DBRS Confirms Markville and Chinook Shopping Centres at A (high) with a Stable Trend

DBRS has today confirmed its A (high) rating of Markville Shopping Centre and Chinook Centre (Markville and Chinook or the Properties), as the Properties maintain a solid credit profile. The confirmation takes into consideration the fact that Chinook is expected to undergo a $280 million expansion project that will include approximately 175,000 square feet of additional commercial retail unit (CRU) space and a two-level underground parkade with 1,205 parking stalls. The expansion project will occur at the north end of Chinook and will feature additional retail space in a two-level racetrack configuration. The project is expected to contribute approximately $22 million in additional net operating income (NOI) and will provide greater security for bondholders with the additional equity invested into Chinook. The project, which is expected to be completed in the fall of 2010, should further enhance Chinook’s market position in Calgary and provide additional draw, resulting in increased customer traffic.

The current rating category also takes into consideration:

(1) For F2007, NOI increased by approximately 3%, driven by strong retail leasing conditions and higher average CRU net rental rates at Chinook. (Chinook and Markville account for 62% and 38% of the total NOI, respectively.)

(2) CRU sales at the Properties continued to increase in 2007, with Chinook achieving very strong sales results of $896 per square foot (a year-over-year increase of 8%). Chinook has benefited from strong market conditions in Calgary, characterized by increased consumer spending and a strong job market as a result of the booming oil and gas industry. DBRS expects that these conditions will continue to positively affect the overall performance and re-leasing rental rates at Chinook in 2008. However, DBRS expects that the pace of sales growth will likely moderate over the medium term and that the expansion project could disrupt sales performance until it is completed. Markville’s sales performance continues to lag other DBRS-rated shopping centres of comparable size ($500 to $700 CRU sales per square foot); however, DBRS expects sales to continue to grow at Markville, given its competitive market position and a significant amount of residential development within its trade area.

(3) Bondholders have a secured interest in the Properties and full recourse back to Ontrea Inc. (Ontrea), one of the key real estate operating entities owned by the Ontario Teachers’ Pension Plan Board. DBRS views Ontrea as a strong investment-grade credit.

(4) Over the past several years, the Properties’ improved operating performance and the reduction in the outstanding loan amount have significantly improved the loan-to-value ratio and coverage metrics for the debentures. The loan-to-value is superior, with only $73.5 million in outstanding debt. Correspondingly, interest coverage and debt service ratios improved to superior levels of 6.92 and 5.53 times, respectively. However, DBRS notes that the current rating has already factored in the Properties’ minimal financial risk with superior coverage metrics and the A (high) rating is limited by the following business risk constraints:

First, the Properties’ anchor tenants (The Bay, Sears and Zellers) continue to face significant competition from discount-type retailers and changing trends in retail formats, including new power centre layouts. DBRS believes that this could potentially result in at least one of the noted tenants undertaking strategic changes, including possible store closures. DBRS notes, however, that any potential disruption would likely be short term in nature, given the overall quality and location of the Properties. Overall, DBRS views this risk as manageable considering the Properties’ noted credit strengths and has reflected this in the current rating category.

Second, Markville has approximately 45% of CRU space set to expire during the 2008 to 2010 period. Combined with the currently high CRU vacancy levels of 8.3%, this could result in potential re-leasing risk if conditions deteriorate during this period.

Overall, given the current market conditions in Alberta, Chinook’s lease maturity schedule will likely provide an opportunity for further increases in average CRU rental rates. DBRS notes that the Zellers lease at Chinook was renewed for another five years under similar terms and conditions. As a result, DBRS expects the Properties’ credit profile to remain stable throughout 2008 with support from solid operating fundamentals and superior financial metrics compared with other shopping centres rated by DBRS.

Note:
All figures are in Canadian dollars unless otherwise noted.