Fitch Affirms SL Green's IDR at 'BBB-'; Outlook Revised to Positive

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has affirmed the Issuer Default Rating (IDR) for SL Green Realty Corp. SLG and its operating partnerships, SL Green Operating Partnership, L.P. and Reckson Operating Partnership, L.P. at 'BBB-'. Fitch has revised the Rating Outlook to Positive from Stable. A full list of rating actions follows at the end of the release.

The Positive Outlook primarily reflects SLG's public commitment to targeting stronger financial metrics, including sustaining leverage at 7.0x or below. Fitch had previously set leverage sustaining below 7.5x as a key positive rating sensitivity for SLG. The company has also improved its unencumbered asset coverage of unsecured debt to 2.3x as of Sept. 30, 2016 from 1.6x at June 30, 2015.

To determine whether to upgrade SLG's ratings to 'BBB', Fitch will examine the level and consistency of the company's credit protection metrics during the one-to-two year Rating Outlook horizon, in the context of SLG's revised financial policy to targets. Fitch will also consider SLG's access to unsecured public and/or private placement notes over the Outlook horizon.

KEY RATING DRIVERS

Fitch's ratings consider SLG's credit strengths, including its strong competitive position and high-quality New York office portfolio that enjoys high occupancy rates, long-term leases to solid credit tenants, and above-average contingent liquidity from institutional lenders and investors. The company also has manageable, well-balanced lease maturity and debt expiration schedules as well as limited floating rate debt exposure.

Geographic concentration in the New York metro area and exposure to capital intensive office properties are factors that balance the company's credit positives. The persistent strength and economic diversity of Manhattan and high face rents help to mitigate these risks. SLG is also a less established unsecured borrower than many similarly- or higher-rated REIT peers.

Fitch views the company's public adoption of more stringent financial policies and use of unsecured bank term loans as demonstrations of its commitment to maintaining an investment grade borrowing strategy, although Fitch considers bank term loans as a lesser form of unsecured debt access than bond issuances.

APPROPRIATE LEVERAGE

SLG's recurring debt-to-EBITDA leverage is in-line with similarly rated equity REIT peers, but appropriate to conservative after adjusting for lower market-level cap rates for Manhattan commercial real estate. Fitch expects SLG to operate with leverage at 7.0x or below during the Rating Outlook horizon.

SLG has tightened its financial policies as it transitions to an investment grade, unsecured borrowing strategy. Asset sales and incremental net operating income (NOI) from repositioning and leasing of assets within the company's growth portfolio, which consists of value-add properties purchased over the past few years, have supported the company's de-levering.

The company's leverage ratio was 6.1x for the trailing 12 months (TTM) ended Sept. 30, 2016 when adjusting for the effects of the 11 Madison Ave. joint venture and the sale of 388-390 Greenwich, down from 9.4x as of Dec. 31, 2015 and 8.0x as of Dec. 31, 2014.

SLG's leverage adjusted for equity credit for hybrid securities was 6.5x, 9.7x and 8.2x for the 12-months ended Sept. 30, 2016, Dec. 31, 2015 and Dec. 31, 2014, respectively. Equity adjusted leverage provides 50% equity credit for the company's perpetual preferred obligations and 0% for its preferred units. The latter are puttable on demand, for cash from unitholders.

Fitch's leverage-based ratings sensitivities are based on recurring debt-to-EBITDA leverage without considering the impact of hybrid obligations. However, Fitch recognizes the potential liquidity demands posed by the approximately $300 million preferred units that can be put to the company.

APPROPRIATE FIXED-CHARGE COVERAGE

Fitch expects SLG's fixed-charge coverage (FCC) to remain relatively flat as growth in cash flow is partially offset by an environment in which landlords will continue to offer attractive tenant improvement packages. FCC was 2.5x for the 12 months ended Sept. 30, 2016 when excluding the effects of 11 Madison Ave. and 388-390 Greenwich, up from 2.1x in 2015 and 1.8x in 2014. The improvement in coverage has been driven primarily by improved financing costs and significantly reduced debt balances, particularly with the company's unsecured credit facility.

ADEQUATE UNENCUMBERED ASSET COVERAGE OF DEBT

Fitch expects this SLG's consolidated unencumbered asset coverage of net unsecured debt (UA/UD) to sustain in the low 2.0x during the Outlook Horizon. The company's UA/UD - calculated as annualized third quarter 2016 (3Q16) unencumbered property NOI divided by a stressed 7% capitalization rate - results in coverage of 2.3x, up from 1.6x as of June 30, 2015 and Dec. 31, 2014. SLG improved coverage through considerable reduction of its unsecured debt balance, most of which was through the pay down of its revolving credit facility in the first nine months of 2016.

The company's improved UA/UD ratio is an important credit positive. SLG's UA/UD coverage below 2.0x had historically hindered the credit profile of SLG in comparison to similarly-rated companies, particularly given that the stressed capitalization rate applied to SLG's NOI is the lowest across Fitch's rated universe. However, when considering that Midtown Manhattan assets are highly sought after by secured lenders and foreign investors, the results are a stronger contingent liquidity relative to most asset classes in other markets.

STRONG MANAGEMENT TEAM

The ratings also consider the strength of SLG's management team given their knowledge of the Manhattan office sector and their ability to maintain occupancy and liquidity throughout the downturn. This expertise has also been demonstrated by the company's ability to identify off-market acquisition opportunities, and its maintenance and growth of portfolio occupancy and balance sheet liquidity throughout the downturn and into the current cycle. The management team has also led the company towards an even greater property focus within Manhattan, not only within the office segment, but expanding to the potentially highly profitable retail segment as well.

LOW LIQUIDITY COVERAGE

Fitch's stressed, base case liquidity analysis shows SLG's sources of liquidity (cash, availability under the company's unsecured revolving credit facility, and Fitch's expectation of retained cash flows from operating activities after dividends and distributions) covered uses of liquidity (pro rata debt maturities, Fitch's expectation of recurring capital expenditures and non-discretionary development expenditures) by 0.9x for the period from Oct. 1, 2016 to Dec. 31, 2018.

Fitch's analysis assumes SLG does not raise any external capital to repay debt maturities. This notwithstanding the company's demonstrated access to a variety of capital sources over time, mitigating refinance risk. Under a scenario where the company refinances 80% of maturing secured debt, liquidity coverage improves to 1.9x, which would be adequate for the rating.

SLG's conservative common dividend policy has supported its liquidity as the company has distributed approximately 45% of its adjusted funds from operations (AFFO) in the first nine months of 2016. The lower payout ratio has provided the company with additional financial flexibility, which is of high importance considering the consistently elevated level of tenant inducements required in the NYC office leasing environment. Fitch expects the company's projected AFFO payout ratio to trend towards industry norms in the coming years, at levels between 70%-90%.

STRONG, ALBEIT RELATIVELY CONCENTRATED TENANT BASE

SLG's portfolio has a modest degree of tenant concentration, with the top 10 tenants representing 28.2% of annual base rent. This compares to the contribution from the top 20 tenants of Boston Properties and Vornado Realty of 27.8% and 28.2%, respectively. Despite the concentration, the largest tenant Credit Suisse ('A-' IDR with a Stable Outlook) comprises 7.8% of SLG's share of annual cash rent, and four of SLG's top 10 tenants have strong investment grade Fitch ratings.

MANAGEABLE LEASE EXPIRATION PROFILE

SLG has a manageable lease expiration schedule with only an average of 8.2% of consolidated Manhattan rents expiring annually 2017-2020. While slightly more of the company's consolidated suburban property rents expire during that same period (10.0% on average), the suburban portfolio represents a limited portion of the company's total assets and only 7.8% of annualized cash rent.

LADDERED DEBT MATURITIES

Further supporting the ratings is SLG's manageable debt maturity schedule. Over the next five years, 2017 and 2019 are the largest years of debt maturities with 17.8% and 20.2% of pro rata debt expiring, respectively. The 2017 maturities are comprised of $1.3 billion of non-recourse mortgage debt and $345 million of unsecured debt, while the 2019 maturities are comprised of SLG's $1.2 billion term loan and $600 million of non-recourse mortgage debt.

SLG has demonstrated consistent access to secured financing and Fitch anticipates the company could enter the public unsecured bond market to repay a portion of the maturing term loan obligation. Otherwise, the company's strong existing bank relationships should allow it to easily refinance some or the entire term loan obligation. Additionally, SLG's ratios under its unsecured credit obligations' financial covenants do not hinder the company's financial flexibility at this point in time.

RECKSON'S IDR LINKED TO SLG'S

Consistent with Fitch's criteria, 'Parent and Subsidiary Rating Linkage' dated Aug. 31, 2016 and available on 'www.fitchratings.com', Reckson's IDR is linked and synchronized with SLG's due to strong legal, operational and strategic ties between SLG and Reckson, including each entity guaranteeing certain corporate debt of the other.

JUNIOR SUBORDINATED NOTES NOTCHING

The one-notch differential between SLG's IDR and junior subordinated notes (trust preferred securities) is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's Web site at www.fitchratings.com, these securities are senior to SLG's perpetual preferred stock but subordinate to SLG's corporate debt. Holders of such notes have the ability to demand full repayment of principal and interest in the event of unpaid interest.

PREFERRED STOCK NOTCHING

The two-notch differential between SLG's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB-'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's Web site at www.fitchratings.com, 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 SLG include:

--Low single-digit growth in annual same-store NOI in 2017-2019;

--Secured debt maturities refinanced dollar-for-dollar with secured mortgage debt;

--Public unsecured bond issuance in 2019 to partially refinance maturing unsecured term loan;

--$200 million of acquisitions in 2018-2019 at 5% capitalization rate;

--No common equity issuance through the forecast period absent a material shift in equity price relative to consensus NAV. Fitch also assumes no equity buybacks despite the $1 billion stock buyback program currently in place.

RATING SENSITIVITIES

The following factors may have a positive impact on SLG's ratings:

--Fitch's expectation of leverage sustaining below 7.0x (leverage was 6.1x for the TTM ended Sept. 30, 2016);

--SLG's demonstrated access to unsecured bonds;

--Fitch's expectation of fixed charge coverage sustaining above 2.25x (coverage was 2.5x for the TTM ended Sept. 30, 2016).

The following factors may have a negative impact on SLG's ratings and/or Outlook:

--Fitch's expectation of UA/UD sustaining below 2.0x;

--Fitch's expectation of leverage sustaining above 8x;

--Fitch's expectation of fixed-charge coverage sustaining below 1.5x;

--A sustained liquidity shortfall (base case liquidity coverage was 0.9x for the period Oct. 1, 2016 to Dec. 31, 2018).

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

SL Green Realty Corp.:

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Perpetual preferred stock at 'BB'.

SL Green Operating Partnership, L.P.

--IDR at 'BBB-';

--Unsecured line of credit at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Exchangeable senior notes at 'BBB-';

--Junior subordinated notes at 'BB+'.

Reckson Operating Partnership, L.P.

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-'.

The Rating Outlook is revised to Positive from 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 and recurring distributions from unconsolidated joint venture operations;

--Historical and projected recurring operating EBITDA is adjusted to exclude non-routine gains from the company's preferred and mezzanine investments;

--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $80 million of cash for working capital purposes which is otherwise unavailable to repay debt;

--Leverage adjusted for equity credit includes 50% equity credit for the company's perpetual preferred stock and 0% equity credit for preferred units.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

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

https://www.fitchratings.com/site/re/878264

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1016503

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016503

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https://www.fitchratings.com/regulatory

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