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Fitch Affirms HCP post-HCR Rent Reduction and Lease Amendment
[March 30, 2015]

Fitch Affirms HCP post-HCR Rent Reduction and Lease Amendment


Fitch Ratings has affirmed HCP, Inc.'s (NYSE: HCP) ratings including the Issuer Default Rating (IDR) at 'BBB+' and maintains the Stable Rating Outlook. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The affirmation of HCP's IDR at 'BBB+' reflects that the issuer's conservative capitalization provided a sufficient buffer against the potential for reduced rent from its largest tenant and allowed for ratings stability. Fitch expects HCP will be able to restore key credit metrics from the weaker end of the range to past levels over the next one-to-two years via organic growth, given its largely triple-net lease portfolio with contractual rental escalators.

Notwithstanding the manageable immediate effects, the largest remaining concerns surrounding HCP will be the sufficiency of the rent reduction (i.e. HCR ManorCare's (HCR) ability to grow enough to improve coverage to industry averages or require additional reductions in the future) and the impact on HCP's equity valuation. While HCP does not need to issue equity to maintain its current capitalization, Fitch views consistent and appropriately priced capital markets access as a key factor for all REIT ratings given distribution requirements. Furthermore, equity issuance has been critical in allowing HCP and its healthcare peers to fund the sizable acquisition volume largely on a leverage-neutral basis.

RENT REDUCTION; LONG-TERM SUFFICIENCY UNCERTAIN

On March 30, 2015, HCP announced that it had entered into an agreement to amend the lease with HCR, its largest tenant. The agreement reduces 2015 cash rent by $68 million ($49.7 million versus 2014 levels), extends the term by five years and provides HCP with $525 million of other considerations (i.e. nine additional facilities and a PIK note). HCP expects the amendments coupled with the to-be-completed sale of 50 underperforming assets operated by HCR should improve coverage metrics by approximately 20%-30%. HCP estimates pro forma guarantor fixed-charge coverage will improve to 1.3x from the 1.07x projected coverage based on HCR's 2015 base financial forecast and facility level coverage will improve to 1x from 0.8x at Dec. 31, 2014. Such levels imply HCR will have sufficient free cash flow to honor the lease though it will still require growth to forestall coverage reversions and to improve towards the industry average.

LEVERAGE INCREASES TWO TENTHS OF A TURN

Fitch estimates HCP's leverage will increase to 5.7x pro forma for the lease amendment and asset sales ("pro forma") from 5.5x for the year and quarter ended Dec. 31, 2014. HCP should be able to reduce leverage back towards the low-to-mid-5x range via organic growth assuming no other rent reductions which reduces execution risk. Fitch views leverage sustaining between 4.5x - 6x as appropriate for HCP at the 'BBB+' IDR. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA including recurring cash distributions from joint venture operations.

LONG-TERM IMPACT ON (News - Alert) EQUITY VALUATION IS FOCAL POINT

Notwithstanding the immediate effects on headline metrics, the largest question concerns the impact on the price at which HCP can issue equity. Fitch views consistent and appropriately priced debt and equity capital as key factors to REIT ratings as distribution requirements necessitate consistent (but not constant) access. Equity issuances have been of increased importance to HCP and its healthcare peers, allowing them to quickly fund their rapid growth largely on a leverage-neutral basis.

On one hand, equity investors may have been expecting a larger rent reduction, thus the amendment may be viewed positively and improve the issuer's capacity to issue equity. On the other hand, should the reduction be viewed as insufficient over the long term, the overhang could remain.

CONTINGENT LIQUIDITY DETERIORATES

HCP's contingent liquidity, as measured by unencumbered asset coverage of unsecured debt, will decline to 1.7x-2.2x, assuming a stressed 8%-10% capitalization rate, from 2x-2.4x at Dec. 31, 2014. As with leverage, contingent liquidity should improve via organic rowth.



FUNDING STRATEGY BASED ON DISPOSITIONS TO OFFSET CHARTWELL ACQUISITION

Fitch projects HCP will operate with a moderate liquidity deficit (0.9x) for the period Jan. 1, 2015 through Dec. 31, 2016 before the effects of dispositions and proceeds from debt repayments. HCP's largest use of cash will be to fund the $849 million portfolio acquisition from Chartwell Retirement Services in third quarter 2015. Fitch expects the issuer will look to use proceeds from the sale of 50 underperforming HCR assets which HCP expects will yield between $250 million and $350 million and, potentially, the repayment of certain loan obligations where HCP is the lender in order to fund the Chartwell portfolio. Fitch calculates liquidity coverage as sources (readily available cash, availability under the unsecured revolving line of credit and retained cash flow from operations) to uses (debt maturities, development expenditures, recurring maintenance capital expenditures and committed acquisitions) pro forma for recent transactions such as the unsecured note issuance and term loan in January 2015.


HCP's capacity to generate liquidity via retained cash flow from operations after dividends will be reduced by the cash rent reduction but remain sufficient. Fitch estimates HCP's dividend payout ratio will increase to 85% from 82% for 2015 based upon the mid-point of funds available for distribution (FAD) guidance. Fitch views FAD as a reasonable proxy for adjusted funds from operations (AFFO) for HCP.

FIXED-CHARGE COVERAGE REMAINS STRONG

Fixed-charge coverage (FCC (News - Alert)) will remain strong for the rating at 3.5x pro forma compared to 3.6x for 4Q'14. FCC was 3.8x for 2014 up from 2.7x and 3.2x for 2011 and 2012, respectively. Fitch defines FCC as recurring operating EBITDA including recurring cash distributions from joint venture operations less recurring maintenance capital expenditures and straight-line rent to interest expense.

STABLE OUTLOOK

The Stable Outlook reflects Fitch's view that HCP's capitalization will remain consistent with the rating over the next one-to-two years and that the issuer will be able to largely improve its metrics away from the weak end of the range via contractual organic growth.

KEY ASSUMPTIONS

--HCR maintains coverage with growth in operating cashflows sufficient to meet contractual rental escalators;

--SSNOI growth in 2016 of low- to mid-single digits;

--HCP funds the Chartwell portfolio acquisition on a leverage-neutral basis largely via proceeds from dispositions;

--HCP's access to the debt and equity capital markets is unchanged.

RATING SENSITIVITIES

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

--Reduced risk from skilled-nursing/post-acute operators as measured by reduced exposure or a sustained and material improvement in coverage in whole and in part;

--Reduced tenant concentration;

--Fitch's expectation of FCC sustaining above 3x for several consecutive quarters (coverage was 3.5x pro forma);

--Fitch's expectation of leverage sustaining below 4.5x (leverage was 5.7x pro forma).

The following factors may have a negative impact on the ratings or Outlook:

--A sustained and material weakening in coverage for skilled-nursing/post-acute operators in whole and in part;

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

--Fitch's expectation of FCC sustaining below 2.5x;

--A liquidity shortfall.

Fitch has affirmed the following ratings:

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

--Unsecured bank credit facility at 'BBB+';

--Unsecured term loans at 'BBB+';

--Senior unsecured notes 'BBB+'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'HCP, Inc. - Ratings Navigator' Feb. 26, 2015;

--'Recovery Ratings and Notching Criteria for Equity REITs' Nov. 18, 2014;

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' May 28, 2014.

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628

HCP, Inc. - Ratings Navigator

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=862025

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982164

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.


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