SAFEHOLD INC.
Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) and unsecured debt rating of
The Rating Outlook has been revised to Positive from Stable.
Key Rating Drivers
IDR AND SENIOR DEBT
The Positive Outlook reflects a sustained increase in the proportion of SAFE's unsecured debt, which was 57% of total debt at 3Q22, a continued extension of funding duration, and enhanced portfolio diversity. Fitch believes the pending merger with
The ratings affirmation reflects SAFE's focus on the relatively low-risk ground lease asset class, which is characterized by growing, long-dated revenue streams and significant overcollateralization; strong asset quality performance; low leverage; solid dividend coverage and an experienced management team.
Ratings constraints include SAFE's short standalone operating history, modest profitability, limited history of capital markets access and real estate investment trust (REIT) distribution requirements, which limit the ability to retain capital.
On
SAFE will also make a loan of
SAFE's asset quality performance remains stable despite a more challenging economic backdrop. SAFE continued to collect 100% of amounts due under its ground leases through 3Q22. The weighted average ratio of SAFE's investments in ground leases to the portfolio's total value (GLTV) was 40% at 3Q22 versus a four-year average of 39%, indicating strong asset coverage.
Fitch also considers the rent coverage ratio, as measured by property net operating income to annualized cash rent due to SAFE, in assessing asset quality. As of 3Q22, the weighted average rent coverage ratio was 3.9x, versus a four-year average of 3.9x, which Fitch views as solid. A meaningful increase in GLTV or a sustained reduction in the rent coverage ratio would be viewed negatively by Fitch.
Although portfolio diversification by asset class and geography are improving, SAFE continues to have concentrated exposures to office (45% of the portfolio at 3Q22) and the Northeast (39% of the portfolio). Still, Fitch views the increasing share of multi-family in SAFE's portfolio (35% at 3Q22) favorably. While high-value properties may be concentrated, SAFE operates in all top 30 metropolitan statistical areas.
SAFE's pre-tax return on average assets was 3.0% (2.0% excluding extraordinary gains and one-time merger expenses) for the TTM ended 3Q22 and averaged 1.8% between 2018 and 2021. Future earnings growth will be highly dependent on SAFE's ability to identify attractive investment opportunities and raise growth capital. In the absence of growth, Fitch believes the business should generate sufficient earnings consistency over time, relative to its ratings, given the long-duration assets, matched funding and lease escalator clauses.
SAFE's gross debt to tangible equity ratio was 1.8x as of 3Q22, in line with its stated leverage target of 2.0x or lower, which Fitch views favorably. SAFE has maintained low leverage despite meaningful growth, demonstrating strong access to the equity markets, although access has been limited more recently given challenging market conditions. Incremental issuance will also be highly dependent on the firm's share price relative to book value. SAFE's most recent public equity issuance was for
SAFE has materially shifted its debt funding mix over the last two years, going from a fully secured profile at FYE 2020 to 57% unsecured debt at 3Q22. Fitch views this shift and the extension of funding duration to 23.5 years at 3Q22 positively.
As an Umbrella Partnership REIT, SAFE is required to distribute at least 90% of its net taxable income to shareholders. SAFE's cash earnings coverage of dividend distributions has been near 100% to date and Fitch believes SAFE has the ability to reduce distributions, if necessary.
The unsecured debt rating is equalized with Safehold's and SOP's Long-Term IDRs and reflects the predominantly unsecured funding mix and the size of the unencumbered asset pool, which suggests average recovery prospects in a stressed scenario.
SUBSIDIARY AND AFFILIATED COMPANIES
SOP serves as the debt-issuing entity for SAFE's non-recourse debt and owns all the assets through which SAFE conducts its ground leasing business. The Long-Term IDR of this entity is equalized with the ratings assigned to SAFE, reflecting its 100% ownership by SAFE.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Effective navigation of current market headwinds, related both to overall economic conditions and potential structural shifts in demand for office properties.
A sustained increase in the proportion of unsecured debt funding above 60%;
Continued diversification of portfolio by property type and geography while remaining within core competencies;
Maintenance of leverage within the targeted range; and
Maintenance of strong cash earnings dividend coverage.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
An inability to execute on strategic objectives and falling materially short on management projections;
Meaningful deterioration in asset quality metrics, including ground lease defaults or rent deferrals; or a material, sustained reduction in the rent coverage ratio;
Sustained increase in leverage above the targeted range of 2.0x.
The unsecured debt rating is primarily linked to changes in the Long-Term IDR and would likely move in tandem with it. However, a sustained decline in the level of unencumbered assets that weakens the recovery prospects on the unsecured debt could result in the unsecured debt ratings being notched down from the IDR.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Criteria Variation
In Fitch's 'Non-Bank Financial Institutions Rating Criteria', the core asset quality benchmark ratio for balance sheet intensive finance and leasing companies is impairments on leased assets to total leased assets. That ratio is not relevant to SAFE, so instead Fitch focuses on the rent coverage ratio as its core measure of asset quality, which represents a variation to criteria.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
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