DBRS Confirms Calloway REIT at STA-3 (high)

DBRS has today confirmed Calloway Real Estate Investment Trust’s (Calloway or the Trust) stability rating at STA-3 (high). The rating confirmation takes into consideration that Calloway has made progress in improving its financial flexibility and liquidity position through recent financing activity to fund the Trust’s development and earnout pipeline and other capital commitments occurring over the next couple of years.

During Q2 2009, Calloway issued a total of $225 million of senior unsecured debentures, including $150 million of Series C senior unsecured debentures and $75 million of Series D senior unsecured debentures. The Trust also raised $62 million of new mortgages in Q2 2009 and more recently issued $50 million of equity. DBRS notes that Calloway’s two secured revolving credit facilities, both maturing in Q3 2009, were replaced with a new two-year $160 million secured revolving credit facility, which matures in September 2011. DBRS notes that this facility has a higher interest rate than the previous facilities and a lower debt service coverage ratio covenant (1.35 times from 1.5 times). While the cost of these debt proceeds is relatively high, DBRS believes that Calloway now has reasonable financial flexibility to fund committed development projects/earnouts ($58.8 million for the remainder of 2009 and $78.5 million in 2010) and modest debt maturities until the end of 2010.

The rating confirmation also takes into consideration the defensive features of Calloway’s portfolio, which include (1) a large portfolio of new format, unenclosed retail properties, many of which are anchored by Wal-Mart (accounts for 26.7% of gross rental revenue). The Trust’s properties are also relatively new with 87.4% of the portfolio developed since 2000, which minimizes capital requirements over the medium term. (2) Calloway’s portfolio has a focus on discount-/value-oriented tenants, which are generally less sensitive to recessionary periods than discretionary or fashion-oriented tenants. (3) Calloway has one of the longest lease profiles in the sector, with an average lease term to maturity of 9.6 years (Wal-Mart at 13 years), which should provide stability to cash flow and good protection from changes in market conditions. Overall, the Trust’s portfolio continues to perform well, with high occupancy levels (98.6% as at Q2 2009) and positive re-leasing activity with higher average rental rates on lease renewal and high tenant retention rates. In addition, Calloway has been fairly successful at re-leasing the manageable amount of space left vacant by tenant bankruptcies/disruptions earlier this year and in late 2008. Going forward, Calloway’s minimal near-term lease maturities (0.6% of GLA in 2009 and 2.5% of GLA in 2010) are expected to limit its expose to the challenging leasing environment and continue to contribute to stable cash flow.

Nevertheless, DBRS expects economic and retail conditions to remain challenging in the near term and to continue to put modest pressure on occupancy levels and the performance of the Trust’s smaller or lower-quality tenants. Although debt levels are expected to remain reasonable in the 55% to 60% range, DBRS expects that this environment combined with the higher costs of recent debt financing activity will cause EBITDA interest coverage (including capitalized interest) to fall into the 1.90 times range. While this level is low for the current rating category, DBRS expects this metric to improve with recovering retail fundamentals and cash flow contributions from completed developments/earnouts in 2010. DBRS also takes comfort in the fact that Calloway’s portfolio exhibits low cash flow volatility on account of its focus on newer properties and strong tenants with long-term leases.

Overall, DBRS believes that 2009 should represent the bottom of the cycle for retail fundamentals, as we expect the economy and consumer spending levels in Canada to stabilize and recover in 2010. If the Trust performs as we expect and maintains current operating metrics and acceptable levels of financial flexibility while improving its free cash flow position, the trend should remain Stable. However, if the Trust’s credit metrics trend away from levels appropriate for the current environment and rating (i.e., below the EBITDA interest coverage range of 1.90 times (including capitalized interest)) caused by weaker-than-expected operating performance, inadequate financial flexibility and/or a deeper/longer-than-expected economic downturn (which would erode the Trust’s capacity to manage its payout ratio), the rating would be pressured.

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

The applicable methodology is Rating Real Estate, which can be found on our website under Methodologies.

This is a Corporate rating.