Fitch Opines on Financial Covenants in U.S. REIT Bond Indentures.

NEW YORK -- The emergence of U.S. real estate investment trusts (REITs) issuing senior unsecured notes governed by indentures that lack financial covenants raises the possibility of further erosion in REIT bondholder protections but does not guarantee negative rating migration in the REIT sector, according to a new report by Fitch Ratings.

More broadly, this development signals the possibility of widespread omission or elimination of financial covenants in REIT bond indentures going forward. Some REITs may solicit bondholder consent for outstanding bonds guarded by financial covenants. If issuers receive the requisite level of consents to eliminate financial covenants, they may intend to exercise different financial and strategic options, resulting in more secured debt or total debt. "Looking forward, Fitch believes that a large-scale removal of financial covenants governing unsecured REIT debt securities would ultimately facilitate REITs' ability to operate in a manner that could change the quality of those securities," said Steven Marks, Managing Director and REIT Group Head for Fitch. "If Fitch then observes material negative changes in REIT credit profiles, ratings will change accordingly," said Marks.

Historically, finance company REITs have issued senior unsecured notes that have been governed by indentures omitting certain financial covenants. However, in recent weeks, two equity REITs, Camden Property Trust (CPT; rated 'BBB+' by Fitch with a Stable Outlook) and Kimco Realty Corp. (KIM) issued senior unsecured notes that are not restrained by any financial limitations, a condition that is atypical for the REIT industry.

Fitch believes that the lack of financial restrictions in the most recent CPT and KIM bond indentures alone does not negatively impact CPT and KIM's credit profiles. In fact, CPT and KIM operate at levels that are solidly distanced from this implication. Moreover, indentures for CPT's $300 million of 5.7% senior unsecured notes due 2017, as well KIM's $300 million of 5.7% senior unsecured notes due 2017, contain cross default provisions, effectively obliging CPT and KIM to operate within the parameters of secured debt leverage, total debt leverage, unencumbered asset coverage and interest coverage limits in previous, outstanding bond indentures.

Moreover, Fitch's REIT unsecured bond ratings reflect an opinion about the credit quality of securities, rather than an opinion about the quality of financial covenants governing those securities, as most issuers operate at levels well in excess of their financial covenants. "A change in Fitch's view of credit quality, which includes an assessment of an issuer's projected credit metrics, drives rating actions, regardless of the presence or absence of financial covenants, as these covenants protect and benefit investors only after considerable deterioration in issuer credit quality," according to Marks. "That said, financial covenants do contribute to Fitch's assessment of default probability and recoveries of unsecured REIT bonds and preferred stock."

'Unsecured REIT Bonds Without Financial Covenants' is available on the Fitch Ratings web site at www.fitchratings.com.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.