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Fitch Affirms American Assets Trust's IDR at 'BBB'; Outlook Stable
September 21, 2017 / 6:39 PM / 3 months ago

Fitch Affirms American Assets Trust's IDR at 'BBB'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, September 21 (Fitch) Fitch Ratings has affirmed the ratings of American Assets Trust, Inc. (NYSE: AAT) and American Assets Trust, L.P., including the Long-Term Issuer Default Ratings (IDR) at 'BBB'. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS The rating and Stable Outlook are based on AAT's credit strengths, which include a portfolio focus on high growth and high-barrier-to-entry U.S. West Coast markets that Fitch expects will result in growing cash flow in excess of fixed charges. Other credit strengths include a portfolio diversified by property sector, good unencumbered asset coverage of unsecured debt and a long management track record. Offsetting these strengths is AAT's pro forma leverage, which is in the high 6.0x range as of June 30, 2017 and exceeds Fitch's expectations. The recent rise in leverage is due to two large debt-funded acquisitions and moderating NOI growth; Fitch expects leverage to move lower over time and eventually sustain below 6.5x, which represents Fitch's negative rating sensitivity. Elevated Leverage: In April, AAT acquired Pacific Ridge Apartments in San Diego for approximately $232 million with proceeds from privately placed debt offerings and funds drawn against existing facilities, increasing leverage for the quarter ending June 30, 2017 to the high 6.0x range pro forma for the acquisition. The acquisition is large for AAT and, along with the debt issuances, has had a significant impact on its financial profile. The company had reduced its leverage to 6.0x for the quarter ended March 31, 2017 from 6.5x and 6.6x for the years ended Dec. 31, 2015 and 2014, respectively; the company's stated leverage target is 5.5x. The current level of leverage is on the weaker end for a 'BBB' rating, and Fitch does not expect it to sustain at that level. Fitch expects leverage to decline below 6.5x over the next 12 months as the company pays down maturing debt while managing vacancies. Over the longer term, AAT is committed to paying down secured debt using internal cash flow and organic EBITDA growth; asset sales and equity issuance are also options, although the significant discount at which the stock trades relative to the company's stated NAV makes equity issuance a less desirable alternative, and calls into question the company's willingness to raise equity to reduce debt. Negative rating action could result if leverage exceeds 6.5x for several quarters. High Growth/High Barrier-to-Entry Markets: At June 30, 2017, AAT's portfolio included 104 retail buildings (11 properties) totalling 3.1 million square feet (sf), 28 office buildings (seven properties) totaling 2.7 million sf, as well as 2,112 multifamily units (eight properties) and Waikiki Beach Walk, a retail/hotel mixed-use property in Honolulu. The company's core markets include Greater San Diego (40% of 2Q17 annualized base rent (ABR)), Portland (15%), Greater San Francisco (13%), and Hawaii (13%). Fitch has a more favorable view of companies that own properties in high-growth and high-barrier-to-entry markets such as San Diego and San Francisco than in other markets, due to their consistently strong asset liquidity and leveragability. Management Track Record and Development Discipline: Ernest Rady, the company's CEO and Chairman founded the company's predecessor, American Assets, Inc. in 1967 and the company's Chief Financial Officer, Robert Barton, has been with the company and its predecessor since 1998. AAT has successfully overseen development and redevelopment 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 June 30, 2017, the development pipeline included one in-process development (the Torrey Point office project in San Diego, which took 17 years to obtain entitlements and permits for construction) and four pipeline projects. Torrey Point's total estimated investment is $55 million - or approximately 2% of undepreciated assets - with an estimated cost-to-complete of $18.6 million as of June 30, 2017. 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. As of June 30, 2017, AAT's property types as a percentage of ABR included Office (41%), Retail (38%) and Multifamily (21%) AAT's office and, until recently, retail segments have outperformed the company's public office and retail REIT peers due to sustained demand for AAT's properties, combined with limited supply. The company does have asset concentration with its largest asset - The Landmark at One Market in San Francisco - representing approximately 11% of ABR. Moderating Internal Growth Company-wide SSNOI was up 0.4% on a GAAP basis for the first six months of 2017 and 2.6% for the year ended 2016, down from 7.3% for the year ended 2015; SSNOI was 1.9% for 2014. AAT's retail portfolio in particular has experienced soft SSNOI growth. SSNOI was -1.4% for the six months ending June 30, 2017 and 0% for the year ended 2016. The company's retail properties have had weak rental growth the past two quarters, 2.2% in 1Q17 and -12.8% in 2Q17, while same store occupancy has declined to 96.8%, down 1.8% since 4Q15. AAT's office properties have had positive rental rate growth in each of the past six quarters but the company's same store office occupancy has declined. Fitch expects same store growth to continue to be impacted by shifting factors including asset repositionings, expected vacancies and positive rental rent spreads on renewals and vacancies. The company has publicly stated that marked-to-market rents for its retail and office portfolios are approximately 7% and 18% below market, respectively, on a GAAP basis. Exposure to Weak Credit Tenants: AAT is materially exposed to below investment grade-rated and unrated tenants and its largest tenant was salesforce.com, representing 15.4% of total office ABR and 8% of total 2Q17 annualized base rent. Salesforce.com has a growing presence in San Francisco, and Fitch expects it will to continue leasing at AAT's The Landmark at One Market with significant rent bumps on upcoming lease expirations. The largest retail tenant, Kmart Corporation (rated 'CC' by Fitch), represented 6.5% of retail ABR and 2.8% of total rent in 2Q2017, and the top 10 retail and office tenants represented 10.7% and 22.9% of annualized based rent, respectively. The Kmart space, which expires on June 28, 2018, is currently vacant, but Kmart continues to remain fully liable for the leased space. The space is located at Waikele Center, which AAT is in the process of repositioning. DERIVATION SUMMARY AAT's diversified portfolio across multiple property types leaves the company with no true peer. Similarly rated Vornado Realty Trust (VNO; BBB/Stable) owns and operates office, retail and residential properties and has a geographic focus - in VNO's case approximately 90% of EBITDA will be from NYC post its spin-off of a large D.C. focused portfolio. VNO has a target leverage in the mid-6.0x range - higher than AAT - and a fixed charge coverage ratio of approximately 2.0x but is significantly larger than AAT and has a significantly better track record/access to the public capital markets. Federal Realty Investment Trust (FRT; A-/Stable) is a comparable given its development capability and its focus on both retail shopping centers and mixed use assets in coastal urban markets. Federal Realty's sector-leading SSNOI growth and leasing spreads, and demonstrated access to multiple forms of capital justifies its higher rating. FRT's leverage has sustained in the mid-5.0x range with a FCCR sustaining in excess of 3.5x. AAT's high-barrier-to-entry markets and the company's development capabilities also lend comparison to a number of property-sector focused REITs including CBD office owner and developer Boston Properties (BBB+/Stable), and Regency Centers (BBB+/Stable), a nationwide owner and developer of high-quality shopping centers; both of these companies have more developed capital structures and demonstrated capital access and are more diversified by geography, property and tenant base than AAT. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Approximately 1.5% SSNOI growth in 2017 and 2018, increasing to 4.5% in 2019 and 2020; --G&A to maintain historical margins relative to total revenues; --Development expenditures of approximately $20 million in 2017-2020 annually with development yields ranging from 7% to 8%; --Acquisitions of $200 million in 2020; --Secured debt repayment through excess cash flow and the issuance of $100 million of new unsecured bonds in 2019 and $150 million in 2020; --Recurring capital expenditures to remain approximately $35 million through 2020; --An AFFO payout ratio of approximately 75% through 2018. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Fitch's expectation of leverage sustaining below 5.5x for several quarters (leverage was in the high-6.0x range for the quarter ended June 30, 2017, and Fitch expects it will sustain at 6.5x or below beginning in 2018); --Fitch's expectation of fixed-charge coverage (FCC) sustaining above 3.0x for several quarters (FCC was 3.0x for the quarter ended June 30, 2017); --Continued access to the unsecured debt markets, in particular execution of public unsecured debt offerings. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Fitch's expectation of leverage sustaining above 6.5x for several quarters; --Fitch's expectation of FCC sustaining below 2.0x for several quarters. LIQUIDITY Liquidity coverage of 1.9x is considered adequate. For the period July 1, 2017 to Dec. 31, 2019, AAT's sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility and projected retained cash flows from operating activities after dividends). The company's uses of liquidity are debt maturities, projected maintenance capital expenditures and development costs. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: American Assets Trust, Inc. --Long-Term Issuer Default Rating (IDR) at 'BBB'. American Assets Trust, L.P. --Long-Term IDR 'BBB'; --$250 million unsecured credit facility at 'BBB'; --$100 million unsecured term loan A at 'BBB'; --$100 million unsecured term loan B at 'BBB'; --$50 million unsecured term loan C at 'BBB'; --$800 million unsecured notes at 'BBB'. The Rating Outlook is Stable. Contact: Primary Analyst Christopher G. Pappas Director +1-646-582-4784 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Steven Marks Managing Director +1-212-908-9161 Committee Chairperson Alex Bumazhny Senior Director +1-212-908-9179 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. --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $20 million of cash for working capital purposes, which is otherwise unavailable to repay debt. Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. 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