DBRS Morningstar Finalizes Provisional Rating of AA (low) on BCI QuadReal Realty’s Senior Notes

DBRS Limited (DBRS Morningstar) finalized its provisional rating of AA (low) with a Stable trend on BCI QuadReal Realty’s (BQR) Senior Notes. BQR issued $350 million of 1.68% Senior Notes, Series 1, due March 3, 2025. The rating takes into consideration (1) BQR’s stand-alone credit risk profile, (2) the expected low level of secured debt in its capital structure, (3) expected mitigants to structural subordination to material prior-ranking debts, and (4) DBRS Morningstar’s view of implicit support from the British Columbia Investment Management Corporation (BCI). DBRS Morningstar notes that BQR’s stand-alone credit risk profile encompasses the results of BQR and the initial guarantor, Parkpool, on a combined basis and that the guarantee provided by Parkpool complies with “DBRS Morningstar Criteria: Guarantees and Other Forms of Support.” All references to BQR shall mean BQR and Parkpool on a combined basis.

The stand-alone credit risk profile is supported by (1) the high-quality real estate portfolio with exposure across multiple asset classes, including office, retail, industrial, multifamily residential, and manufactured housing; (2) a strong market position that benefits from the reputation and market leadership of its manager, QuadReal Property Group Limited Partnership, BCI’s leading global real estate management services platform with more than $30 billion in assets under management; and (3) a diversified tenant base with low counterparty risk, where the top 10 tenants only represent 21.9% of gross revenues and six of these tenants have investment-grade ratings from DBRS Morningstar, albeit five have either a Negative trend or Under Review with Negative Implications status primarily because of exposure to the oil and gas industry.

The stand-alone credit risk profile is constrained by (1) the execution risks around the Royal Bank of Canada’s (rated AA (high) with a Stable trend by DBRS Morningstar) Global Asset Management transaction, the current development pipeline, and elevated rent deferrals and loss of ancillary income related to the Coronavirus Disease (COVID-19); (2) geographic concentration in Alberta, representing 31.1% of net operating income (NOI) for F2019; (3) property concentration, with 32.3% of NOI for F2019 derived from its top 10 assets; and (4) anticipated increase in leverage over the next few years resulting from rising debt levels while EBITDA declines.

The Stable trend takes into consideration BQR’s good liquidity position with $171 million cash and access to $653 million in available credit lines. Despite high debt maturities in 2020, DBRS Morningstar considers this level of liquidity as adequate given that the bulk of the maturities relate to Canada Mortgage and Housing Corporation mortgages (of which $821 million were refinanced May 1, 2020) and commercial paper; these two important capital markets are available to entities like BQR which have good-quality assets, including unencumbered assets, and strong credit profiles.

BQR’s ratio of secured debt-to-total debt at the end of F2019 was 33.8%, which is below the 40% threshold. This combined with an investment-grade leverage profile allows BQR to receive the benefit of a one-notch rating uplift for a low level of secured debt in the debt stack.

The Senior Notes will be secured by back-to-back intercompany loans to subsidiary bcIMC Realty Corporation (BRC; rated AA (low) with a Stable trend by DBRS Morningstar) that contain essentially the same terms and conditions as the Senior Notes. The equivalency of the two debt instruments allows the Senior Notes to carry the same AA (low) rating as BRC’s Medium-Term Notes. The Senior Notes rank pari passu with the senior unsecured debt of BRC in terms of interest payments and claims, and as such, mitigates concerns regarding structural subordination to debt lower in the organizational structure. DBRS Morningstar notes that under certain conditions in the future, this collateral may be released.

While DBRS Morningstar does not anticipate that BCI will provide explicit support to the Senior Notes issued by BQR, DBRS Morningstar believes that certain factors would motivate BCI to provide implicit support to BQR, including essentiality, contractual obligations, reputation, and integration. DBRS Morningstar considers the strength of the implicit support to be medium/high. As a result, DBRS Morningstar determined that the value of implicit support warranted a two-notch rating uplift, consistent with other DBRS Morningstar-rated pension plan real estate entities.

BQR’s leverage (total debt-to-EBITDA) and coverage (EBITDA-to-interest) metrics, as calculated by DBRS Morningstar, were 6.1 times (x) and 6.79x, respectively, at year-end 2019. In the near-to-medium term, DBRS Morningstar anticipates the leverage to rise because of higher levels of overall debt and anticipates interest coverage to decline but remain at levels appropriate for the rating category.

A negative rating action could result if BQR’s total debt-to-EBITDA ratio increases above 7.3x on a sustained basis, all else equal, or if DBRS Morningstar changes its views on the level and/or strength of implicit support provided by BCI. Given the constraints noted above, a positive rating action is unlikely at this time.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies are Rating Entities in the Real Estate Industry (April 23, 2019), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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