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Fitch Rates DDR's Senior Unsecured Notes 'BBB-'; Outlook Stable
May 23, 2017 / 3:32 PM / in 7 months

Fitch Rates DDR's Senior Unsecured Notes 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, May 23 (Fitch) Fitch Ratings has assigned a 'BBB-' rating to DDR Corp.'s (NYSE: DDR) senior unsecured notes. The Rating Outlook is Stable. A full list of Fitch's current ratings for DDR follows at the end of the release. KEY RATING DRIVERS DDR's 'BBB-' Issuer Default Rating (IDR) takes into account the company's credit strengths including refining the quality of its retail property portfolio, strong expected fixed charge coverage for the rating, a granular tenant roster, and proven access to a number of capital sources. Fitch also anticipates leverage will be toward the stronger end of the range it considers appropriate for the 'BBB-' rating over the next 12 to 24 months. Credit concerns include the frequency of leadership turnover and weak unencumbered asset coverage of net unsecured debt. While DDR continues to grow its unencumbered pool, Fitch projects that unencumbered asset coverage of unsecured debt will remain below 2.0x in the near term. Refining Asset Base DDR's strategic plan entails owning and operating market-dominant power centers in select markets with favorable population demographics, thereby generating consistent cash flow growth while opportunistically engaging in capital recycling. The Puerto Rico portfolio remains a laggard within the larger DDR portfolio, but management has reaffirmed its intention to avoid becoming a distressed seller. Management has also committed to repositioning its portfolio via redevelopment opportunities arising from tenant bankruptcies or by taking space offline upon expiration of existing leases. DDR accelerated disposition plans for lower quality assets, and these sales should result in an improved credit profile. Fitch expects net proceeds from asset sales to be focused towards strengthening the balance sheet, with the primary objective of delevering while also reinvesting into the remaining portfolio. Ongoing Portfolio Review and Simplification DDR segmented the portfolio by examining market and asset factors. This analysis was predicated on the company's focus on power centers based on the belief that they have greater scale, a larger mix of tenants, and serve larger trade areas than grocery-anchored neighborhood shopping centers, which Fitch views favorably. Currently, DDR's portfolio demographics are below average with respect to its publicly traded shopping center REIT peers, as measured by population density and average household income. Secular Retailer Trends Favor Power Centers DDR has limited absolute tenant concentration. Major tenants are TJX Companies (3.8% of consolidated base rents for the TTM ended March 31, 2017), Bed Bath & Beyond (3.1%), PetSmart (2.9%), and Dick's Sporting Goods (2.5%). The top 20 tenants comprised 36.2% of rental revenues, more concentrated than its REIT peers. Numerous retailers, particularly the value and convenience segments, are exploring larger footprints while non-traditional grocers have gained market share of traditional retailers, which should bolster power center demand. C-Suite Finally Stabilized David Lukes is the company's fifth CEO since 2009, and leadership turnover has likely prevented the company from adopting a consistent financial and portfolio strategy. Fitch views Mr. Lukes and other members of senior management positively given their prior roles at publicly-traded REITs across the retail sector. Leverage Appropriate for 'BBB-' Fitch projects that leverage, excluding preferred stock, will remain in the mid-6x range over the next 12 to 24 months due to asset sales and organic EBITDA growth, which would be strong for the 'BBB-' rating. Leverage was 6.4x for the TTM ended March 31, 2017, compared to 6.3x in 2016 and 7.2x in 2015. When including 50% of preferred stock in total debt, DDR's leverage was 6.6x for the TTM ended March 31, 2017. Low Unencumbered Asset Coverage (UA/UD) As of March 31, 2017, DDR's unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 1.8x, which is weak for the 'BBB-' rating. The company's UA/UD has remained consistently below the typical 2.0x threshold that Fitch views as appropriate for investment-grade REITs, and Fitch does not expect meaningful improvement in this ratio in the near term, absent delevering. Strong Leasing Spreads and Fixed Charge Coverage Blended leasing spreads on new and renewal leases were 5.6% in 1Q17 following 9.1% growth in 2016. DDR has reported strong 8% - 10% blended leasing spreads each year since 2013 leading to organic EBITDA growth within the portfolio. Organic growth combined with reduced interest costs has improved DDR's fixed charge coverage to 2.8x for the TTM ended March 31, 2017. Fitch anticipates fixed charge coverage will remain in the high-2x through 2018, as the company refinances higher cost secured mortgage maturities with more cost-effective unsecured bond issuances, which is strong for the 'BBB-' rating. Weak Liquidity Coverage Fitch forecasts DDR's liquidity coverage at 0.6x through year-end 2018 when including development cost-to-complete. The shortfall is largely attributable to $1.3 billion in pro rata debt maturities. The company's AFFO payout ratio was 73.1% in 1Q'17, above DDR's typical mid- to high-60% average payout, due to reduced cash flow from the company's accelerating disposition program that saw more than $650 million in assets sold between 4Q16 - 1Q17. Fitch does not expect the company to reduce its dividend, so it is likely DDR's payout will remain in the low 70% range in the near term. Fitch estimates DDR can retain over $100 million of internally generated liquidity annually even with an elevated 1Q17 payout ratio relative to previous periods. Preferred Stock Notching The two-notch differential between DDR's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch's criteria report, 'Non-Financial Corporates Hybrids Treatment and Notching Criteria,' dated April 27, 2017, the company's preferred stock is deeply subordinated and has loss absorption elements that would likely result in poor recoveries in the event of a corporate default. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for DDR include: --Net disposition proceeds expected to be used largely for delevering; --$225 million of acquisitions and development expenditures in each 2017 and 2018; --Maturing debt refinanced with the issuance of new unsecured bonds; --Fitch assumes no equity issuance through the forecast period. RATING SENSITIVITIES The following factors may result in positive momentum in the ratings and/or Outlook: --Fitch's expectation of leverage, excluding preferred stock, sustaining below 6.5x (leverage was 6.4x for the TTM ended March 31, 2017); --Fitch's expectation of growth in the size and quality of the unencumbered pool with unencumbered assets (unencumbered NOI divided by a stressed capitalization rate of 8%) covering net unsecured debt by 2.5x (UA/UD was 1.8x at March 31, 2017); --Fitch's expectation of fixed charge coverage sustaining above 2.3x (coverage was 2.8x for the TTM ended March 31, 2017). The following factors may result in negative momentum in the ratings and/or Outlook: --Fitch's expectation of leverage sustaining above 7.5x; --UA/UD sustaining below 2.0x; --Continued management turnover, reducing market confidence in the company's ability to execute on its strategy; --Fitch's expectation of fixed charge coverage sustaining below 2.0x; --Base case liquidity coverage sustaining below 1.0x (0.6x for period April 1, 2017 - Dec. 31, 2018). FULL LIST OF RATING ACTIONS Fitch currently rates DDR as follows: DDR Corp. --IDR 'BBB-'; --Unsecured revolving credit facilities 'BBB-'; --Unsecured term loan 'BBB-'; --Senior unsecured notes 'BBB-'; --Senior unsecured convertible notes 'BBB-'; --Preferred stock 'BB'. The Rating Outlook is Stable. Contact: Primary Analyst Steven Marks Managing Director +1-212-908-9161 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Stephen Boyd, CFA Senior Director +1-212-908-9153 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 Date of Relevant Rating Committee: Oct. 6, 2016 Summary of Financial Statement Adjustments - Financial statement adjustments that depart material 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; --Recurring JV distributions are added to EBITDA to calculate leverage and fixed charge coverage; --Fitch adjusted the historical and projected net debt by assuming the issuer requires $15 million of cash for working capital purposes and is otherwise unavailable to repay debt. 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