Fitch Affirms Welltower at 'BBB+'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the ratings of Welltower, Inc. (NYSE: HCN) including the long-term Issuer Default Rating (IDR) at 'BBB+'. The Rating Outlook is Stable. A full list of rating actions follows at the end of the release.

KEY RATING DRIVERS

HCN's 'BBB+' IDR reflects the company's solid credit metrics, strong access to capital and a deep management team. Credit concerns center on the potential for higher volatility in operating cash flows given REIT Investment Diversification and Empowerment Act (RIDEA) structured investments through-the-cycle and Fitch's broader worries concerning the healthcare REIT sector's rapid growth and higher leverage than in prior years.

LOWER LEVERAGE BUT TOWARDS HIGH-END OF RANGE; FURTHER IMPROVEMENTS TO MODERATE

Fitch projects leverage will remain between 5.5x-6x over the next several years assuming blended 2.5% same store net operating income (SSNOI) growth, net dispositions in 2016 and future investments funded with a split of 40% debt/60% equity and/or proceeds from asset sales. Leverage in the mid-5x range is down from the 6x-7.7x levels reported for the years ended 2010-2013, but towards the high-end of the range that Fitch views to be appropriate for 'BBB+'. Fitch views leverage sustaining above 6x as being more consistent with a 'BBB' IDR. Fitch calculates leverage was 5.7x and 6x for the fourth quarter 2015 (4Q15) and 2015, respectively excluding preferred stock and 5.9x and 6.2x over the same periods when including 50% of preferred stock as debt.

Fitch's projections for HCN and its peers are sensitive to the timing, volume and funding mix of investment activity more so than other REITs that have a greater balance between acquisitions and dispositions. As such, Fitch places less emphasis on specific projections and more emphasis on the overarching expectation that the issuer will continue to modestly delever and will adjust investment activity to do so if it is unable or unwilling to issue equity or sell assets at then market prices.

Similar to leverage metrics, Fitch projects HCN's fixed charge coverage (FCC) will remain appropriate for the rating, in the low-3x range over the next several years. FCC was 3.4x for the year ended Dec. 31, 2015. Fitch defines FCC as recurring operating EBITDA less straight-line rents and recurring capital expenditures, divided by total cash interest incurred and preferred dividends.

FOCUSING ON PRIVATE-PAY, LOWER COST SETTINGS; HIGHER RIDEA RISK

HCN's investment thesis focuses on reducing reimbursement risk exposure (private pay comprised 89% of 2015 facility revenue mix) and focusing on lower cost settings, which Fitch views favorably. However, as a result, HCN's largest segment has been RIDEA seniors housing operating assets which made up 35.6% of 4Q15 NOI, followed by triple net seniors housing at 28% and skilled nursing/post-acute at 21%.

Fitch views RIDEA structured seniors housing as having the potential for higher volatility through the cycle than other healthcare property types. While Fitch acknowledges the strength of HCN's RIDEA performance to-date, it has not been proven through cycles as the investments were largely made in recent years after the changes in RIDEA regulations allowed for the investments. Operating fundamentals over the past few years have been largely accommodative but have been slowing from high single-digit growth rates to 3.2% for 4Q15 over 4Q14. New supply is currently and expected to continue to pressure senior housing operating fundamentals. Data from NICMAP indicates that construction comprises 5.6% of total inventory and it remains to be seen whether the impact on HCN's portfolio will be as isolated as it is expecting it to be. Fitch will assess HCN's ability to weather the supply through the operating performance of its RIDEA portfolio and how tenant coverage ratios change within the senior housing net lease portfolio.

HCN faces additional headline risk as its second largest tenant (14% of NOI), Genesis Healthcare, Inc., is a post-acute operator with significant skilled nursing (SNF) exposure. SNF margins are being pressured by increasing coverage under Medicare Advantage (i.e. shorter stays, lower rates), the DOJ investigations potentially influencing billing practices and pilot programs for bundled payments and coordinated care. Stronger operators should be able to manage these long-term challenges as they are fairly well-telegraphed rather than changes to the payment methodology like those that occurred in the Balanced Budget Act of 1997. As a result, we do not expect secular bankruptcies like those that occurred after BBA1997. Tenant credit issues will be determined by financial policies in the context of changes to reimbursement policy.

Healthcare REITs generally and HCN can benefit from two forms of cushion against this risk. The first being tenant rent coverage and the second being operating towards the lower end of their leverage range. Both measures are adequate indicating there should be little to no effect on HCN from SNF headwinds. However, these headwinds could dampen investor demand for REITs with exposure and increase the cost at which HCN could issue debt or equity.

APPROPRIATE LIQUIDITY & STRONG ACCESS TO CAPITAL

Fitch views HCN as having demonstrated strong access to multiple sources of capital across markets and types including in the United States, United Kingdom and Canada. HCN's primary source of liquidity is its $2.5 billion unsecured revolving credit facility due 2018 with a one-year extension option. The facility bears interest at LIBOR + 92.5bps and had $1.67 billion of availability at Dec. 31, 2015, before the receipt of $124 million of cash proceeds from a joint venture transaction and the $700 million note issuance proceeds. Debt maturities are generally well-staggered through 2018 when 7%-9% matures per year.

Fitch projects HCN's sources of liquidity cover its uses by 1.1x for the period Jan. 1, 2016 through Dec. 31, 2017 pro forma for the note issuance and announced acquisitions and joint venture proceeds. Sources of liquidity include unrestricted cash, availability under the company's unsecured credit facility pro forma, and projected retained cash flows from operating activities after dividends. Uses of liquidity include debt maturities, recurring maintenance capital expenditures, projected development costs and announced investments.

HCN's unencumbered assets provided sufficient contingent liquidity to unsecured bondholders. Assuming a stressed capitalization rate of 8.5%, unencumbered assets covered unsecured debt by 2.4x as of Dec. 31, 2015.

PREFERRED STOCK NOTCHING

The two-notch differential between HCN's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', 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.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for HCN include:

--Operating headwinds in the senior housing portfolio and at the operator level in skilled nursing pressure fundamentals and result in a deceleration but not decline in SSNOI growth;

--The issuer increasingly uses dispositions to fund developments and acquisitions;

--The issuer limits acquisition volumes if unable or unwilling to issue equity or dispose of assets to maintain leverage below 6x.

RATING SENSITIVITIES

The following factors may result in positive momentum in the ratings and/or Outlook:

--Fitch's expectation of leverage sustaining below 4.5x (leverage was 6.2x including 50% of preferred stock and 6x excluding at Dec. 31, 2015);

--Fitch's expectation of fixed-charge coverage sustaining above 4x (fixed charge coverage was 3.4x for the trailing 12 months (TTM) ended Dec. 31, 2015);

--Fitch's expectation of unencumbered asset coverage of unsecured debt at a stressed 8.5% capitalization rate sustaining above 4x (UA/UD was 2.4x at Dec. 31, 2015).

The following factors may result in negative momentum on the ratings and/or Outlook:

--Increased cash flow volatility through the cycle due to heightened RIDEA exposure and/or a material increase in RIDEA exposure;

--Fitch's expectation of leverage sustaining above 6x;

--Fitch's expectation of fixed-charge coverage sustaining below 3x;

--Fitch's expectation of liquidity coverage sustaining below 1x.

FULL LIST OF RATING ACTIONS

Fitch has affirmed HCN as follows:

Welltower Inc.

--Long-term IDR at 'BBB+';

--Senior unsecured revolving credit facility at 'BBB+';

--Senior unsecured term loans at 'BBB+';

--Senior unsecured notes at 'BBB+';

--Preferred stock at 'BBB-'.

HCN Canadian Holdings

--Senior unsecured guaranteed notes at 'BBB+'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially 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;

--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $100 million of cash for working capital purposes, which is otherwise unavailable to repay debt.

--Fitch has included 50% of perpetual preferred stock as debt.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=878264

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1003302

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1003302

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160426006416/en/

Fitch Ratings
Primary Analyst
Britton Costa, CFA
Director
+1-212-908-0524
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks
Managing Director
+1-212-908-9161
or
Committee Chairperson
Stephen Boyd, CFA
Senior Director
+1-212-908-9153
or
Media Relations
Alyssa Castelli, +1 212-908-0540
[email protected]
Elizabeth Fogerty, +1 212-908-0526
[email protected]

Source: Fitch Ratings

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