December 22, 2017 / 5:28 PM / 3 months ago

Fitch Affirms AIMCO at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, December 22 (Fitch) Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of Apartment Investment and Management Company (NYSE: AIV) and its operating partnership, AIMCO Properties, L.P. (collectively AIMCO) at 'BBB-'. Fitch also assigns a 'BBB-' rating to AIV's term loan, which is co-issued by AIMCO Properties, L.P. and Apartment Investment and Management Company. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Key factors supporting the ratings include the expected material improvement in leverage in following the pair-trade disposition of assets and repayment of the term loan facility related to the Palazzo acquisition as well as the creation of a sizable pool of unencumbered assets. Balancing these strengths are the below-average financial flexibility relative to peers resulting from the small absolute size of the company's unencumbered pool and fewer capital sources given the secured-only borrowing strategy. LEVERAGE EXPECTED TO STABILIZE POST PALAZZO Fitch expects AIV to maintain leverage between 6x-7x through business cycles, likely trending towards the lower end of the range through 2019 given our expectation for positive albeit decelerating fundamentals. AIV reduced leverage from a peak of 9.2x at Dec. 31, 2010 to 6.7x at Dec. 31, 2016 and 7.2x for the trailing 12 months (TTM) ended Sept. 30, 2017. Asset sales, market-driven recurring operating EBITDA growth and equity issuance have driven the improvement. Fitch expects leverage to settle around mid-6x following the pair-trade dispositions related to the minority interest acquisition in the Palazzo communities in June 2017. Leverage excluding non-recourse property debt and associated EBITDA related to AIV's asset management business was 7.0x as of the quarter ending Sept. 30, 2017. Fixed-charge coverage (FCC) has also improved, and Fitch expects modest improvements through 2019 to remain above 2.5x as compared to 2.6x for 2016, 2.3x for 2015, 2.1x for 2015 and 1.9x for 2014. ASSET UNENCUMBRANCE SUPPORTS RATINGS AIV had an unencumbered pool totalling 28 properties (or 20% of all consolidated properties) with an estimated stressed value of approximately $1.15 billion at Nov. 30, 2017 assuming an 8% stressed capitalization rate of its TTM unencumbered net operating income (NOI). Growth in the company's unencumbered pool was a primary driver behind the upgrade in 2015. AIV had only three unencumbered properties when Fitch initiated ratings in 2Q'13. The pool provides adequate contingent liquidity coverage to the generally small and episodic amounts of recourse debt from borrowings under AIV's revolving credit facility. The pool's value exceeds the full $600 million available under the company's secured revolver, though not quite by the 2x coverage of total unsecured debt that is common within Fitch's investment-grade rated REIT portfolio. A line balance of that magnitude is not within Fitch's expectations and if it were to occur could result in negative rating momentum, absent growth in the unencumbered pool. The size of the pool continues to comprise only a small fraction of the overall portfolio. AIV's unencumbered asset coverage of its credit facility was 1.9x assuming a fully drawn revolver and 3.2x given the 3Q17 credit facility balance. Historically, coverage was 9.6x and 15.5x based on the average revolver balance since 1999 and 2009, respectively. UNCOMMON BORROWING STRATEGY FOR RATED REIT ISSUER AIV has a publicly stated strategy of primarily financing via asset-level non-recourse amortizing mortgages, which is common for REITs generally given the depth of the commercial real estate mortgage market but uncommon for investment-grade rated REITs. The implications of AIV's strategy are mixed. The lack of recourse debt, save for periodic and modest draws on the line of credit, reduces the probability of a default, while the unencumbered pool improves recovery prospects in the unlikely event of a default. Conversely, maintaining investment-grade ratings may be a lower priority for AIV given fewer commercial incentives to do so. AIV's lack of unsecured financing optionality further reduces the company's financial flexibility. The corporate rating has only an indirect effect on access to capital. AIV does not plan to issue long-term unsecured debt; further, sponsor quality plays a less critical role in mortgage lender underwriting and has limited effect on interest expense (and therefore funds from operations and net income), as rating changes would only impact line of credit pricing. AVERAGE PORTFOLIO QUALITY, IMPROVING AIV's portfolio quality continues to improve as the company disposes of its affordable segment and recycles capital from weaker assets (principally those in markets with below-average demographics or limited constraints on new supply) and into higher quality assets via its pair-trade strategy that identifies a specific disposition to offset any acquisition. For example, acquisitions in 2016 had average per-unit rents averaging $4,130 per month upon stabilization as compared to dispositions at $1,412 per month. Fitch views AIV's portfolio as average relative to its public peers when measured by average rent per unit, enterprise value per unit and implied cap rate. Nonetheless, many of the public peers are rated 'BBB+' or in the 'A' category, thus indicating that in isolation from all other credit factors, AIV's portfolio quality alone would be consistent with a higher rating. STABLE OUTLOOK The Stable Outlook reflects Fitch's expectation that while key metrics and portfolio quality may continue to be enhanced on the margin, the majority of the improvements have been completed. Moreover, absent a material balancing between the unencumbered and encumbered pools, positive momentum in the ratings is unlikely. PREFERRED STOCK NOTCHING The two-notch differential between AIV's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch criteria in 'Non-Financial Corporates Hybrids Treatment and Notching Criteria', dated April 27, 2017 and available at, 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. DERIVATION SUMMARY AIV's secured borrowing strategy is uncommon not only amongst investment grade REITs, but also renders it the only multifamily investment grade equity REIT that implements this strategy. AIV's portfolio is generally located along coastal U.S. with pockets in major inland metropolitan cities, most closely geographically resembling peers, Essex Property Trust (BBB+/Stable) and Equity Residential (A/Stable). AIV's portfolio's quality has improved over the years, and Fitch generally considers it on par with most other higher rated multifamily peers. AIMCO will still be the highest levered multifamily REIT following the planned pair-trade dispositions, with peers maintaining some of the strongest balance sheets since the financial crisis. Fitch links and synchronizes the IDRs of the parent REIT and subsidiary operating partnership, as the entities operate as a single enterprise with strong legal and operational ties. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer --Mid-single digit SSNOI growth in 2017 followed by gradually deceleration of apartment fundamentals leading to annual low-single digit SSNOI growth over the next two to three years; --Leverage settles around the mid-6x range following the planned pair-trade dispositions related to the Palazzo acquisition; --Maintenance of secured strategy with a majority of secured debt being refinanced. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action The ratings assume no change to AIV's financing strategy and that AIV will not have recourse debt beyond normal use of its revolving credit facility and term loan. A change or expected change in financing strategy could result in a change to the ratings and/or Outlook. Moreover, Fitch does not envision positive momentum in the ratings and/or Outlook given the relative size of the unencumbered pool and Fitch's expectation that AIV will not access the unsecured bond market, in contrast to all other investment-grade rated REITs. However, the issuer's asset class and portfolio quality are consistent with higher ratings if matched with material improvements to contingent liquidity and financial flexibility via an expansion in the unencumbered pool and access to the unsecured bond market. Developments That May, Individually or Collectively, Lead to Negative Rating Action --Fitch's expectation of leverage sustaining above 7.5x (7.2x as of TTM Sept. 30, 2017); --Fitch's expectation of fixed-charge coverage sustaining below 2.0x (2.6x for the TTM ended Sept. 30, 2017); --The encumbrance of or a material deterioration in the value of the unencumbered asset pool. LIQUIDITY WELL-LADDERED DEBT MATURITIES BUT LIQUIDITY DEFICIT AIV maintains sufficient liquidity driven by its staggered debt maturities, and conservative dividend payout policies. Approximately 19% of AIV's non-recourse real estate segment property debt will be repaid via amortization, thereby reducing refinancing risk. In addition, AIV's dividends have comprised 65%-75% of adjusted funds from operations (AFFO) and 85%-95% of AFFO after mortgage amortization, which allows the company to retain meaningful amounts of internally generated liquidity. However, AIV is projected to operate with a liquidity deficit (0.8x) for the period Oct. 1, 2017 through Dec. 31, 2018, assuming no access to external capital. This deficit is driven principally by development and redevelopment expenditures and higher borrowings under the revolving credit facility, though Fitch expects AIV will manage through via refinancing mortgages and receipt of subsequent incremental proceeds and additional asset sales. As AIV's mortgages have significant amortization, they typically mature with below-market loan-to-value ratios, thus incremental proceeds upon refinancing are probable. Under the scenario where AIV refinances 80% of its secured debt, AIV is projected to operate with a liquidity surplus (1.5x) through the same period. Fitch defines liquidity coverage as sources (unrestricted cash, availability under the $600 million revolving credit facility due 2022, committed and undrawn construction financing and retained cash flow from operations after dividends) to uses (debt maturities and amortization, remaining development and redevelopment expenditures and recurring maintenance capital expenditures). FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Apartment Investment and Management Company --Issuer Default Rating (IDR) at 'BBB-'; --Secured revolving credit facility at 'BBB-'; --Preferred stock at 'BB'. AIMCO Properties, L.P. --IDR at 'BBB-'; --Secured revolving credit facility at 'BBB-'. Fitch has also assigned the following ratings: Apartment Investment and Management Company --Secured term loan 'BBB-'. AIMCO Properties, L.P. --Secured term loan 'BBB-'. The Rating Outlook for both entities is Stable. Contact: Primary Analyst Peter Siciliano Director +1-646-582-4760 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Stephen Boyd Senior Director +1-212-908-9153 Committee Chairperson Steven Marks Managing Director +1-212-908-9161 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock-based compensation and include operating income from discontinued operations; --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $10 million of cash for working capital purposes which is otherwise unavailable to repay debt. 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