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Fitch Removes HCP from Rating Watch Negative; Affirms 'BBB' IDRFitch Ratings has removed HCP, Inc. from Rating Watch Negative and affirmed the company's Issuer Default Rating (IDR) and debt ratings at 'BBB'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS The 'BBB' IDR and Stable Outlook reflect Fitch's expectation that HCP's leverage and liquidity will stabilize pro forma following its spin-off of HCP's HCR ManorCare Inc.'s (HCR) real estate into Quality Care Properties (NYSE:QCP). The recently completed $1.75 billion debt issuances by QCP and subsequent dividend to HCP, along with significant progress on dispositions resolve the uncertainty and execution risk that the previous Rating Watch Negative captured. Round-trip, Fitch views the HCR investment as having been a distraction to management and a headwind against relative access to capital over the past few years. The lease amendment in 2015 and the QCP spin-off in 2016 will have increased leverage by approximately 1x. HCP will be a predominantly private-pay healthcare REIT focusing on senior housing, medical office and life science with some debt and hospital investments pro forma for its permanent separation from HCR. LEVERAGE TO SUSTAIN IN LOW 6x RANGE Fitch projects that leverage will sustain in the 6x - 6.5x range in 2017 and 2018 pro forma for announced dispositions and assuming $750 million per year of acquisitions. Fitch views leverage sustaining between 6x - 7x as being appropriate for the 'BBB' rating. Leverage could migrate lower depending upon acquisition volumes and funding mix, though Fitch expects the issuer's primary focus will be demonstrating accretive growth to shareholders. This compares to leverage in the high-4x to mid-5x range in 2012 through 2014 before the lease amendment and spin-off. Fitch projects fixed-charge coverage (FCC (News - Alert)) will sustain in the mid-to-high 3x range through 2018, which is strong for the 'BBB' rating and comparable to prior years (3.5x in 2015 and 3.8x in 2014). AMPLE LIQUIDITY WHILE RE-ESTABLISHING ITSELF WITH INVESTORS HCP will have ample liquidity to retire maturing debt obligations through 2018 which provides it time to re-establish itself with debt and equity investors. HCP has not issued non-bank debt or issued equity since late 2015. Fitch views HCP as having weaker access to capital relative to its higher rated peers, which is another factor driving the ratings differential, and Fitch does not expect this will change meaningfully through the rating horizon. However, the differential should stabilize, if not improve, given the removal of the HCR overhang and return to growth. HCP will receive approximately $1.7 billion as a dividend from QCP, which recently completed its debt issuance along with at least $700 million of additional proceeds from announced dispositions on a net basis. These proceeds, when combined with unrestricted cash, availability under the $2 billion revolving credit facility due 2018 and Fitch's estimate of pro forma retained cash flow from operations after dividends, cover uses by 1x assuming no access to external capital for the period July 1, 2016 through Dec. 31, 2018. Fitch considers uses to be debt maturities, development expenditures, maintenance capital expenditures and announced acquisitions. Fitch's projections assume HCP will return to the unsecured debt capital markets in 2017 to re-establish itself with investors and fund growth. HIGHER QUALITY PORTFOLIO BUT COST OF CAPITAL INFLUENCES COMPETITIVE POSITION HCP's portfolio will be of a higher quality going forward focusing on senior housing (54% of net operating income), life science (21%) and medical office buildings at 19%. Government reimbursement risk will decline with NOI backed by private-pay sources comprising approximately 95% of revenues. While improved, Fitch expects management will look to resolve or dispose of assets with thinner coverage (e.g. the Brookdale assets, certain debt investments in the United Kingdom) and to reduce tenant concentration. Fitch believes there is some risk that HCP will be incentivized to acquire weaker assets or ones with more execution risk (i.e. higher yielding) as it is pressured to demonstrate growth while at a competitive disadvantage to do so given its relative cost of capital. Cost of capital is a key differentiator between healthcare REITs given their acquisitiveness. Fitch expects HCP's cost of debt and equity capital will remain higher than its peers as a result of weaker metrics, lower ratings and the uncertainty surrounding operating and financial policies until the permanent management team is finalized. CONTINGENT LIQUIDITY TO REMAIN BELOW AVERAGE Unsecured bondholders will be supported by less contingent liquidity after the spin-off and asset sales as the HCR portfolio was one of the largest contributors of wholly-owned unencumbered net operating income. Fitch estimates that unencumbered assets (assuming a stressed 8% - 10% cap rates) will cover unsecured debt by 1.4x - 1.7x pro forma. This compares to 1.7x - 2.2x at Dec. 31, 2015 and from 2x - 2.4x before the rent reduction earlier in 2015. HCP's contingent liquidity will likely sustain below the 2.0x typically carried by investment grade REITs. Unencumbered assets are REITs' primary sources of contingent liquidity to raise proceeds via a sale or pledge against during a time of stress. Moreover, this metric may fluctuate depending on the extent to which HCP uses joint ventures. EVOLVING MANAGEMENT TEAM HCP will have new leadership at the CEO, CFO and CIO positions once a permanent CEO is hired. Fitch recognizes the potential for new leadership to change strategic goals and financial policies but expects the Board of Directors will have an active role given the continuity in financial policies during prior management changes. Fitch expects HCP's initial investments will receive more scrutiny than its peers' from debt and equity investors. Highly successful or unsuccessful outcomes may play an outsized role in shaping investors' perception of the company, its deal sourcing and underwriting expertise and, as a result, its access to capital. Fitch generally views the additions of J. Hutchens (CIO) and K. Hsiao (EVP - Senior Housing) favorably given their prior roles at operating companies (COO of Emeritus Corporation and CEO of Holidy Retirement, respectively) considering the higher degree of interconnectedness between healthcare REITs and their tenants than other REIT sectors. Prior leadership at HCP came from banking, commercial real estate services and life science / office backgrounds. KEY ASSUMPTIONS Fitch's key assumptions within its rating case for the issuer include: --Operating fundamentals remain favorable with low single digit growth in same-store net operating income despite supply in some senior housing markets; --The issuer completes the QCP spin-off and announced dispositions; --The issuer manages acquisition volumes and capital markets activity to sustain leverage between 6x-6.5x; --The issuer's access to debt and equity capital improves but remains below prior levels and peers. RATING SENSITIVITIES The following factors may result in positive momentum for the ratings and/or Outlook: --Fitch's expectation of leverage sustaining below 6x; --Fitch's expectation of HCP restoring its access to unsecured debt and equity capital to levels consistent with years prior to 2016 and consistent with higher rated peers. The following factors may result in negative momentum for the ratings and/or Outlook: --Fitch's expectation of leverage sustaining above 7x; --Fitch's expectation of unencumbered asset coverage of unsecured debt sustaining below 2x; --Fitch's expectation of HCP having weak absolute or weaker relative access to capital than its peers. FULL LIST OF RATING ACTIONS Fitch has removed from Rating Watch Negative and affirmed the following ratings: HCP, Inc. --Long-Term IDR at 'BBB'; --Unsecured bank credit facility at 'BBB'; --Unsecured term loans at 'BBB'; --Senior unsecured notes at 'BBB'. The Rating Outlook is Stable. 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 and include operating income from discontinued operations. --Historical recurring operating EBITDA referenced in prior press releases calculated DFL income on a cash basis rather than GAAP increasing leverage by 0.2x to 0.3x. This adjustment became less relevant when HCP began to report the HCR DFL on a cash basis; --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $25 million of cash for working capital purposes which is otherwise unavailable to repay debt. Additional information is available at 'www.fitchratings.com'. Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) https://www.fitchratings.com/site/re/885629 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013892 Solicitation Status https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013892 Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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