–Issuer Default Rating (IDR) at ‘A+’; –$300 million unsecured revolving line of credit at ‘A+’; –$3.6 billion preferred stock at ‘A’.
In addition, Fitch assigned an ‘A’ rating to the company’s $225 million 6.375% series Y preferred stock priced on March 10, 2014. Fitch does not rate the company’s $700 million one-year unsecured term loan as this is a short-term obligation.
The Rating Outlook is Stable.
KEY RATING DRIVERS The rating affirmation reflects the company’s minimal debt, which results in low leverage and limited refinance risk, coupled with Fitch’s expectation of sustained improvements in fixed-charge coverage due to solid performance of the company’s self-storage property portfolio and lower preferred dividends. Credit strengths also include strong liquidity and a long management track record.
The rating is balanced by the company’s focus on a specialty property type and moderate portfolio concentration in regions such as California and Texas, although the portfolio includes over 2,200 properties in 38 states and seven European countries.
UNCONVENTIONAL FINANCING STRATEGY LIMITS REFINANCE RISK Fitch expects PSA’s net debt plus preferred stock-to-recurring operating EBITDA ratio to sustain in the mid-2.0x range over the next 12 to 24 months, which is solid for the ‘A+’ IDR. Fitch expects to see modest improvement over the rating horizon (typically two to three years) due to mid-to-low single-digit same-store net operating income (NOI) growth and incremental NOI as the company stabilizes recent developments and acquisitions. In a stress case in which same-store NOI declines, this metric would approximate 3.0x, which would be consistent with an IDR of ‘A’.
PSA’s unique financing strategy, which emphasizes preferred equity, results in minimal refinance risk that supports Fitch’s ratings for the company. PSA’s debt-to-recurring operating EBITDA, was 0.6x as of Dec. 31, 2013, compared with 0.3x and 0.2x as of Dec. 31, 2012 and Dec. 31, 2011, respectively. While not indicative of leverage, given the perpetual nature of PSA’s preferred stock, the ratio of net debt plus preferred stock-to-recurring operating EBITDA was appropriate for the ‘A+’ IDR at 3.2x as of Dec. 31, 2013, compared with 2.5x and 2.8x as of Dec. 31, 2012 and Dec. 31, 2011.
STRONG FUNDAMENTALS AIDED BY LOW SUPPLY GROWTH Fitch expects PSA’s same-store NOI growth to moderate, but remain solidly positive through 2016. Conservatively, same-store NOI growth should taper off but remain in the positive low- to mid-single-digits during the forecast period. Higher rental rates for new and renewal leases will drive the majority of the gains. Occupancies are expected to remain flat and are conservatively assumed that expenses grow by approximately 2% per year, compared to expense decreases of 1.3% and 2.2% in 2013 and 2012.
PSA’s U.S. portfolio same-store NOI grew by 8.2% during 2013; Europe decreased by 3.4% due to moderate oversupply in select markets against the backdrop of weak macro-economic conditions. Low levels of new supply for the industry are supporting PSA’s operating fundamentals. The company’s realized annual rent per occupied square foot in the U.S. same-store portfolio increased by 3.8% to $14.13 in 2013 from $13.61 in 2012. Weighted average occupancy for the year rose by 1.4% to 93.3% in 2013 from 91.9% in 2012.
PSA’s internal growth has slightly lagged its public REIT peers during the last five years. Since 2009 the company has averaged 3.8% same-store NOI growth vs. 4.3% growth for the sector. PSA’s peers have generally benefited from larger occupancy gains stemming from a greater amount of vacant space at the trough of the last cycle. Indeed, PSA’s occupancy has averaged a 540-basis point premium to the sector during the last five years, but the spread has compressed from 6.5% in 2009 to 3.2% in 2013.
Differences in calculation methodologies can challenge making same-store NOI growth comparisons across REITs, including self-storage REITs. For example, some companies will include tenant insurance in same-store NOI; PSA does not. Additionally, PSA allocates internet marketing expense at the property level while some of its peers reflect this expense at the corporate level, in general and administrative expense.
REFINANCING OF HIGHER-COST PREFERRED BOOSTS COVERAGE Fitch anticipates that fixed-charge coverage (FCC) will approach the mid-6.0x range by 2016, benefiting from preferred stock transactions during 2013. In a stress case in which same-store NOI declines by approximately 4%, coverage would fall to the mid-5.5x range, which would remain consistent with the ‘A+’ IDR.
Fitch expects FCC to sustain at levels appropriate for the ‘A+’ rating. FCC was 6.3x for 2013, compared with 5.5x and 4.7x in 2012 and 2011, respectively. Improving fundamentals and lower preferred dividends via lower-coupon issuance used to redeem higher cost preferred stock have contributed towards improving coverage. Fitch defines coverage as recurring operating EBITDA less recurring capital expenditures divided by total interest incurred and preferred dividends and distributions.
NEAR-TERM LIQUIDITY PRESSURE PSA’s $700 million unsecured term loan that matures on Dec. 2, 2014 is pressuring its near-term liquidity coverage. The company has taken several actions subsequent to the year-end to improve its liquidity position. These include the sale of a 51% interest in its loan to Shurgard Europe ($216 million of net proceeds) and the issuance of $225 million of preferred equity. Fitch estimates that the company has paid down $50.1 million of year-end revolver debt and approximately $300 million under its term loan with the proceeds from these activities. Pro-forma liquidity coverage has improved to 1.4x from 0.9x at year-end 2013.
Fitch defines liquidity coverage as liquidity sources divided by uses. Sources of liquidity include unrestricted cash pro forma, availability from the unsecured revolving credit facility, and projected retained cash flows from operating activities after dividends and distributions. Uses of liquidity include debt maturities and projected recurring capital expenditures.
The company has excellent contingent liquidity from a large unencumbered self-storage property pool. Approximately 97.6% of the company’s $12.3 billion real estate portfolio was unencumbered as of Dec. 31, 2013. Fitch calculates that based on a 10% capitalization rate on the company’s unencumbered property NOI, unencumbered asset coverage of unsecured debt and preferred stock was 3.2x as of Dec. 31, 2013 and 3.5x pro forma for the company’s sale of a 51% interest in its Shurgard Europe loan and $225 million preferred equity issuance.
DISCIPLINED AND CYCLE-TESTED MANAGEMENT Public Storage’s management team has navigated through various commercial real estate and capital market cycles with a conservative balance sheet, which is factored into the ‘A+’ rating. The company’s utilization of preferred stock provides permanent funding for a specialty property type that may be less liquid than other commercial real estate sectors. This strategy also insulates Public Storage from weak capital market environments, which Fitch views favorably.
MODERATE GEOGRAPHIC PORTFOLIO CONCENTRATION RISK The company has moderate portfolio concentration within certain U.S. regions, including Southern California at 12% of rentable square feet, Texas at 12% and Florida at 12%. While not anticipated by Fitch, reduced economic activity and an increase in price-sensitive customers in geographic regions in which PSA is concentrated could reduce overall earnings power.
STABLE OUTLOOK The Stable Outlook reflects the company’s specialty focus coupled with Fitch’s view that fixed-charge coverage will sustain in the mid-6.0x range over the rating horizon. The Stable Outlook also reflects that the size of the unencumbered portfolio is also not likely to change materially.
The one-notch difference between the company’s IDR and preferred stock rating reflects that unlike the majority of preferred stock issuers in the REIT industry (which have a two-notch difference between their IDRs and preferred stock ratings), Public Storage has, and is expected to maintain, limited levels of debt. Therefore recoveries of preferred stock would likely be stronger than recoveries of preferred stock of other REITs.
Fitch’s ratings for PSA contemplate a moderate level of transitional (i.e. short-term) unsecured debt in its capital structure used to bridge the timing gap between completing investments and raising permanent common and/or preferred equity capital funding. However, the one-notch differential between PSA’s IDR and its preferred obligations has little tolerance for any long-term unsecured debt in PSA’s capital stack.
RATING SENSITIVITIES The following factors may result in positive momentum on the ratings and/or Outlook:
–Fitch’s expectation of fixed-charge coverage sustaining above 7.0x (coverage was 6.3x in 2013); –Fitch’s expectation of net debt plus preferred stock-to-recurring operating EBITDA sustaining below 2.0x (this metric was 3.2x at Dec. 31, 2013).
The following factors may result in negative momentum in the ratings and/or Outlook:
–Fitch’s expectation of fixed-charge coverage sustaining below 4.0x; –Fitch’s expectation of net debt plus preferred stock-to-recurring operating EBITDA sustaining above 3.0x.
In addition, a change in PSA’s stated financing strategy that included the issuance of long-term unsecured debt would likely cause Fitch to revise the company’s preferred obligations down two-notches below its IDR, as opposed to the current one-notch differential.
Applicable Criteria and Related Research: –‘Rating U.S. Equity REITs and REOCs: Sector Credit Factors,’ Feb. 26, 2014′ (Feb. 26, 2014); –‘Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis’ (Dec. 23, 2013); –‘Recovery Ratings and Notching Criteria for REITs’ (Nov. 19, 2013); –‘Corporate Rating Methodology’ (Aug. 5, 2013); –‘Parent and Subsidiary Rating Linkage’ (Aug. 5, 2013).
Applicable Criteria and Related Research: Parent and Subsidiary Rating Linkage https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685552 Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139 Recovery Ratings and Notching Criteria for Equity REITs https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722363 Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863 Criteria for Rating U.S. Equity REITs and REOCs https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=700091