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Fitch Affirms Sabra Health Care REIT at 'BBB-'; Outlook Stable
September 26, 2017 / 5:57 PM / in 3 months

Fitch Affirms Sabra Health Care REIT at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, September 26 (Fitch) Fitch Ratings has affirmed the ratings on Sabra Health Care REIT (NASDAQ: SBRA) following the announcement of its acquisition of a 49% stake in a senior housing operator and its real estate for $371 million, the acquisition of 24 skilled nursing facilities for $430 million and the intention to sell its remaining Genesis HealthCare real estate. Upon closing of the transactions, SBRA will have improved operator diversification and scale. The affirmation reflects Fitch's view that the steps to reducing leverage are achievable in a reasonable timeframe. Nonetheless, the announcements may signal growth goals priority relative to credit given they are occurring so soon after the Care Capital Properties merger and upgrade to investment grade. KEY RATING DRIVERS Transactions Should Improve Quality, Diversification and Scale: Sabra will be adding a senior housing operating portfolio (183 senior housing communities) through a $371 million minority interest in privately held Enlivant. Sabra will also have the option to purchase the remaining 51% along with other rights that Fitch expects will result in Sabra ultimately acquiring and consolidating the portfolio. Upon completion, this will mark a sizable foray into owning a senior housing operating portfolio. Portfolio occupancy has improved from 60% to 82% following TPG's 2013 acquisition and installation of Enlivant as the operator. SBRA's investment would benefit should Enlivant deliver additional growth through high-ROI projects and expansions of existing properties. SBRA also believes that Enlivant will be a strategic partner through which a significant pipeline of acquisitions or development opportunities may come to fruition. The second transaction is the acquisition of 21 skilled nursing facilities for $378 million. Fitch considers the assets to be higher quality than the rest of the portfolio as measured by CMS Quality Rating Systems with 21 of the 24 facilities at 5 stars and the others at 4 stars. Genesis Disposition Plan Should Improve Quality and Partially Fund Acquisitions: To fund part of the transaction, SBRA has announced its intention to sell its remaining Genesis real estate by YE2018 aiming to raise $425 million to $475 million from the dispositions, which Fitch views positively given the operator's weaker than average operating measures. The market for Genesis real estate has been better than Fitch envisioned given the sales by Welltower, Inc. (BBB+'/Stable) and SBRA over the past year; nevertheless, Fitch believes there is reasonable execution risk to sell the remaining assets. Leverage to Exceed Financial Policies: Fitch expects the combined effect of the two acquisitions will cause leverage to increase from the 5.0x level to approximately 5.75x by YE2017 on a look-through basis, which is above the issuer's 5.5x and Fitch's rating sensitivity for negative momentum. SBRA will use the completed equity offering and Genesis sales proceeds to come to reduce leverage back to the 5x to 5.5x range. The increase in leverage is less significant than the fact that the issuer was willing to stretch beyond its financial policies so soon after being upgraded to investment grade. Sabra publicly reiterated its commitment to maintaining its investment grade balance sheet during this period as well as maintaining leverage in line with its historical target range of 4.5x to 5.5x. Modest Execution Risk: Fitch notes that the GEN asset sales have some execution risk and any difficulty selling these assets could result in leverage persisting above the company's financial policies and what would be appropriate to maintain an investment grade rating. Delayed GEN dispositions would also result in a portfolio with a higher percentage of SNFs should the disposition program not prove successful. Fitch does not see significant execution risk or integration risk of the two acquired portfolios beyond the demands that two acquisitions, the CCP merger and the GEN portfolio sale, will place on a relatively small organization. Improved Capital Markets Relevance: While Fitch regards portfolio quality as one of the most important differentiators between high yield and investment grade REITs, we recognize that larger REITs are more relevant in the capital markets and thus have better access to capital. The increase of enterprise value due to the transactions including the Care Capital Properties merger, should aid SBRA to experience augmented importance with its bank lending group. Moreover, the company's follow-on equity offering should lower leverage further to create momentum for the company's inaugural investment grade bond issuance. SNF Headwinds Persist: While these transactions result in improved SBRA's tenant diversification (a credit positive), the company still will derive a majority of its revenues from the skilled nursing segment, which weakens most quality metrics (i.e. tenant coverage and occupancy). Quality dilution is inherently a credit negative; it implies the likelihood of a lease default / or rent reduction is higher. This has increasing relevance given the continued headwinds for skilled nursing operators. Fitch expects skilled nursing revenues and profitability will continue to be constrained by volume shifting to other settings, shorter stays, expense growth (i.e. rent and labor) and price growth that either does not keep up with inflation or is under pressure (depending on payor). DERIVATION SUMMARY The 'BBB-' IDR reflects a skilled-nursing focused REIT with good tenant diversification, strong financial policies and the scale necessary to be a meaningful issuer in the debt and equity capital markets. The ratings are limited by what will remain a still immature debt capital stack given some debt maturity concentrations and a higher utilization of bank debt than similarly rated peers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --The $371 million Enlivant transaction is expected to close prior to YE2017, $378 million of the skilled nursing portfolio having already closed on September 19, 2017 and the remaining $52 million of skilled nursing facilities closing by YE2017; --The transactions are anticipated to take leverage up to approximately 5.75x from 5x until the incremental Genesis dispositions ($425 million to $475 million) are completed. After this occurs, issuer expects leverage to sustain between 4.5x to 5.5x; RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Fitch's expectation of leverage sustaining below 4.0x (leverage was 5.2x and 5.0x for TTM ending June 30, 2017 and year ended Dec. 31, 2016, respectively); --Fitch's expectation of fixed-charge coverage sustaining above 3.5x (coverage was 3.1x and 3.2x for the TTM ending June 30, 2017 and year ended Dec. 31, 2016, respectively). --Should Sabra become a more diversified health care REIT, where skilled nursing facilities comprise a substantially lower percentage of net operating income without a material change in its financial policies. --SBRA demonstrating access to capital consistent with higher rated peers. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Further pressure on operators through potential legislation revisions that result in lower coverages or other changes in regulatory framework; --Fitch's expectation of leverage sustaining above 5.5x; --Fitch's expectation of fixed-charge coverage sustaining below 2.5x. LIQUIDITY Pro forma for the transactions, Sabra will have made $801 million in investments, which may result in pressured liquidity in the shorter term. We anticipate the acquisitions will be funded through a combination of an approximate $350 million follow-on equity offering, use of the company's ATM program, and an increase in the revolving credit facility that may approach approximately 50% of capacity until asset sales from the Genesis portfolio are monetized in 2018. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Sabra Health Care REIT, Inc. --Long-Term IDR at 'BBB-'; Outlook Stable; --Cumulative redeemable preferred stock at 'BB' . Sabra Health Care Limited Partnership --Long-Term IDR at 'BBB-'; Outlook Stable; --Unsecured revolving credit facility at 'BBB-'; --Unsecured term loan at 'BBB-'; --Senior unsecured notes at 'BBB-'. Sabra Canadian Holdings. LLC --Senior guaranteed term loan at 'BBB-'. Contact: Primary Analyst Peter Siciliano Director +1-646-582-4760 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Britton Costa, CFA Senior Director +1-212-908-0524 Committee Chairperson Joan Okogun Senior Director +1-212-908-0384 Date of Relevant Rating Committee: Sept. 25, 2017 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 discussed 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 $1 million of cash for working capital purposes that is otherwise unavailable to repay debt; --Fitch has included 50% of the company's preferred operating units as debt in relevant metrics. 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