OREANDA-NEWS. Fitch Ratings has downgraded the Issuer Default Rating (IDR) for Mack-Cali Realty Corporation (NYSE: CLI) and its operating partnership Mack-Cali Realty, L.P. (collectively, Mack-Cali) to 'BB+' from 'BBB-'. A full list of rating actions follows at the end of the release.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The downgrade primarily reflects the company's weaker credit metrics and capital markets access relative to other low investment grade rated REITs, as well as challenging fundamentals in many of its core northeast suburban office markets. Fitch expects CLI's credit metrics to remain appropriate for a 'BB+' rated REIT through our 2017 projection period.

CLI's new management has communicated a credible turnaround plan that considers bondholders, but favors equity holders. The company could reduce leverage below Fitch's 7.0x rating sensitivity for positive rating momentum with the proceeds from $600 million to $800 million of identified non-core asset sales. However, the agency believes CLI is more likely to use the proceeds for acquisitions and asset stabilization; repositioning and development capex, particularly in the context of its manageable debt maturity profile; and adequate access to unsecured bank term loan and secured mortgage debt.

Longer-term, Fitch believes that management intends to reposition CLI's portfolio and balance sheet to levels consistent with a low investment grade rating, including leverage sustaining in the mid-to-high 6x range. Fitch views public equity issuance as the most likely avenue for future deleveraging, assuming successful execution of the company's turnaround plan narrows the net asset value (NAV) discount for its shares. Incremental net operating income (NOI) from developments could also lead to lower leverage; however, Fitch expects the company to continue to start new developments as existing projects are delivered and stabilized.

SPECULATIVE GRADE CREDIT METRICS

Fitch expects Mack-Cali's leverage will sustain in the low-to-mid-7.0x range through 2017, which is appropriate for a 'BB+' rated REIT with Mack-Cali's asset profile. Mack-Cali's portfolio is principally comprised of capital intensive suburban office properties in select New Jersey and, to a lesser extent, New York and Connecticut suburbs - markets generally characterized by stubbornly high vacancy rates and weak same-store NOI growth prospects.

The company's leverage for the trailing 12-months (TTM) ended Sept. 30, 2015 was 7.2x. Fitch defines leverage as recurring operating EBITDA, excluding non-cash above and below market lease adjustments, over total debt net of readily available cash.

Fitch expects CLI's fixed-charge coverage (FCC) will weaken to the mid-1.0x range, largely driven by elevated recurring maintenance and leasing capex, including amenity capex related to the company's portfolio repositioning and stabilization efforts. The latter is somewhat non-routine in nature; however, Fitch has included it in its estimate of maintenance capex, viewing it as deferred capital spending, now required to keep the properties competitive. The company's FCC was 1.8x for the LTM ended Sept. 30, 2015. Fitch defines FCC as recurring operating EBITDA, excluding non-cash revenues and including recurring cash distributions from joint ventures, less maintenance capex over cash interest incurred.

FEWER CAPITAL AVENUES AVAILABLE

Fitch views CLI's access to attractively priced public equity and debt as limited, based on the market implied discount to net asset value (NAV) and yield for its shares and unsecured bonds. However, Fitch believes the company retains adequate access to competitively priced debt capital from unsecured bank term loans, as well as mortgage debt capital for select higher value unencumbered assets. CLI also has $565 million (94%) of availability under its $600 million revolver that matures in 2017.

During November 2015, the company created a separate REIT subsidiary for its residential operations called Roseland Residential Trust (RRT) to facilitate raising approximately $300 million of equity (through entity or project level joint ventures) to help fund a portion of its residential development pipeline at more attractive prices than what the company could achieve by issuing CLI shares.

Fitch views the creation of RRT as a modest net credit positive in so far as it reduces the need for CLI to take on additional debt to fund RRT's development equity needs. However, the move adds some financial reporting complexity while reducing operational flexibility. Longer term, isolating RRT could also facilitate a shareholder spin-off of the company's residential operations. Fitch would likely view this as a credit negative that reduces the earnings power and collateral value of CLI.

WEAK LIQUIDITY

CLI's sources of liquidity fall short of uses by $560 million, resulting in 0.6x liquidity coverage under Fitch's liquidity analysis for the period from Oct. 1, 2015 to Dec. 31, 2017. Fitch's base case assumes that CLI successfully raises $300 million of third-party equity to help fund its development pipeline at RRT. Fitch expects the company to use the proceeds from non-core asset sales (net of acquisitions) and secured mortgage and bank term loan financings to fund its share of development equity. CLI's liquidity coverage improves to 0.8x assuming it refinances 80% of its secured mortgage maturities through 2017.

CLI's unencumbered asset coverage of unsecured debt (UA/UD) is strong for the 'BB+' rating at 2.1x based on a stressed 9% capitalization rate. Fitch expects this coverage to moderately deteriorate due to incremental mortgage encumbrances and the sale of select unencumbered properties. The company may also contribute additional office assets to its RRT subsidiary for redevelopment. Although these are likely to be underperforming suburban office properties, they could lower the absolute value of UA, nonetheless.

Fitch also sees the potential for CLI's UA portfolio quality to decline in the near-to-medium term given the company's stated plans to sell lower cap rate assets, such as its 125 Broad Street office condo interest, depending on the use of proceeds. The company has also indicated that it will consider putting mortgages on select properties to help fund its share of development equity.

Mack-Cali has a low 40.8% dividend payout ratio of its adjusted funds from operations (AFFO) for the quarter ended Sept. 30, 2015. However, Fitch expects the company's AFFO payout ratio to exceed 100% during 2016, due to elevated maintenance and leasing capex, including the company's planned building amenity enhancements.

CREDIBLE PLAN FACES HEADWINDS

Fitch views CLI's '20/15' turnaround strategy as generally credible. Successful plan execution should improve the company's overall asset and market quality and increase its property NOI. The 20/15 plan is a multi-year, multi-step strategy for reducing costs, improving business relationships and enhancing the portfolio's asset and market quality by 2018.

Regarding the latter, CLI plans to reposition its portfolio to include 20 million square foot of office and 15,000 apartment units by selling non-core and/or class B properties, reducing its office and flex R&D portfolio exposure to roughly 10 submarkets from more than 25. After completing its portfolio repositioning, CLI's office portfolio will principally be concentrated in New Jersey markets with access to transportation. The company will also exit its small portfolio positions in the New York City, D.C. and suburban Maryland office markets, as a result.

CLI has also outlined an aggressive, $2.7 billion apartment development program to reach its 15,000 unit goal at its RRT subsidiary by 2018. CLI will fund its share of the estimated development costs with retained cash flow from operations and/or asset sales, and possibly incremental borrowings.

The company's plan faces external execution risk, primarily from challenging property market dynamics. Fitch expects New Jersey office fundamentals will remain a headwind given the state's relatively inhospitable business environment that includes high labor and living costs, as well as regulatory and tax burdens. Employment growth has been lackluster in New Jersey during the past decade, partly due to consolidation in the telecom and pharmaceutical industries, which has caused some jobs to be eliminated or leave the state. Fitch's ratings case projections assume the company's GAAP SSNOI grows by 3% during 2016 and is flat during 2017 due to lease expiration driven vacancy in its New Jersey waterfront portfolio.

Fitch is also less optimistic regarding some of the plan's underlying assumptions. Amenity enhancements at select suburban office properties should allow CLI to take leasing market share and help stabilize portfolio occupancy, resulting in higher property operating income. However, the agency lacks conviction that tenants will pay premium rents for greater amenities given high submarket vacancy rates and an uncertain competitive response from other New Jersey office landlords. Separately, Fitch views the company's goals for the retail at its New Jersey waterfront office assets as ambitious relative to the $25 million estimated capital investment.

CLI's turnaround plan also assumes accommodative commercial real estate (CRE) investment and capital markets. Although generally open and attractively priced, the CRE debt capital markets have experienced some disruption around interest rate volatility this year. The company has identified roughly 40 non-core assets that management estimates are worth between $600 million to $800 million that CLI plans to sell in tempo with its capital needs. A delay in timing or reduction in estimated proceeds could cause the company's credit metrics to weaken further.

SOME NOTABLE GREEN SHOOTS

CLI's renewed operational focus appears to be gaining traction on several fronts. Management has worked swiftly to devise and begin implementing the 20/15 turnaround plan since joining the company in June 2015. The initial phases have primarily focused on expense reductions at the property and corporate levels, as well as rebuilding relationships with market participants (i.e. CRE brokers). The company has identified $25 million of annual savings it expects to realize during 2016 from lower personnel, G&A, property operating and interest costs.

Indeed, CLI's third-quarter 2015 (3Q'15) results showed improvements in select portfolio operating metrics, as well as the company's cost structure. The portfolio was 85.8% leased at Sept. 30, 2015, up from 82.3% at June 30, 2015. The improvement was partly due to solid leasing velocity, which contributed about 150 basis points (bps). However, the 250 bps majority came from reclassifying certain transitional/repositioning candidate properties, thereby removing them from the company's 'in-service' portfolio.

Same-store NOI grew by 6.5% year-over-year on a cash and GAAP basis during the third quarter. However, a 7.9% reduction in expenses drove the result, which Fitch views as lower quality relative to top-line gains. SSNOI would have been negative 3.9% if selected low vacancy properties were classified as
'in-service' and, therefore kept in the same-store pool.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for CLI include:
--SSNOI grows by 3% during 2016 and is flat during 2017 due to lease expiration driven vacancy in its NJ waterfront portfolio;
--Dispositions of $575 million during 2016 and $150 million during 2017 at cap rates of 5.3% and 8%, respectively;
--Acquisitions of $700 million during 2016 at a 6.5% cap rate;
--Development spending of $354 million, including investments in unconsolidated JVs;
--CLI's RRT subsidiary raises $300 million of JV equity during 2016;
--Recurring maintenance and amenity capital spending of $150 million during 2016 and 2017;
--The company raises $300 million of term loan debt, using a portion of the proceeds to refinance its $200 million of unsecured bonds that mature on Jan. 15, 2016;
--CLI issues net mortgage debt of $489 million through 2017; and
--No equity issuance by Mack-Cali, Inc. through the forecast period.

In accordance with Fitch's updated Recovery Rating (RR) methodology, Fitch is now providing RRs for issuers with IDRs in the 'BB' category. The 'RR4' for Mack-Cali's senior unsecured debt supports a rating of 'BB+', the same as CLI's IDR, and reflects average recovery prospects in a distressed scenario.

RATING SENSITIVITIES

Although Fitch does not anticipate positive rating actions in the near-to-medium term, the following factors could result in positive rating momentum:

--Fitch's expectation of leverage sustaining below 7x (leverage was 7.2x for the TTM ended Sept. 30, 2015);
--Fitch's expectation of fixed charge coverage sustaining above 2x (coverage was 1.8x for the TTM ended Sept. 30, 2015).
--Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining below 2x, or a material change in the quality of the unencumbered pool due to sale of best relative assets (coverage was 2.1x at Sept. 30, 2015).

The following factors may result in negative rating momentum:

--A sustained liquidity shortfall and/or deterioration in the breadth and depth of capital access;
--Fitch's expectation of leverage sustaining above 8x;
--Fitch's expectation of fixed charge coverage sustaining below 1.5x.

FULL LIST OF RATING ACTIONS

Fitch has downgraded and assigned Recovery Ratings as follows:

Mack-Cali Realty Corporation
--IDR to 'BB+' from 'BBB-'.

Mack-Cali Realty, L.P.
--IDR to 'BB+' from 'BBB-';
--Unsecured Revolving Credit Facility to 'BB+'/'RR4' from
'BBB-';
--Senior Unsecured Notes to 'BB+'/'RR4' from 'BBB-'.

The Rating Outlook is Stable.