S&P Upgrades Extended Stay America (STAY) to 'BB-'; Notes Expected CMBS Debt Repayment

Standard & Poor's Ratings Services today said it raised its corporate credit rating on Charlotte, N.C.-based Extended Stay America (NYSE: STAY) to 'BB-' from 'B+.' The outlook is stable.

At the same time, we raised our issue-level rating on ESH Hospitality Inc.'s senior secured term loan to 'BB+' (two notches above the corporate credit rating) from 'B+' and revised our recovery rating on the term loan to '1' from '3.' The '1' recovery rating indicates our expectation for very high (90% to 100%) recovery for lenders in the event of a payment default. We also assigned the company's proposed $500 million senior unsecured notes issuance due 2025 our 'BB-' issue-level rating (the same as the corporate credit rating) and '3' recovery rating, indicating our expectation for meaningful (50% to 70%; lower half of the range) recovery for lenders in the event of a default.

The favorable revision of the term loan recovery rating reflects anticipated CMBS debt repayment using proposed notes proceeds. Given that CMBS lenders have a priority claim to ESH Hospitality's collateral value, a reduction in the level of CMBS debt results in a greater level of residual collateral value to cover the secured term loan, resulting in a higher recovery value for lenders in the event of a default.

"The upgrade reflects our expectation for sustained improvement in total adjusted debt to EBITDA below 5x and funds from operations to total adjusted debt above 12% through 2016," said Standard & Poor's credit analyst Carissa Schreck.

We expect a continuation of good operating fundamentals in the lodging industry and expected returns from renovation capital spending at Extended Stay will drive a moderate increase in revenue and EBITDA, resulting in a good cushion compared to our 5x adjusted debt to EBITDA and 12% FFO to total debt thresholds for the "aggressive" financial risk assessment by 2016. We incorporate into these credit measures our expectation for the company to continue to invest a significant amount of capital in hotel reinvestment, maintenance spending, and IT-related projects over the next two years.

The stable outlook reflects our expectation for sustained improvement in operating performance that enables the company to sustain total adjusted debt to EBITDA below 5x and FFO to total adjusted debt above 12% over the next two years. In addition, we expect EBITDA coverage of interest expense to remain good, above 4x, over the same period.

We could lower the rating if operating performance is materially worse than our current expectation because of a substantial decline in RevPAR performance or renovation efforts that do not generate a meaningful return, resulting in debt to EBITDA above 5x and FFO to total debt below 12% on a sustained basis. Although unlikely given the company's improving hotel portfolio and receptive capital markets, if we begin to believe that Extended Stay will have unexpected difficulty refinancing a significant amount of CMBS debt over the next several years, we could lower the rating.

An upgrade is unlikely given Extended Stay's public leverage target of 4x. However, we could raise the rating if the company sustains total adjusted debt to EBITDA and FFO to total adjusted debt below 4x and above 20%, respectively.

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