OREANDA-NEWS. Fitch Ratings has affirmed its 'BBB-' Issuer Default Rating (IDR) for Terreno Realty Corp. (NYSE: TRNO) and its operating partnership Terreno Realty LLC. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

Fitch's ratings take into account TRNO's portfolio concentration in strong markets, transparent industrial property-focused business model, experienced management, and credit metrics that are moderately strong for the rating. The potential for greater cash flow volatility stemming from market, asset and tenant concentration risk and possible missteps surrounding the company's value added acquisition-led growth strategy balance these credit positives. Also, the company has a less developed and shorter track record as an unsecured borrower.

The Stable Outlook reflects Fitch's expectation that TRNO will maintain credit metrics that are consistent with the 'BBB-' rating over the two-year Outlook horizon, as well as Fitch's view of near - to medium-term industrial property fundamentals.

Portfolio Concentrated in Strong Markets

Fitch expects TRNO's portfolio market fundamentals to outperform the U. S. average over the near - to medium-term, based on its superior demographics and barriers to new supply. The company's portfolio is located in six of the strongest U. S. industrial markets, characterized by vibrant and growing local and regional economies, favorable population and income demographics and meaningful barriers to new supply.

The above-average occupancies and rents in Terreno's markets highlight these strong fundamentals relative to the total U. S. industrial property base. Institutional investor and lender interest in TRNO's assets is likely above its peer average given the desirable market locations, thus supporting the company's contingent liquidity position.

Transparent Operating Strategy

Terreno's transparent, well-defined operating strategy is a credit positive. The company targets 100% fee simple ownership of industrial assets in six key logistics markets that include Northern NJ/NY (23.7% of annualized base rent [ABR]), D. C./Baltimore (22.8%), San Francisco (15.5%), Miami (15.4%), Los Angeles (12.1%) and Seattle (10.5%).

TRNO's strategy does not contemplate investments in ground-up development or unconsolidated joint venture partnerships (JVs). The absence of these items helps simplify the company's business model, improve financial reporting transparency and reduce potential contingent liquidity claims.

Fitch's ratings for TRNO include some flexibility for selective ground-up development at existing owned in-fill properties, as well as a limited amount of JVs if, for example only a partial interest in an attractive industrial portfolio in its markets was available for purchase.

Appropriate Credit Metrics

Fitch expects TRNO's leverage to sustain within a range of 6.0x-6.5x through 2019, on an adjusted basis that includes a full-year's contribution from external investment activity. TRNO's leverage was 5.9x for the TTM ending June 30, 2016, which is appropriate for the 'BBB-' rating. The company's leverage was 6.2x including 50% equity credit for its perpetual preferred stock in total debt.

Fitch expects the company's fixed-charge coverage (FCC) to improve moderately over the Rating Outlook horizon as the company stabilizes value-add acquisitions and achieves better leverage of its fixed costs as total assets grow. TRNO's FCC was 2.9x for the TTM ending June 30, 2016, compared to 3.2x and 3.1x for year ended Dec. 31, 2015 and 2014. Fitch's projections show the company's FCC improving to the mid-3.0x range through 2019.

The company has publicly committed to financial policies through the cycle that are consistent to moderately strong for a 'BBB-' rated REIT with TRNO's asset profile. These include maintaining net debt-to-recurring operating EBITDA below 6.5x and FCC above 2.0x. The company's dividend policy is to pay 100% of its taxable net income to its equity holders. Fitch expects TRNO's dividend payout ratio of AFFO to range between the mid-80% to mid-90% over the rating horizon, excluding stabilization capex related to value-add acquisitions.

Solid Liquidity Position

TRNO's sources of capital cover its uses by 3.3x for the July 1, 2016 to Dec. 31, 2017 period under Fitch's base case liquidity analysis. Full availability under the company's $200 million revolver, cash on hand and a modest amount of retained cash flow after dividends are the company's primary sources of liquidity. TRNO's liquidity improves to 3.9x under an alternative scenario where the company refinances 80% of its secured debt maturities. However, Fitch expects the company to repay mortgages at maturity with new unsecured debt and equity capital.

TRNO's base case liquidity was 2.3x for July 1, 2016 to Dec. 31, 2017 after adjusting for events subsequent to quarter-end, including $50 million of private placement unsecured notes and $6.1 million of contracted dispositions, which was offset by $8.2 million of completed acquisitions and $47.5 million under contract.

Although near-term maturities are modest, the company's debt ladder has elevated maturities in the 2020s, consisting of term loans and unsecured borrowings. Fitch expects the company to refinance the 2020 term loan ahead of its stated maturity, most likely with proceeds from new unsecured private placement notes. TRNO's longer-dated maturities should decline as a percentage of total debt as the company executes its value-add acquisition growth strategy.

TRNO's unencumbered assets cover its unsecured debt (UA/UD) by 2.6x using a direct capitalization approach of TRNO's annualized second quarter 2016 (2Q16) unencumbered net operating income (NOI) that assumes a stressed 8.75% through the cycle cap rate. Fitch expects the company's UA/UD to moderate to the low - to mid 2x range as it progresses in its unsecured borrowing strategy, which would remain appropriate for the 'BBB-' rating.

Experienced Management

TRNO has a strong management team with extensive industrial real estate and capital markets experience. Many of the company's key executives previously held high-level executive positions at AMB Property prior to its merger with ProLogis.

Portfolio Market and Tenant Concentration

Fitch expects the portfolio's asset and tenant granularity to improve as TRNO executes on its value-add acquisition-led growth strategy. However, we do not expect the company to expand beyond its six major markets. TRNO's concentrated portfolio strategy exposes it to idiosyncratic market and asset risks and could result in above-average property income volatility. Examples could include a regional economic downturn or loss of a significant tenant.

The company's small size and concentration in markets with higher per square foot industrial values relative to its peers has contributed to its below-average asset granularity. However, the multiple-building nature of many of its larger assets, as well as their infill locations help to offset the asset concentration risk.

Two markets - Northern NJ/NY and D. C./Baltimore - comprised 46.5% of the company's ABR as of June 30, 2016. Moreover, its 10 largest properties (at cost) accounted for roughly 35% of its total investment in real estate.

TRNO's top-20 tenants comprised 39.5% of ABR at June 30, 2016, which is more concentrated than the industrial REIT peer median of slightly more than 20%. Moreover, the company's largest tenant (FedEx Corp.) was 5.5% of its ABR versus a comparable peer median of approximately 2%. Fitch views the company's portfolio tenant concentration as a credit risk that could lead to greater cash flow volatility. However, the generally strong credit quality of its largest tenants and multiple leases with several of these tenants help balance the concentration risk.

Execution Risk in Value-Add Acquisitions

TRNO's external growth strategy centers on the acquisition and stabilization of industrial assets, primarily through some combination of lease-up and property redevelopment. Fitch generally views the value-add strategy as being inbetween 'core' investments and ground-up development in risk/return space. Value-add acquisitions can entail additional risk given less familiarity with an asset compared to the repositioning of existing owned assets. However, Fitch views TRNO management's extensive industrial property experience and the small dollar value and homogeneity of industrial assets as risk mitigants. The company has improved its portfolio occupancy to 92.7% from 81.2% at acquisition, demonstrating its ability to successfully stabilize value-add acquisitions.

Improving Unsecured Capital Access

Fitch continues to view TRNO as a less established unsecured bond issuer pending further private placement issuance. However, TRNO has raised $150 million of private placement unsecured notes since September 2015, including $50 million last July. This demonstrated access to private placement unsecured notes is an important milestone in the company's transition to a predominantly unsecured borrowing strategy.

Preferred Stock Notching

The two-notch differential between TRNO's IDR and 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.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for TRNO include:

--GAAP SSNOI growth in the 4% to 5% range through the 2018 projection period;

--Net acquisitions of roughly $200 million to $300 million through 2018;

--Annual unsecured issuance of between $50 million and $150 million at interest rates in the low-to-mid 4% range;

--Equity issuance of $100 million to $150 million per annum;

--The company unencumbers assets as mortgages mature with the proceeds from new unsecured debt and equity raises.

RATING SENSITIVITIES

The following factors may have a positive impact on the ratings and/or Rating Outlook:

--TRNO's demonstrated adherence to its financial policies during through the cycle given its value-add acquisition strategy, which could result in greater relative cash flow volatility;

--Fitch's expectation of leverage sustaining in the low 6.0x range (leverage was 5.9x for the TTM ended June 30, 2016);

--Fitch's expectation of FCC sustaining above 3.0x (coverage was 2.9x for the TTM ended June 30, 2016).

--Increased asset and tenant level diversification within the company's concentrated, six-market portfolio;

--Further demonstrated access to the unsecured bond market.

The following factors may have a negative impact on the ratings and/or Rating Outlook:

--Fitch's expectation of leverage sustaining above 7.0x;

--Fitch's expectation of FCC sustaining below 2.0x.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Terreno Realty Corporation

--Issuer Default Rating (IDR) at 'BBB-';

--Preferred stock at 'BB'.

Terreno Realty LLC

--IDR at 'BBB-';

--Senior unsecured revolving line of credit at 'BBB-';

--Senior unsecured term loan at 'BBB-';

--Senior unsecured private placement notes at 'BBB-'.

The Rating Outlook is Stable