Fitch Ratings released unsolicited comment today that stated that investment grade ratings assigned to the most junior class of the City Center Trust 2011 CCHP CMBS would most probably warrant no more than a ‘BBsf’ rating. The conclusion is based on the rating agency's current analysis of hotel properties.
JPMorgan Securities is the sole bookrunner on the offering with Wells Fargo as a co-manager. The 144A offering was rated by Moody’s Investors Service, Standard & Poor's and Morningstar.
While initially asked to offer preliminary feedback, Fitch said that it was not asked to rate the deal. The rating agency also clarified that it did not have the benefit of direct access to the properties, their ownership or the management when conducting its preliminary analysis.
Considering Fitch's typical cap rate assumptions for hotel properties, the agency would need to apply a pro-forma analysis of cash-flow of around $70 million annually to pass an investment grade rating stress. This is not in line with Fitch’s rating approach. Alternatively, based on in-place cash-flow, Fitch would need to examine the assets with a cap rate of less than 9.5%, which is much less thant the historical mean for hotel cap rates.
The rating agency thinks that the expectation of future growth should be a risk for property owners and not investment grade bondholders. This is why Fitch’s property valuations are limited to multiple of in-place cash flow.
The CCHP transaction is a portfolio of 13 full-service hotels across 10 U.S. states, the District of Columbia and Canada. CCHP is one of the first floating-rate CMBS deals in several years, the rating agency said. The structure of a floating-rate deal that gives the sponsor the ability to prepay without penalty if cash-flow growth is realized and refinance into longer term financing at higher proceeds more reflective of property cash-flow at that future point.
Fitch’s typical cap rate of between 10.50% and 12% for hotels depends on different of characteristics such as property condition, location, flag, historical performance and diversity. The range is based on the historical mean of hotel cap rates observed by Fitch and exceeds the cap rate ranges of other property types based on the operating nature and historical performance volatility of the lodging sector.
Considering the positive attributes of the CCHP portfolio, a cap rate at the lower and more beneficial end of Fitch’s range is assumed. But this still results in the proceeds falling into the ‘BBsf’ rating category based on current in place cash-flow, according to the rating firm. Additionally, Fitch said that the property performance would need to improve and cash-flow to increase from in place levels to pass the Fitch’s investment grade stress. While Fitch recognizes the strong quality of the collateral and sponsor, the current financing should not include investment grade debt that relies on an assumption of growth.
Furthermore, the rating agency’s ‘AAAsf’ proceeds based on its initial review were roughly $230 million versus the issuance level of $245 million. Thus, Fitch thinks that the subordination level for the senior class is more in line with a rating in the ‘AAsf’ category.
While this deal might benefit from the experience and deep pockets of Blackstone giving realistic prospects for cash flow growth and value appreciation, Fitch has not accounted for any imminent changes to property operations to be implemented by Blackstone. Blackstone took control of the CCHP assets in December 2010 through an assignment in lieu of foreclosure of the properties.
Meanwhile, according to Bloomberg, the $425 million, 144a deal's Class A might be priced at the 225 area.
Inspite of the concerns raised above, Fitch’s outlook on the hotel sector is positive. As hotels have realized a year of positive growth momentum, the number of hotels included in CMBS transactions has risen as well. Fitch has reviewed many of these assets and continues to determine value based only on in-place cash-flow. .