NEW YORK--(BUSINESS WIRE)--Fitch Ratings has removed HCP, Inc. from Rating Watch Negative and affirmed the company's Issuer Default Rating (IDR) and debt ratings at 'BBB'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The 'BBB' IDR and Stable Outlook reflect Fitch's expectation that HCP's leverage and liquidity will stabilize pro forma following its spin-off of HCP's HCR ManorCare Inc.'s (HCR) real estate into Quality Care Properties (NYSE:QCP). The recently completed $1.75 billion debt issuances by QCP and subsequent dividend to HCP, along with significant progress on dispositions resolve the uncertainty and execution risk that the previous Rating Watch Negative captured.
Round-trip, Fitch views the HCR investment as having been a distraction to management and a headwind against relative access to capital over the past few years. The lease amendment in 2015 and the QCP spin-off in 2016 will have increased leverage by approximately 1x. HCP will be a predominantly private-pay healthcare REIT focusing on senior housing, medical office and life science with some debt and hospital investments pro forma for its permanent separation from HCR.
LEVERAGE TO SUSTAIN IN LOW 6x RANGE
Fitch projects that leverage will sustain in the 6x - 6.5x range in 2017 and 2018 pro forma for announced dispositions and assuming $750 million per year of acquisitions. Fitch views leverage sustaining between 6x - 7x as being appropriate for the 'BBB' rating. Leverage could migrate lower depending upon acquisition volumes and funding mix, though Fitch expects the issuer's primary focus will be demonstrating accretive growth to shareholders. This compares to leverage in the high-4x to mid-5x range in 2012 through 2014 before the lease amendment and spin-off. Fitch projects fixed-charge coverage (FCC) will sustain in the mid-to-high 3x range through 2018, which is strong for the 'BBB' rating and comparable to prior years (3.5x in 2015 and 3.8x in 2014).
AMPLE LIQUIDITY WHILE RE-ESTABLISHING ITSELF WITH INVESTORS
HCP will have ample liquidity to retire maturing debt obligations through 2018 which provides it time to re-establish itself with debt and equity investors. HCP has not issued non-bank debt or issued equity since late 2015. Fitch views HCP as having weaker access to capital relative to its higher rated peers, which is another factor driving the ratings differential, and Fitch does not expect this will change meaningfully through the rating horizon. However, the differential should stabilize, if not improve, given the removal of the HCR overhang and return to growth.
HCP will receive approximately $1.7 billion as a dividend from QCP, which recently completed its debt issuance along with at least $700 million of additional proceeds from announced dispositions on a net basis. These proceeds, when combined with unrestricted cash, availability under the $2 billion revolving credit facility due 2018 and Fitch's estimate of pro forma retained cash flow from operations after dividends, cover uses by 1x assuming no access to external capital for the period July 1, 2016 through Dec. 31, 2018. Fitch considers uses to be debt maturities, development expenditures, maintenance capital expenditures and announced acquisitions. Fitch's projections assume HCP will return to the unsecured debt capital markets in 2017 to re-establish itself with investors and fund growth.
HIGHER QUALITY PORTFOLIO BUT COST OF CAPITAL INFLUENCES COMPETITIVE POSITION
HCP's portfolio will be of a higher quality going forward focusing on senior housing (54% of net operating income), life science (21%) and medical office buildings at 19%. Government reimbursement risk will decline with NOI backed by private-pay sources comprising approximately 95% of revenues. While improved, Fitch expects management will look to resolve or dispose of assets with thinner coverage (e.g. the Brookdale assets, certain debt investments in the United Kingdom) and to reduce tenant concentration.
Fitch believes there is some risk that HCP will be incentivized to acquire weaker assets or ones with more execution risk (i.e. higher yielding) as it is pressured to demonstrate growth while at a competitive disadvantage to do so given its relative cost of capital. Cost of capital is a key differentiator between healthcare REITs given their acquisitiveness. Fitch expects HCP's cost of debt and equity capital will remain higher than its peers as a result of weaker metrics, lower ratings and the uncertainty surrounding operating and financial policies until the permanent management team is finalized.
CONTINGENT LIQUIDITY TO REMAIN BELOW AVERAGE
Unsecured bondholders will be supported by less contingent liquidity after the spin-off and asset sales as the HCR portfolio was one of the largest contributors of wholly-owned unencumbered net operating income. Fitch estimates that unencumbered assets (assuming a stressed 8% - 10% cap rates) will cover unsecured debt by 1.4x - 1.7x pro forma. This compares to 1.7x - 2.2x at Dec. 31, 2015 and from 2x - 2.4x before the rent reduction earlier in 2015. HCP's contingent liquidity will likely sustain below the 2.0x typically carried by investment grade REITs. Unencumbered assets are REITs' primary sources of contingent liquidity to raise proceeds via a sale or pledge against during a time of stress. Moreover, this metric may fluctuate depending on the extent to which HCP uses joint ventures.
EVOLVING MANAGEMENT TEAM
HCP will have new leadership at the CEO, CFO and CIO positions once a permanent CEO is hired. Fitch recognizes the potential for new leadership to change strategic goals and financial policies but expects the Board of Directors will have an active role given the continuity in financial policies during prior management changes. Fitch expects HCP's initial investments will receive more scrutiny than its peers' from debt and equity investors. Highly successful or unsuccessful outcomes may play an outsized role in shaping investors' perception of the company, its deal sourcing and underwriting expertise and, as a result, its access to capital.
Fitch generally views the additions of J. Hutchens (CIO) and K. Hsiao (EVP - Senior Housing) favorably given their prior roles at operating companies (COO of Emeritus Corporation and CEO of Holiday Retirement, respectively) considering the higher degree of interconnectedness between healthcare REITs and their tenants than other REIT sectors. Prior leadership at HCP came from banking, commercial real estate services and life science / office backgrounds.
KEY ASSUMPTIONS
Fitch's key assumptions within its rating case for the issuer include:
--Operating fundamentals remain favorable with low single digit growth in same-store net operating income despite supply in some senior housing markets;
--The issuer completes the QCP spin-off and announced dispositions;
--The issuer manages acquisition volumes and capital markets activity to sustain leverage between 6x-6.5x;
--The issuer's access to debt and equity capital improves but remains below prior levels and peers.
RATING SENSITIVITIES
The following factors may result in positive momentum for the ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 6x;
--Fitch's expectation of HCP restoring its access to unsecured debt and equity capital to levels consistent with years prior to 2016 and consistent with higher rated peers.
The following factors may result in negative momentum for the ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 7x;
--Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining below 2x;
--Fitch's expectation of HCP having weak absolute or weaker relative access to capital than its peers.
FULL LIST OF RATING ACTIONS
Fitch has removed from Rating Watch Negative and affirmed the following ratings:
HCP, Inc.
--Long-Term IDR at 'BBB';
--Unsecured bank credit facility at 'BBB';
--Unsecured term loans at 'BBB';
--Senior unsecured notes at 'BBB'.
The Rating Outlook is Stable.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock based compensation and include operating income from discontinued operations.
--Historical recurring operating EBITDA referenced in prior press releases calculated DFL income on a cash basis rather than GAAP increasing leverage by 0.2x to 0.3x. This adjustment became less relevant when HCP began to report the HCR DFL on a cash basis;
--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $25 million of cash for working capital purposes which is otherwise unavailable to repay debt.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013892
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013892
Endorsement Policy
https://www.fitchratings.com/regulatory
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT 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.
Copyright (c) 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.