Equity REITs Toe the Line on Credit

Recapitalized companies reduce their dependence on unsecured credit facilities.

Liquidity positions of U.S. equity real estate investment trusts (REITs) have strengthened considerably over the past year. After harnessing liquidity for defensive measures most of last year, most equity REITs rated by Fitch can now focus more intently on growing their businesses. Armed with ample liquidity, these REITs are now positioned to consider property acquisitions and new development. Nevertheless, Fitch expects this activity to be relatively modest until a more robust economic recovery emerges.

Strong liquidity positions among equity REITs are evident in most REITs' reduced use of unsecured lines of credit. While this type of capital continues to be an important source of liquidity for equity REITs to be used for working capital, property acquisitions and development, REITs have been drawing less frequently on their unsecured lines of credit.

This is primarily a function of significant equity and unsecured bond issuance over the last year, the proceeds of which were used primarily to repay amounts outstanding on unsecured lines of credit. In addition, nearly all REITs curtailed their development pipelines, which resulted in less need to use revolving credit lines. The average percentage drawn from REITs' revolving credit facilities has declined by more than half to 15.9% as of June 30, 2010, from its peak of 37.5% as of March 31, 2009.

Changing credit terms

During the financial crisis, there was some concern that unsecured revolving lines of credit would be converted to secured lines upon their maturity. However, most companies have been able to renew maturing lines of credit on an unsecured basis, albeit at more onerous terms such as reduced line of credit amounts, higher rates, inclusion of pricing floors, shorter terms as well as more stringent covenants.

While Fitch does not anticipate broad rating changes due to the more onerous terms contained in renewals of unsecured lines of credit, it will monitor the impact of these changes on companies' financial flexibility, liquidity and profitability.

The most widespread change to terms for unsecured lines of credit has been higher interest rates, both through higher spreads on amounts drawn and higher annual facility fees. While higher interest expense will impact REIT coverage metrics, the impact should be relatively limited, presuming amounts drawn do not rise sharply and prompt rating changes.

Banks have reduced the size of unsecured revolving lines of credit, although this practice has been less common than initially expected. Three of the nine Fitch-rated REITs that renewed their lines had the size reduced. The cuts ranged from 11.1% to 37.5%, with an average cut of 27.7%, in line with Fitch's expectations for a one-third reduction in line sizes.

Fitch considers the ability of larger U.S. banks to fund lines of credit quite good, given that many of these banks have improved their capital and liquidity positions considerably over the past year.

The other six Fitch-rated companies that renewed their unsecured credit facilities since April 2009 maintained or increased the total size of the line. The average change in size was 19%, and ranged from 0% to 48%.

Counter measures

Actions taken by companies over the past few years to enhance liquidity will help offset the impact of smaller lines of credit going forward. These steps have included deleveraging, new unsecured bond issuance, and a sharp drop in development. Consequently, most companies still have sufficient liquidity to meet their obligations through 2011.

Another trend Fitch noted in unsecured credit facility renewals was somewhat shorter facility terms and fewer extension options. Most REITs have renewed their facilities for a total of three years including extension options, reflecting a one- to two-year reduction from their previous facilities.

Most REITs have demonstrated prudence in maintaining liquidity during and following the financial crisis. As the capital markets recover and REITs reposition themselves for growth, Fitch will maintain a positive bias toward companies that maintain ample liquidity levels. Conversely, Fitch will view with more caution those REITs that pursue growth in a manner that sacrifices liquidity and balance sheet strength.

Steven Marks is a managing director and head of the U.S. REIT group at Fitch Ratings. He can be reached at [email protected]. Linda Hammel, a director in Fitch's U.S. REIT group, contributed to this article.

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