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Fitch Assigns 'BBB (Exp)' First-Time Ratings to Annington Limited and to its New EMTN Programme
June 28, 2017 / 10:55 AM / a month ago

Fitch Assigns 'BBB (Exp)' First-Time Ratings to Annington Limited and to its New EMTN Programme

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(The following statement was released by the rating agency) LONDON, June 28 (Fitch) Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) of 'BBB'(EXP) with a Stable Outlook to UK-based residential property owner Annington Limited. At the same time Fitch has assigned a senior unsecured rating of 'BBB'(EXP) to Annington Funding Plc. Fitch has also rated Annington Funding Plc's proposed GBP4 billion EMTN Programme 'BBB'(EXP). The expected ratings reflect Fitch's expectation that issuer loans under Annington's existing CMBS transaction will be repaid almost immediately following the funding of proposed corporate bond issues and term loans. Fitch will assign a final IDR to Annington Limited and final senior unsecured debt ratings to the bonds following confirmation that the AF4 and AF5 transactions have been fully defeased and that all security under the transaction has been released. Fitch cannot assign a final IDR whilst any form of encumbrance relating to the CMBS transaction continues. KEY RATING DRIVERS Portfolio Leased to MoD: The ratings of Annington are supported by a portfolio of 38,979 residential properties (the retained estate leased to Ministry of Defence (MoD), a department of the United Kingdom (AA/Negative). This generates stable, long-term, contracted rent. The MoD is obliged to pay rent on all leased units, regardless of occupancy, and is responsible for maintenance and repair. The MoD can release units back to Annington, but must ensure the properties are in good condition or pay dilapidation costs. Annington typically sells released units on the open market, generating substantial reversionary returns. Annington was created in November 1996 when it acquired a 999 year head lease over 57,434 homes across 765 sites from the MoD for GBP1.66 billion. Annington then provided 200-year underleases over the sites to the MoD to house married service personnel and their families. Stable, Long-Term Contracted Revenue: The retained estate generates high-quality revenue that anchors the business profile of Annington. MoD rent is set at a 58% discount to open market rent until the 2021-2024 site review. Rent levels are reviewed on a five-year rolling basis, based on designated units on each site. Rent is then adjusted to reflect market movements. This exposes Annington to an element of price risk, but rent on nearly all sites has increased over the past 19 years and total rent has never decreased. Under the terms of the leases, the MoD must pay rent, regardless of occupancy, and is responsible for maintenance and repair, generating high gross to net rental margins. Large Residential Properties Portfolio: As of 31 December 2016, the retained estate was independently valued at GBP7.2 billion based on discounted cash flow under the contract, or GBP8.4 billion using vacant possession values. Units within the retained estate range from flats to large detached houses, although most are two- to three-bedroom semi-detached or terraced houses, largely in south-east and south-west England where housing demand has been strong. Annual rent under the five-year reviews has grown by a CAGR of 3.8% from 1996-2016, despite the retained estate having fewer units owing to sales, higher than the UK CPI of 1.9%. Site Review: Apart from the rent review cycle, each site will be looked at over a four-year period starting in 2021. The 42% currently payable will be reviewed site by site with a view to moving more towards open market rental levels. As a number of elements that make up the current discount will be reduced or eliminated, the discount is expected to fall to 25%-35%, substantially boosting rental income. Annington and the MoD have maintained positive working relations for 20 years, but any disputes during the site review will be resolved through an official arbitration process. Reversionary Gains: The MoD can release surplus property back to Annington with a six-month notice period, after which the company may use the property as it sees fit. To date, Annington has disposed of 18,539 units for more than GBP1.8 billion, achieving 98% of the open market value. The portfolio's current vacant possession value exceeds the discounted cash flow value, which factors in the MoD leases, by almost 15%, indicating strong reversionary potential. Annington also rents released properties, often back to the MoD. The company intends to increase its rental portfolio, which currently comprises around 1,388 owned and 78 managed homes. The MoD is likely to increase releases in the medium to long term to offset potentially higher rents and to reduce vacant properties, which are currently around 20%. UK Market Fundamentals Support Growth: There is a persistent shortage of UK housing and build rates are not closing the gap. This lack of supply continues to push house price inflation well ahead of earnings growth. Affordable rental housing, Annington's primary market, is particularly under pressure, owing to insufficient social housing. Accordingly, the company's ability to generate good returns is unlikely to diminish, despite the portfolio being largely secondary or even tertiary. Brexit: The overall effect of Brexit on Annington is likely to be muted, as Fitch expects the MoD's current housing needs to be maintained, and the number of public-sector and former military personnel is unlikely to decline. MoD housing demand is underpinned by the Joint Force 2025 commitments by the UK government. High Cash-Flow Leverage: Annington has a relatively weak financial profile for the 'BBB' category. This reflects the discounted rental stream, which affects cash flow leverage. We expect Annington's cash-flow leverage to remain high post refinancing, with a forecast LTV of around 47%, an EBITDA NIC of 1.7x and high net debt/EBITDA of 19x at the end of the financial year to March 2018 (FYE18). Further releases by the MoD may contribute to deleveraging, but the effect is likely to be marginal. This financial weakness is mitigated by the quality of the MoD lease. In addition, the site review may significantly improve Annington's position, although the outcome remains uncertain. DERIVATION SUMMARY Annington has a number of unique characteristics that distinguish it from most publicly rated real-estate peers. These include the leases to the MoD, under which there is no void risk and maintenance and repair, as well as dilapidations are passed to the MoD, which is reflected in the rental discount. In addition, military housing needs, rather than residential market needs, drive demand. Fitch views Annington's business profile as stronger than most peers'. Annington, for example, has a similar financial profile to Grainger Plc (BB/Stable), but a significantly stronger business profile. Other European residential peers operate largely in regulated markets, such as Sweden and Germany, where income is below market and there is good reversionary potential. These companies can achieve reversionary gains when tenants vacate properties or when apartments are upgraded, whereas Annington depends on the MoD to releases properties. Like Annington, residential real-estate companies tend to support relatively high net debt/EBITDA and LTVs, given the high number of properties, low voids and stable income. No parent or subsidiary linkage was used in this rating and there is no Country Ceiling in effect. We have not uplifted the issue rating given most properties are leased to the MoD in the retained estate and not easily used in a recovery. KEY ASSUMPTIONS - Low single-digit rental growth - Small scale releases by the MoD - Stable housing prices - Long-term funding across bank term loans and notes issued under its medium-term note programme. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - The results of the site review substantially increasing rental income - Net debt/EBITDA falling below 15x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Substantial weakening of the housing market - Very high levels of releases from the MoD, particularly if concentrated in a single geographic area - Significant fall in house prices leading or releveraging leading to LTV rising above 50% LIQUIDITY Healthy Liquidity: After the refinancing, Annington's liquidity will be strong, given there will be no short-term debt and the company will have cash available on the balance sheet and access to the committed, undrawnGBP300 million revolver. Annington's intention to issue long-dated bonds as part of its refinancing of the existing CMBS structure will further extend the debt profile significantly beyond existing maturities. FULL LIST OF RATING ACTIONS Annington Ltd. Long-Term Issuer Default Rating (IDR): Assigned at 'BBB'(EXP), Stable Outlook Annington Funding PLC Long-term senior unsecured rating: Assigned at 'BBB'(EXP) GBP4bn European medium-term note programme: Assigned at 'BBB'(EXP) Contact: Principal Analyst Jean-Baptiste Bouillaguet Associate Director +44 20 3530 1606 Supervisory Analyst Bram Cartmell Senior Director +44 20 3530 1874 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Paul Lund Senior Director +44 203 530 1244 Date of Relevant Rating Committee: 26 June 2017 Media Relations: Adrian Simpson, London, Tel: 203 530, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. 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