OREANDA-NEWS. Fitch Ratings has assigned an initial Issuer Default Rating (IDR) of 'BBB' to American Assets Trust, Inc. and its operating partnership American Assets Trust, L.P. (collectively, AAT, American Assets Trust, or the company). A full list of Fitch's ratings for AAT follows at the end of this release. The Rating Outlook is Stable.

KEY RATING DRIVERS

The 'BBB' IDR reflects the company's credit strengths, which include a portfolio focus on high barrier-to-entry U.S. west coast markets that is expected to result in growing cash flow in excess of fixed charges, appropriate expected leverage for the 'BBB' rating, a good liquidity position, and long management track record. While most REITs tend to eschew property type diversification, AAT has aggregated a portfolio of retail, office, multifamily and mixed use assets. AAT's retail and office segments have outperformed the company's public office and retail REIT peers due to the sustained demand for AAT's properties, combined with limited supply.

Credit concerns include the company's exposure to below investment grade and unrated tenants, including the largest retail tenant, Kmart, which represented 6.2% of retail rent and 2.7% of total rent in 1Q2015. In addition, while AAT continues its evolution towards a more unsecured funding model, it has issued only three series of private placement bonds since its 2011 IPO.

High Barrier-to-Entry West Coast Focus

As of March 31, 2015, AAT's portfolio included 104 retail buildings (11 properties) totaling 3.1 million square feet, 26 office buildings (seven properties) totaling 2.7 million square feet as well as 922 multifamily units (four properties) and Waikiki Beach Walk, a retail/hotel mixed-use property in Honolulu. The company's core markets include San Diego (33.4% of 1Q2015 cash NOI), Oahu, Hawaii (24.8%), the San Francisco Bay Area (16.0%), Bellevue, Washington (9.7%) and Portland, Oregon (8.3%). Fitch has a more favorable view toward companies that own properties in high-barrier-entry markets such as San Francisco when compared with other markets, due to consistently strong asset liquidity and leveragability. Fitch conducted tours of selected properties owned by AAT in San Diego, Solana Beach, Monterey, and San Francisco, and found that the locations and good quality of AAT's assets should attract tenants and retain value over time.

Growing Fixed Charge Coverage

AAT's fixed-charge coverage was 2.6x in 1Q2015 pro forma for the issuance of the series C notes in April 2015 and repayment of The Landmark at One Market mortgage, up from 2.3x for the trailing twelve months ended March 31, 2015, 2.3x in 2013 and 1.8x in 2012. Fixed-charge coverage has improved due to cash basis SSNOI growth (5.7% in 1Q2015, 1.9% in 2014 and 4.8% in 2013), cash flow from the company's Torrey Reserve office development in San Diego, which was completed in 1Q2015 and is expected to achieve stabilization in 2015, and lower interest incurred.

Fitch projects that fixed-charge coverage will sustain in the 2.5x to 3.0x range over the next several years as AAT continues to refinance higher coupon debt with lower cost unsecured notes. For example, in April 2015, American Assets Trust, L.P. issued $100 million of 10-year 4.50% senior notes and used the proceeds in part to repay a 5.61% mortgage on The Landmark at One Market. Other drivers of improving fixed charge coverage should be positive releasing spreads that should drive same-store NOI growth and the lease up of other developments, including the Torrey Point office building in San Diego and Lloyd District Phase I mixed use project in Portland.

In a stress case not anticipated by Fitch in which same-store NOI is 0.6% for 2015 (the level achieved by the office portfolio in 2012) and development stabilization is prolonged, fixed-charge coverage would remain around 2.5x, which would remain adequate for the 'BBB' rating. Fitch defines fixed-charge coverage as recurring operating EBITDA less straight-line rents and recurring capital expenditures divided by total cash interest incurred.

Appropriate Leverage

AAT's leverage was 6.7x for trailing twelve months ended March 31, 2015, as compared to 6.8x and 7.5x for 2013 and 2012, respectively. Fitch expects leverage to sustain in the 6.0x to 6.5x range over the next 12-to-24 months, primarily due to organic EBITDA growth and cash flow from development, as opposed to via de-levering equity offerings. This level is appropriate for the 'BBB' rating. In Fitch's stress case, leverage would remain in the 6.5x to 7.0x range, which would be weak for the rating. Fitch defines leverage as debt less readily available cash divided by recurring operating EBITDA.

Good Liquidity Position

For the period April 1, 2015 to Dec. 31, 2016, AAT's sources of liquidity (unrestricted cash pro forma, availability under the unsecured revolving credit facility and projected retained cash flows from operating activities after dividends) divided by uses of liquidity (debt maturities pro forma for the repayment of The Landmark at One Market mortgage, projected maintenance capital expenditures and development expenditures) result in a coverage ratio of 1.5x. Fitch does not expect the company to refinance secured debt maturities through 2016 with new secured debt. For illustrative purposes, however, assuming an 80% refinance rate on secured debt maturities through 2016, liquidity coverage improves to 2.5x.

AAT's organic liquidity is moderate as its AFFO payout ratio was 75.5% in 1Q2015, compared to 80.4% in 2014 and 75.7% in 2013. Based on the current payout ratio, AAT retains approximately $19 million annually in organic liquidity.

Transition to Unsecured Funding Profile

To date, the company has only issued three series of private placement unsecured notes. Other unsecured borrowings include the $250 million revolver and $100 million unsecured term loan. As of March 31, 2015, the company's implied value of unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 2.8x pro forma. Fitch projects that unencumbered asset coverage should remain in the 2.5x to 3.0x range through 2017, which is strong for the rating. In addition, the quality of the unencumbered pool is generally stronger than that of the encumbered pool, as evidenced by higher rent levels in the unencumbered retail and office portfolio than the encumbered retail and office portfolio.

Offsetting the quality of the unencumbered pool is the fact that a meaningful portion of the unencumbered properties (including Waikeke) is subject to a tax protection agreement that may limit the company's willingness and/or ability to sell certain assets. As such, realizing value from these properties may be limited to the mortgage market.

Long Management Track Record and Development Discipline

The company's Executive Chairman founded the company's predecessor, American Assets, Inc. in 1967 and the company's Chief Executive Officer and Chief Financial Officer have been with the company and its predecessor since 1989 and 1998, respectively.

AAT has successfully overseen development and re-development projects over the past several years including the redevelopments of Del Monte Center in Monterrey and Carmel Mountain Plaza in San Diego, and the development of Waikiki Beach Walk in Honolulu. As of March 31, 2015, the development pipeline included three in-process developments (including the Torrey Point office project in San Diego, which took 17 years to obtain entitlements and permits for construction) and four pipeline projects. Cost-to-complete development totaled $69.1 million as of March 31, 2015, representing 3.0% of undepreciated assets, a manageable level.

Property Type Diversification

AAT's portfolio strategy runs counter to those of the largest REITs in all major sectors that have eschewed property type diversification in the name of specialization. The argument in favor of focused REITs is predicated on the view that specialization provides opportunities for operational outperformance and that optimal portfolio allocations and diversification can be achieved more efficiently at the shareholder's portfolio level. The argument for focused REITs assumes shareholders ascribe a discount to diversified REITs akin to a conglomerate discount. According to SNL Financial, the share prices of diversified REITs are currently trading at a 10.6% discount to median consensus net asset value compared to the shopping center, office and multifamily issuers, whose common share prices are trading at discounts of 6.2%, 8.6% and 3.2%, respectively. AAT's common shares are currently trading at a 7.8% discount to median consensus net asset value according to SNL Financial.

In spite of this phenomenon, AAT has outperformed its peers at the portfolio level, with AAT's office segment same-store NOI growth exceeding the office REIT peer average same store NOI by 250 basis points and AAT's retail segment same-store NOI exceeding the retail REIT peer average same store NOI by 120 basis points from 2005 to 1Q2015.

Exposure to Select Weak Credit Tenants

AAT is materially exposed to below investment grade rated and unrated tenants, and its largest tenant in 1Q2015 was salesforce.com, representing 7.8% of 1Q2015 annualized base rent. Salesforce.com has a growing presence in San Francisco but is expected to continue leasing at AAT's The Landmark at One Market; AAT expects significant rent bumps on upcoming salesforce.com lease expirations. The largest retail tenant, Kmart (rated CC by Fitch) represented 2.7% of total rent in 1Q2015 and the top 10 retail and office tenants represented 11.8% and 21.7% of annualized based rent, respectively.

Only three of these 20 tenants are rated investment grade by Fitch: Nordstrom Rack ('BBB+'; Outlook Stable, 1.2% of total rent), The Gap ('BBB-'; Outlook Stable, 0.6% of total rent), and California Bank & Trust ('BBB-'; Outlook Stable, 1.0% of total rent). It is possible that certain weak credit tenants will elect not to renew leases upon expiration or default during the lease term, which could provide AAT with the opportunity to push rents given that AAT estimated that its in-place retail and office rents are 9.9% and 18.7% below market rents, respectively. However, the company would be exposed to downtime and capital expenditures during the vacancy period.

KEY ASSUMPTIONS

Fitch's key assumptions for AAT in Fitch's base case include:
--6% same-store NOI growth in 2015 followed by 2.5% growth in 2016-2017;
--G&A to maintain historical margins relative to total revenues;
--Development expenditures of approximately $30-$40 annually through 2017 with development yields ranging from 6.75% to 8.75%;
--No acquisitions or dispositions;
--Debt repayment with the issuance of new unsecured bonds;
--Recurring capital expenditures to remain around 20% of recurring operating EBITDA through 2017;
--No equity issuance and an AFFO payout ratio of approximately 75% through 2017.

RATING SENSITIVITIES

The following factors may have a positive impact on AAT's rating and/or Outlook:
--Continued access to the unsecured debt markets, in particular execution of public unsecured debt offerings;
--Fitch's expectation of leverage sustaining below 5.5x for several quarters (leverage was 6.7x for the TTM ended March 31, 2015 and is expected to sustain in the 6.0 - 6.5x range over the next 12 - 24 months);
--Fitch's expectation of fixed-charge coverage sustaining above 2.5x for several quarters (fixed charge coverage is 2.6x pro forma and was 2.3x for the TTM ended March 31, 2015).

The following factors may have a negative impact on AAT's rating and/or Outlook:
--Fitch's expectation of leverage sustaining above 6.5x for several quarters;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x for several quarters.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following initial credit ratings:

American Assets Trust, Inc.
--IDR 'BBB'.

American Assets Trust, L.P.
--IDR 'BBB';
--$250 million unsecured credit facility 'BBB';
--$100 million unsecured term loan 'BBB';
--$350 million unsecured notes 'BBB'.

The Rating Outlook is Stable.