Fitch Rates Boston Properties' Senior Unsecured Notes Due 2026 'BBB+'; Outlook Stable
KEY RATING DRIVERS
BXP's superior portfolio asset quality, management and capital access support the ratings. The ratings also reflect BXP's adequate liquidity position that is supported by its large unrestricted cash balance, retained free cash flow, near full availability under its $1 billion revolving credit facility and its large unencumbered pool of high-quality assets in markets with excellent investment and financing liquidity characteristics.
The company's moderately concentrated geographical footprint and related exposure to finance, legal and government and defense industry tenants, which currently have relatively soft operating fundamentals, balance the ratings. Execution and liquidity risks associated with the company's development platform are also perennial credit elements.
SUPERIOR ASSET QUALITY
BXP owns a high-quality portfolio of predominantly class 'A' office properties located in supply-constrained central business district (CBD) markets. The company's CBD properties are often leading properties in their submarkets that compete for the highest-profile tenants, and have historically attracted significant investor and lender interest. The latter enhances BXP's contingent liquidity profile, including during challenging property and capital market environments.
APPROPRIATE LEVERAGE AND COVERAGE
Fitch expects BXP's leverage to be in the mid 5x-low-6x range through 2017, which is strong for a 'BBB+' rated office REIT with BXP's large size, superior portfolio asset quality and excellent track record of capital access and financial discipline. BXP has opportunistically sold assets to take advantage of strong investor demand for core properties in high-barrier markets and build liquidity for its development platform, which has helped drive the company's leverage lower.
Fitch's ratings for BXP assume that it will continue to manage leverage closer to its 6.5x-7.0x target through-the-cycle despite the projections of lower leverage through the rating horizon. Fitch views a large, opportunistic acquisition or additions to the development pipeline as the most likely causes for the company's leverage to move higher, although Fitch has not assumed them in its rating case forecast. BXP's net debt-to-recurring operating EBITDA for the trailing 12 months (TTM) was 5.3x as of June 30, 2016, and its annualized second-quarter 2016 (2Q16) leverage was 5.4x.
Fitch does not calculate BXP's metrics on a look-through basis for JVs. All of the company's pro rata unconsolidated JV debt is nonrecourse to BXP. Although BXP has contributed equity to right-size mortgages at times, it has also been willing to offer deeds in lieu of foreclosure on assets where it believes the value of the assets is permanently impaired below the value of the mortgage.
Fitch expects BXP's fixed-charge coverage will improve to the mid-to-high 2.0x range through 2017, aided by low-single-digit cash same store net operating income (SSNOI) growth, incremental NOI from new developments and interest savings from refinancing upcoming debt maturities. BXP's fixed-charge coverage was 2.4x for the TTM ended June 30, 2016. Fitch defines fixed charge coverage as recurring operating EBITDA, including recurring cash distributions from joint ventures, less straight line rents and maintenance capital expenditures and leasing costs, divided by interest incurred plus preferred dividends.
ADEQUATE LIQUIDITY
BXP maintains an adequate liquidity position. For the period July 1, 2016 to Dec. 31, 2017, the company's base case liquidity coverage ratio is 0.5x (0.7x pro forma for its $1 billion unsecured notes offering). BXP's liquidity coverage would improve to 0.9x (1.4x pro forma) assuming the company refinances maturing mortgages at 80% of current balances. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the company's unsecured credit facility, and expected retained cash flows from operating activities after dividends) divided by uses of liquidity (pro rata debt maturities, expected recurring capital expenditures, and development costs).
Fitch-estimated development spending of roughly $850 million (representing just over half of its $1.6 billion of unfunded development commitments at 2Q16) through the rating horizon is the largest anticipated use of capital in our stressed liquidity analysis. BXP likely has some flexibility to defer spending if market conditions weaken unexpectedly and materially. The company demonstrated its willingness to stop development (when possible) in response to changing market conditions when it capped its 250 W. 55th Street development at grade level during the last downturn.
BXP paid out approximately 71% of its adjusted funds from operations (AFFO) as dividends to common shareholders during 2Q16. The company has historically kept its pay-out ratio below 75% - a credit positive. BXP's policy is to pay the minimum 90% of taxable net income dividend required to maintain REIT status. As such, BXP retains approximately $180 million of cash flow per annum that can be used to meet its liquidity obligations including funding new investments and satisfying debt maturities.
EXCELLENT CONTINGENT LIQUIDITY
BXP holds a large, high-quality pool of unencumbered assets with well above-average financeability and saleability characteristics. As of June 30, 2016, BXP owned or had interests in 145 unencumbered assets that generate annualized cash NOI of approximately $1.189 billion, or 77.5% of its consolidated NOI. The company's unencumbered pool includes a number of trophy assets such as 399 Park Avenue and Times Square Tower in New York, Embarcadero Center One, Two, and Three in San Francisco, the Prudential Center complex in Boston (including three office towers, one of the most productive retail centers in the U. S., and a supermarket), and the Capital Gallery complex in Washington, D. C., among others.
BXP's unencumbered pool also benefited from the addition of the John Hancock Building in Boston when the mortgage encumbering the property was legally defeased in December 2015. The delivery and stabilization of BXP's high-quality development portfolio also will further bolster the company's unencumbered portfolio quality.
The company's unencumbered assets cover unsecured debt 3.2x based on a direct capitalization approach of unencumbered NOI using a stressed 7.5% capitalization rate. Fitch views this level of coverage as strong for the rating, and is one of the highest coverages in Fitch's rated universe. BXP has maintained UA/UD coverage between 2.6x-4.0x since 2009.
ELEVATED 2017 DEBT MATURITIES
Fitch views BXP's debt ladder as reasonably well balanced and manageable, notwithstanding the unusually high (24% of its pro rata debt) amount of debt that matures during 2017. The company has historically been able to go to market with sizable unsecured notes offerings to refinance its debt maturities, and $2.1 billion of $2.4 billion in 2017 maturities consists of mortgages which Fitch expects can be easily refinanced with secured debt as well.
The company's 2017 maturities are mostly secured property-level mortgages and, therefore pose limited risk to the corporate entities that Fitch rates. The majority ($1.3 billion; 54%) of its 2017 maturities relates to the company's 767 5th Avenue (GM Building) consolidated JV that Fitch expects will be refinanced with secured mortgage debt. The superior asset quality and conservative existing leverage on the asset limit the refinance risk.
BXP has entered into a handful of forward-starting interest rate swaps to lock in interest rates for a portion of its planned refinancings of the $750 million mortgage loan at 599 Lexington Avenue in New York (matures on March 1, 2017 and can be prepaid without penalty beginning in September 2016), as well as the $1.3 billion mortgage loan at 767 Fifth Avenue (matures on Oct. 7, 2017 but can be prepaid without penalty beginning in June 2017). BXP also plans on refinancing its remaining maturing mortgage loans that are not being targeted by its interest rate swap strategy in late 2016 and early 2017. Fitch expects the company to monitor opportunities to accelerate these financings, despite associated prepayment penalties.
BXP proactively renegotiated and expanded its unsecured revolving line of credit in July 2013 - well ahead of the prior line's June 2014 expiration - partly to ensure adequate liquidity to handle its large maturities in 2017. At that time, BXP increased the capacity on its line to $1 billion from $750 million and purposefully set the expiration date beyond its 2017 maturity wall at July 2018. The company also negotiated an expanded $500 million accordion feature as a potential source of additional contingent liquidity, up from $250 million previously.
TENANT INDUSTRY CONCENTRATION RISK
The company has a high proportion of financial, legal and government-related tenants in its portfolio. Tenants in these segments comprised approximately 27%, 24% and 4% of gross rent, respectively, for a combined total of 55% as of June 30, 2016. Lower trading volumes and increased regulation are causing companies to delay leasing decisions and in many instances have reduced space demand. Legal tenants continue to optimize their space needs and are often shrinking their office footprints when leases expire. Finally, the U. S. Government (BXP's largest tenant at 4% of gross rent) and related government contractors are demanding less space due in large part to the impact of sequestration, particularly in the Washington D. C. metro area.
DEVELOPMENT RISK
Development is a key component of BXP's strategy and the company has historically allowed its pipeline of projects under construction to become a large percentage of its portfolio on both a relative and absolute basis. For example, the pipeline grew to 20.3% of total undepreciated book assets in 2Q08, with the unfunded portion representing 11% of total assets.
The total estimated investment of BXP's development pipeline was $2.1 billion at June 30, 2016, which represented 9.2% of total assets, with the unfunded portion comprising a smaller 5.3% of total assets. Fitch would view cautiously a pipeline that grows close to 20% of total assets or approaching 10% of remaining funding, absent significant pre-leasing.
PREFERRED STOCK NOTCHING
The two-notch differential between BXP's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch's research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' 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.
STABLE RATING OUTLOOK
The Stable Outlook reflects Fitch's expectations that fixed-charge coverage and leverage will sustain at current levels over the next 12-24 months, but that the company will target higher through-the-cycle leverage of roughly 6.5x to 7.0x.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
SSNOI is flat - to slightly down during 2016 and grows at a low single-digit rate during 2017;
Development completions of $500 million and $400 million during 2016 and 2017, respectively;
G&A growth of 2% per annum through 2017.
RATING SENSITIVITIES
Although Fitch does not expect positive rating momentum, the following factors could result in an upgrade to BXP's ratings and/or Outlook:
Fitch's expectation of leverage sustaining below 6.0x for several quarters (leverage was 5.3x for the TTM ended June 30, 2016);
Fitch's expectation of fixed-charge coverage sustaining above 3.0x for several consecutive quarters (coverage was 2.4x for the TTM ended June 30, 2016).
Conversely, the following factors may result in negative momentum in the ratings and/or Outlook:
Fitch's expectation of net debt-to-recurring operating EBITDA sustaining above 7.5x;
Fitch's expectation of fixed-charge coverage sustaining below 2.0x;
A liquidity coverage ratio of below 1.0x.
FULL LIST OF CURRENT RATINGS
Boston Properties, Inc.
Issuer Default Rating (IDR) 'BBB+';
Preferred stock 'BBB-'.
Boston Properties, L. P.
IDR at 'BBB+';
Unsecured revolving credit facility 'BBB+';
Senior unsecured notes 'BBB+'.
The Rating Outlook is Stable.
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