally second lien it should have better recovery prospects in the event of a default given its equity pledge on subsidiaries.
The RR of '4' for FCE's convertible notes supports a rating of 'BB-', the same as FCE's IDR, and reflects average recovery prospects in a distressed scenario.
POSITIVE OUTLOOK
The Positive Outlook reflects that the issuer's post-conversion targeted capitalization should be consistent with a 'BB' IDR though headline metrics will be volatile in the interim given the number of steps remaining (e.g. asset sales, non-core dispositions and margin improvement from organizational restructuring).
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
--FCE will convert to a REIT and complete the requisite transactions;
--FCE will maintain its lower leverage and continue to work toward lower levels;
--Operating performance will remain accommodative with SSNOI growth in the mid-single digits per year;
--FCE will not meaningfully increase its development exposure.
RATING SENSITIVITIES
The following factors may have a positive impact on the ratings and/or Outlook:
--The completion of the issuer's plans to delever and simplify, including asset sales and margin expansion resulting in headline metrics stabilizing at targeted levels;
--The maintenance of a sizable unencumbered asset pool;
--Fitch's expectation of leverage sustaining below 10x (leverage was 8.1x and 9.3x as of June 30, 2015 on a consolidated and pro rata basis, respectively, pro forma for the note exchanges subsequent to the end of 2Q15).
The following factors may result in negative momentum in the ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 13x;
--Fitch's expectation of fixed charge coverage sustaining below 1x (coverage was 1.9x and 1.6x for 2Q15 on a consolidated and pro rata basis, respectively);
--Material growth in on-balance-sheet development projects;
--A material investment in a non-real estate project or entity.
FULL LIST OF RATING ACTIONS
Forest City Enterprises, Inc.
--IDR affirmed at 'BB-'
--Secured bank revolving credit facility upgraded to 'BB' / RR2 from 'BB-';
--Senior unsecured convertible notes affirmed at 'BB-' and assigned a Recovery Rating of 'RR4'.
--Fitch has assigned an IDR of 'BB-' to Forest City Realty Trust.
Fitch has revised the Rating Outlook to Positive from Stable.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
Recovery Ratings and Notching Criteria for Equity REITs (pub. 18 Nov 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 25 Nov 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=991663
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=991663
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.