OREANDA-NEWS. Fitch Ratings has affirmed Czech Republic-based property group RPG Byty's (RPG) Long-term Issuer Default Rating (IDR) at 'B+' with Stable Outlook and its EUR400m senior secured bond at 'BB-'/Recovery Rating 'RR3'.

The ratings reflect RPG's high geographical concentration and small scale. They also factor in stable rental income received from the company's Czech residential housing portfolio, de-regulation of rents and limited future capex requirements. Fitch expects leverage to remain stable at around 40% of loan-to-value (LTV) and interest cover at around 2.0x.

The senior secured notes are rated a notch above the IDR as they benefit from a security package including a first-rank mortgage on the real estate portfolio offering around 2.0x asset cover and a pledge on issuer shares

KEY RATING DRIVERS
Stabilising Vacancies
Following rental increases resulting from de-regulation, vacancies increased to 10.8% at Dec 13 from a low 4.7% in 2010, as tenants left what had been heavily subsidised accommodation. Vacancies are now stabilising or even slightly improving (vacancy of 9.6% at end-1H15 vs. 10.6% a year ago).

The improvement comes as the number of cancellations decreased (4,932 in 2014 vs. 5,672 in 2012) and reflects various initiatives including an improvement investment programme or the split of larger flats into smaller units. The gap between market rent and post-regulated rent is also shrinking both in terms of rent and importance for RPG.

Change in Ownership
RPG Byty announced in August that it will be acquired by Round Hill Capital, which was subsequently approved by the Czech antitrust office (UOHS). This acquisition is not unexpected given the consent solicitation made in March 2015 and previous attempts to list the company. Fitch does not expect any significant shift in strategy but will monitor any announcements the company may make at its coming quarterly results.

FX and Bullet Refinancing Risk
RPG Byty is a Czech residential home letting business with all rental income denominated in the local currency. While the coupon on its sole EUR400m bond is fully hedged against CZK depreciation, the principal is not. Fitch views this exposure as a significant risk for the company even though the Czech currency has so far been fairly stable versus the euro, with declines failing to have a negative cash impact.

In an extreme scenario of depreciation of 15%-20% versus the EUR the option protection on 50% of the bond principal would kick in at CZK/EUR 32.3, resulting in a still manageable LTV of around 50% (within our guidelines).

Reasonable Leverage Metrics
Fitch forecasts LTV to remain around 40% (41% in 2014). RPG Byty does not undertake any residential development and hence execution and budget risk on capex is low. Since 2006 EUR280m has been spent on upgrading the portfolio. Capex declined significantly in 2014, following the execution of most of the upgrade programme. Fitch expects future capex to remain at around CZK500m.

Stable Rental Income
RPG Byty's business strategy is based on delivering increased rents as contractually agreed with its tenants and tightly managing operating costs. Rental income has grown as a result of the Czech rental market de-regulation in 2010. The average tenure for residents is long at 15 years, reflects a still high, albeit decreasing, average age profile (52-year vs 56-year last year) of tenants. Tenants on market rent contracts are 40-year old on average.

Strong Concentration Risk
RPG' Bytys 44,000 unit portfolio is located in the Moravia-Silesia region with all properties situated within a 50km radius. Rental income and portfolio valuations are strongly linked to the local economy. Although local demographics are not entirely favourable, Moravia's economic performance has been solid with an average annual growth of 4.3% over the last 10 years, above the EU average of around 1%.

Positively, the region has attracted new sectors of activity, such as electronics, software companies and pharmaceutical groups but retains a strong, albeit declining, focus on the cyclical industrial sector. In both Ostrava and Havirov, RPG Byty's portfolio represents over 10% and 30% of the town's housing stock respectively. In addition, Ostrava and Havirov together accounted for 62% of the portfolio by units at December 2014. However, the portfolio is sizeable and RPG Byty benefits from economies of scale in terms of letting and asset management.

KEY ASSUMPTIONS
- Flat occupancy ratio
- Modest increase in rent
- Capex reflecting that most of the value enhancing programme has already been executed

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Improved corporate governance with an established dividend policy, most likely through a successful IPO
-Improved portfolio diversification where RPG Byty establishes a critical size of residential portfolio outside the Ostrava region
-A sustainable improvement in financial metrics with LTV below 40% (41% at YE 2014), net debt/ EBITDA below 5.0x (7x at end-2014) and EBITDA net interest cover (NIC) ratio above 2.0x
-Increased liquidity on a sustained basis to a score of 1.0x, resulting from undrawn committed debt facilities or increased unrestricted cash.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Significant deterioration in vacancy rates or rise in tenant arrears
-EBITDA NIC falling below 1.5x and net debt/EBITDA rising above 8.0x
-Declining valuation or FX mismatch leading to weaker leverage metrics (LTV above 55%) that make re-financing prospects for the company's bullet bond more difficult
-Evidence that financial problems at the other investments held at the ultimate owner level are having a negative impact on RPG Byty

LIQUIDITY
RPG Byty has sufficient liquidity up to bond maturity in 2020 but could face significant refinancing risk at a later stage.