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Fitch Rates Terreno's Private Placement Offering 'BBB-'
June 22, 2017 / 5:41 PM / 6 months ago

Fitch Rates Terreno's Private Placement Offering 'BBB-'

(The following statement was released by the rating agency) NEW YORK, June 22 (Fitch) Fitch Ratings has assigned a 'BBB-' rating to the private placement offering issued by Terreno Realty LLC, the operating partnership of Terreno Realty Corp (NYSE: TRNO). The offering consists of $100 million of unsecured notes due 2024 that will bear interest at 3.75%. The transaction is anticipated to close on or around July 14, 2017. As part of the use of proceeds, the company intends to redeem all of its 7.75% Series A Cumulative Preferred Stock on July 19, 2017. KEY RATING DRIVERS Fitch's ratings take into account TRNO's portfolio concentration in strong markets, transparent industrial property-focused business model, experienced management, and credit metrics that are moderately strong for the rating. The potential for greater cash flow volatility stemming from market, asset and tenant concentration risk and possible missteps surrounding the company's value-added acquisition-led growth strategy balance these credit positives. Also, the company has a less developed and shorter track record as an unsecured borrower. The Stable Outlook reflects Fitch's expectation that TRNO will maintain credit metrics that are consistent with the 'BBB-' rating over the two-year Outlook horizon, as well as Fitch's view of near- to medium-term industrial property fundamentals. Portfolio Concentrated in Strong Markets: Fitch expects TRNO's portfolio market fundamentals to outperform the U.S. average over the near- to medium-term, based on its superior demographics and barriers to new supply. The company's portfolio is located in six of the strongest U.S. industrial markets, characterized by vibrant and growing local and regional economies, favorable population and income demographics and meaningful barriers to new supply. The above-average occupancies and rents in Terreno's markets highlight these strong fundamentals relative to the total U.S. industrial property base. Institutional investor and lender interest in TRNO's assets is likely above its peer average given the desirable market locations, thus supporting the company's contingent liquidity position. Transparent Operating Strategy: Terreno's transparent, well-defined operating strategy is a credit positive. The company targets 100% fee simple ownership of industrial assets in six key logistics markets that include Northern NJ/NY (23.7% of annualized base rent), D.C./Baltimore (23.2%), Los Angeles (14.4%), Miami (13.9%), San Francisco (13.5%) and Seattle (11.3%). TRNO's strategy does not contemplate investments in ground-up development or unconsolidated joint venture partnerships (JVs). The absence of these items helps simplify the company's business model, improve financial reporting transparency and reduce potential contingent liquidity claims. Fitch's ratings for TRNO include some flexibility for selective ground-up development at existing owned in-fill properties, as well as a limited amount of JVs if, for example, only a partial interest in an attractive industrial portfolio in its markets was available for purchase. Appropriate Credit Metrics: Fitch expects TRNO's leverage to sustain within a range of 6.0x-6.5x through 2019, on an adjusted basis that includes a full-year's contribution from external investment activity. TRNO's leverage was 5.2x for the TTM ending March 31, 2017, which is appropriate for the 'BBB-' rating. The company's leverage was 5.6x including 50% equity credit for its perpetual preferred stock in total debt. Fitch expects the company's fixed-charge coverage (FCC) to improve moderately over the Rating Outlook horizon as the company stabilizes value-add acquisitions and achieves better leverage of its fixed costs as total assets grow. Fitch expects the company's FCC will be in the mid-3.0x range through 2019. The company has publicly committed to financial policies through the cycle that are consistent to moderately strong for a 'BBB-' rated REIT with TRNO's asset profile. These include maintaining leverage below 6.5x and FCC above 2.0x. The company's dividend policy is to pay 100% of its taxable net income to its equity holders. Fitch expects TRNO's dividend payout ratio of AFFO to range between the mid-80% to mid-90% level over the rating horizon, excluding stabilization capex related to value-add acquisitions. Experienced Management: TRNO has a strong management team with extensive industrial real estate and capital markets experience. Many of the company's key executives previously held high-level executive positions at AMB Property prior to its merger with ProLogis. Portfolio Market and Tenant Concentration: Fitch expects the portfolio's asset and tenant granularity to improve as TRNO executes on its value-add acquisition-led growth strategy. However, we do not expect the company to expand beyond its six major markets. TRNO's concentrated portfolio strategy exposes it to idiosyncratic market and asset risks and could result in above-average property income volatility. Examples could include a regional economic downturn or loss of a significant tenant. The company's small size and concentration in markets with higher per square foot industrial values relative to its peers has contributed to its below-average asset granularity. However, the multiple-building nature of many of its larger assets as well as their infill locations helps to offset the asset concentration risk. Two markets - Northern NJ/NY and D.C./Baltimore - comprised 46.9% of the company's ABR as of March 31, 2017. Moreover, its 10 largest properties (at cost) accounted for roughly 35% of its total investment in real estate. TRNO's top-20 tenants comprised 37.8% of ABR at March 31, 2017, which is more concentrated than the industrial REIT peer median of slightly more than 20%. Moreover, the company's largest tenant (FedEx Corp.) was 5.7% of its ABR versus a comparable peer median top tenant exposure of approximately 2%. Fitch views the company's portfolio tenant concentration as a credit risk that could lead to greater cash flow volatility. However, the generally strong credit quality of its largest tenants and multiple leases with several of these tenants help balance the concentration risk. Execution Risk in Value-Add Acquisitions: TRNO's external growth strategy centers on the acquisition and stabilization of industrial assets, primarily through some combination of lease-up and property redevelopment. Fitch generally views the value-add strategy as being in between "core" investments and ground-up development in risk/return space. Value-add acquisitions can entail additional risk given less familiarity with an asset compared to the repositioning of existing owned assets. However, Fitch views TRNO management's extensive industrial property experience and the small dollar value and homogeneity of industrial assets as risk mitigants. The company has improved its portfolio occupancy to 97.4% at 1Q17 from 90.7% at 1Q16, demonstrating its ability to successfully stabilize value-add acquisitions. Improving Unsecured Capital Access: Fitch continues to view TRNO as a less established unsecured bond issuer. However, this transaction improves TRNO's demonstration of its added financial flexibility; it has now raised $250 million of private placement unsecured notes since September 2015. This repeated, ongoing access to private placement unsecured notes is an important milestone in the company's transition to a predominantly unsecured borrowing strategy. Preferred Stock Notching: The two-notch differential between TRNO's Issuer Default Rating (IDR) and preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB-' IDR. 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. Upon the expected closing of the notes offering on July 14, 2017, the company intends to redeem all of its 7.75% Series A preferred stock on July 19, 2017, at which point the company will not have any preferred stock outstanding DERIVATION SUMMARY TRNO's ratings reflect the issuer's strong portfolio of industrial real estate in the top U.S. markets with a solid management team and leverage that is relatively low for the rating category. The company should experience outsized growth in the next few years and has a rather simple business model with minimal exposure to development risk. These strengths are partially offset by lower FCC and higher dividend payout ratio than its peers as well as a smaller size and scale, which provides less overall granularity and diversification in comparison to the other larger industrial REITs. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for TRNO include: --GAAP SSNOI growth in the 4% to 5% range through the 2018 projection period; --Net acquisitions of roughly $200 million to $300 million through 2018; --Annual unsecured issuance of between $50 million and $150 million; --Equity issuance of $100 million to $150 million per annum; --The company unencumbers assets as mortgages mature with the proceeds from new unsecured debt and equity raises. RATING SENSITIVITIES The following factors may have a positive impact on the ratings and/or Rating Outlook: --TRNO's demonstrated adherence to its financial policies during through the cycle given its value-add acquisition strategy, which could result in greater relative cash flow volatility; --Fitch's expectation of leverage sustaining in the low 6.0x range (leverage was 5.2x for the TTM ended March 31, 2017); --Fitch's expectation of FCC sustaining above 3.0x; --Increased asset and tenant level diversification within the company's concentrated, six-market portfolio; --Further demonstrated access to the unsecured bond market. The following factors may have a negative impact on the ratings and/or Rating Outlook: --Fitch's expectation of leverage sustaining above 7.0x; --Fitch's expectation of FCC sustaining below 2.0x. LIQUIDITY TRNO's sources of capital cover its uses by 1.9x for the April 1, 2017 to Dec. 31, 2018 period under Fitch's base case liquidity analysis after adjusting for events subsequent to quarter-end, including $100 million of private placement unsecured notes, $46 million of preferred stock redemption and $25.3 million of contracted dispositions, which was offset by $51.3 million of completed acquisitions. This includes $16 million drawn on the company's $200 million revolver, cash on hand, and a modest amount of retained cash flow after dividends as the company's primary sources of liquidity. Although near-term maturities are modest, the company's debt ladder has elevated maturities in the 2020s, consisting of term loans and unsecured borrowings. Fitch expects the company to refinance the 2021 term loan ahead of its stated maturity, most likely with proceeds from new unsecured private placement notes. TRNO's longer-dated maturities should decline as a percentage of total debt as the company executes its value-add acquisition growth strategy. TRNO's unencumbered assets cover its unsecured debt (UA/UD) by 2.4x using a direct capitalization approach of TRNO's annualized 1Q17 unencumbered net operating income (NOI) that assumes a stressed 8.75% through-the-cycle cap rate. Fitch expects the company's UA/UD to moderate to the low- to mid-2x range as it progresses in its unsecured borrowing strategy, which would remain appropriate for the 'BBB-' rating. FULL LIST OF RATING ACTIONS Fitch rates TRNO as follows: Terreno Realty Corporation --Issuer Default Rating (IDR) 'BBB-'; --Preferred Stock 'BB'. Terreno Realty LLC --IDR 'BBB-'; --Senior unsecured revolving line of credit 'BBB-'; --Senior unsecured term loan 'BBB-'; --Senior unsecured private placement notes 'BBB-'. The Rating Outlook is Stable. Contact: Primary Analyst Peter Siciliano Director +1 646 582 4760 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Stephen Boyd, CFA Senior Director +1 212 908 9153 Committee Chairperson Steven Marks Managing Director +1 212 908 9161 Date of Relevant Rating Committee: Sept. 14, 2016. Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage - Effective from 17 August 2015 to 27 September 2016 (pub. 17 Aug 2015) here Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis- Effective from 26 February 2016 to 27 April 2017 (pub. 29 Feb 2016) here Additional Disclosures Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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