Fitch Rates Duke Realty's $300MM 3.750% Sr. Unsecured Notes 'BBB'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has assigned a 'BBB' rating to the $300 million 3.750% senior unsecured notes due Dec. 1, 2024 issued by Duke Realty Limited Partnership, the operating partnership of Duke Realty Corp. DRE (Duke). A full list of ratings is provided at the end of this release.

The issue priced at 98.795% of par, representing a 3.896% yield to maturity and a 153 basis point spread to the benchmark treasury rate.

Duke will use the proceeds from the offering and planned asset sales to pay down revolver borrowings, repay its $250 million 7.375% senior notes due Feb. 15, 2015, redeem all of its 6.6% Series L preferred shares outstanding and help fund its $252 million of committed development expenditures at Sept. 30, 2014.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The ratings take into account Duke's large pool of diversified industrial, office, and medical office properties, strong access to various forms of capital, and adequate unencumbered asset coverage of unsecured debt. These credit strengths are tempered by a modest pro forma liquidity surplus over the next several years and execution risk tied to asset sales in the near term.

Asset Sales Improve Credit Profile

Duke sold $877 million of properties during 2013 at a 6.8% in-place cap rate. The transactions furthered previous portfolio repositioning consistent with a 60%, 25% and 15% mix of bulk industrial, suburban office, and medical office building (MOB) assets, respectively. The company has disposed of an additional $532 million of assets year-to-date through Sept. 30, 2014 at a blended cap rate of 7.2% on in-place net operating income (NOI). The company's systematic disposition program has accelerated de-levering while strengthening the durability of Duke's cash flows, in Fitch's view. Additional single asset and portfolio sales (predominantly comprised of suburban office assets) are likely during next 12-24 months, which should further improve Duke's financial flexibility and reduce its portfolio capital intensity.

Appropriate Leverage for Ratings

Duke's leverage was 6.6x at Sept. 30, 2014 based on trailing 12-month (TTM) recurring operating EBITDA compared to 6.8x at Dec. 31, 2013 and 8.0x at Dec. 31, 2012. Fitch expects that leverage will stabilize around 6.5x during its two- to three-year rating horizon, helped by pre-leased development completions in 2014 and a 60%/40% mix between equity and debt to fund net investments. The 6.5x leverage is appropriate for a 'BBB' rated REIT focused primarily on high-quality bulk industrial properties. Fitch defines leverage as consolidated debt, net of readily available cash over recurring operating EBITDA, including cash distributions from unconsolidated joint ventures (JVs).

Adequate Fixed Charge Coverage

Fixed charge coverage (FCC) was 2.1x for the TTM ending Sept. 30, 2014, an increase from 1.9x and 1.6x during 2013 and 2012. Fitch expects that FCC will exceed 2.0x over the next 12-24 months and sustain in the low 2.0x range, driven by low single-digit same-store net operating income (SSNOI) growth, incremental NOI from development deliveries and lower recurring capex given a reduced suburban office footprint. Duke's preferred equity repurchases have also helped its FCC. Projected FCC is consistent with the 'BBB' IDR. Fitch defines FCC as recurring operating EBITDA, less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred dividends.

Pre-Leasing Mitigates Development Risk

Duke's committed development expenditures represented 2.7% of gross assets at Sept. 30, 2014. This is down from 3.9% at Dec. 31, 2013 due to recent deliveries, but up from its 0.7% cycle low in 2009. Fitch is comfortable with Duke's development exposure in the context of improving U.S. industrial fundamentals and 59% pre-leasing for its total pipeline, including Duke's share in unconsolidated JVs. Fitch expects the company to generally emphasize pre-leased projects over the near term -- a credit positive -- with a measured appetite for speculative development depending on individual submarket fundamentals.

Improving Fundamentals

Duke's SSNOI increased by 3.8% for the TTM ending Sept. 30, 2014, with its three core property types - bulk distribution, suburban office and medical office - growing in excess of 3%. The company's small retail portfolio showed a 6% decline in SSNOI during the same period. Duke's in-service portfolio occupancy was 95.4% at the end of the third quarter, up from 94.2% at Dec. 31, 2013. Spreads on renewal leases were positive 8% year-to-date (YTD) through September compared with 3.1% during 2013 and 1.5% in 2012 and (0.9%) in 2011. Stronger occupancy rates have improved Duke's pricing flexibility across all property types, though suburban office rent spreads continue to lag (+5.6% YTD).

Adequate Financial Flexibility

The company's liquidity profile is also adequate with total sources of liquidity covering total uses by 1.2x for the Oct. 1, 2014 - Dec. 31, 2016 period. Including the cost to complete its development pipeline reduces Duke's coverage to an adequate 1.0x. On a pro forma basis, adjusting for the company's $300 million 3.750% senior unsecured issuance, Duke's liquidity ratio improves to 1.2x, including development.

Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources of liquidity include unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flow from operating activities after dividends. Uses of liquidity include pro rata debt maturities, expected recurring capital expenditures, and remaining development costs.

DRE's liquidity profile is also supported by 2.1x pro forma unencumbered asset coverage of unsecured debt assuming a stressed 8.25% cap rate, which is adequate for the 'BBB' rating.

Duke has a well-balanced debt maturity schedule. Following the repayment of its 7.375% senior unsecured notes due Feb. 15, 2015 with proceeds from this issuance, Duke's next unsecured maturity is not until March 1, 2016 when its $150 million 5.500% senior unsecured notes mature.

Conservative Dividend Payout

Fitch expects Duke's dividend to increase moderately over the next 12-24 months given higher earnings from development completions, improved operational stability from the realigned portfolio, and fact that the quarterly dividend has remained at $0.17/share since 2009, which is inconsistent with peers. Nonetheless, Fitch expects the adjusted funds from operations (AFFO) payout ratio to remain in a prudent range.

The company's AFFO payout ratio has improved to 68% for the nine months ending Sept. 30, 2014 from 74% in 2013 and 84% in 2012. Growth in property operating cash flows and the lack of dividend increases have driven the improvement in Duke's payout ratio. Fitch estimates that the company's low dividend payout ratio allows it to retain roughly $75 million of internally generated cash flow that can be used to satisfy its financial obligations and fund external investments.

Stable Outlook

The Stable Rating Outlook is based on Fitch's expectation that leverage will stabilize around 6.5x, that coverage will exceed 2.0x, and that the company will maintain adequate financial flexibility over the near to medium term.

Preferred Stock Notching

The two-notch differential between DRE's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB' IDR. 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.

RATING SENSITIVITIES

The following factors may have a positive impact on the ratings and/or Rating Outlook:

--Fitch's expectation of leverage sustaining below 6.0x (leverage was 6.6x for the TTM ended Sept. 30, 2014);

--Fitch's expectation of FCC sustaining above 2.5x (TTM coverage was 2.1x).

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

--Fitch's expectation of leverage sustaining above 7.0x;

--Fitch's expectation of FCC sustaining below 1.5x.

Fitch currently rates Duke Realty Corp. and Duke Realty Limited Partnership as follows:

Duke Realty Corporation

--Issuer Default Rating (IDR) at 'BBB';

--Preferred stock at 'BB+'.

Duke Realty Limited Partnership

--IDR at 'BBB';

--Senior unsecured line of credit at 'BBB';

--Senior unsecured term loan at 'BBB';

--Senior unsecured notes at 'BBB'.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014);

--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);

--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).

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

Rating U.S. Equity REITs and REOCs (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=737957

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722363

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=924155

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