Fitch Affirms Health Care REIT's IDR at 'BBB'; Outlook Stable

Fitch Ratings has affirmed the following credit ratings of Health Care REIT, Inc. (NYSE: HCN):

--Issuer Default Rating (IDR) at 'BBB';

--Senior unsecured lines of credit at 'BBB';

--Senior unsecured term loans at 'BBB';

--Senior unsecured notes at 'BBB';

--Senior unsecured convertible notes at 'BBB';

--Preferred stock at 'BB+'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The ratings reflect HCN's broad healthcare real estate platform, which generates largely predictable cash flow principally from private pay sources in markets with strong demographics. The company has projected fixed charge coverage and leverage appropriate for a 'BBB' rated healthcare REIT. HCN also has strong access to capital and a solid liquidity position, including contingent liquidity from unencumbered assets, and a strong management team. Credit concerns center on operational volatility associated with the company's REIT Investment Diversification and Empowerment Act of 2007 (RIDEA)-related investments, modest operator concentration, and impact on future growth financing given broad equity underperformance in the healthcare real estate sector.

Stable Cash Flow

HCN's portfolio features long-term leases that create a recurring stream of cash flows to service fixed charges and fund external growth. The company's weighted average lease maturity was 12 years at Sept. 30, 2013, and only 6.8% of revenue (excluding RIDEA investments) expires through 2016. Further, the company's leases have structural protections including parent guarantees, letters of credit/security deposits, and master leases/cross-collateralization agreements, which limit operators' ability to selectively renew leases for better performing assets.

Favorable Portfolio Characteristics

Approximately 91% of the portfolio is located in the top 31 domestic metropolitan statistical areas or on the East or West coasts, based on data from the National Investment Center for the Seniors Housing & Care Industry. The company's RIDEA investments (33% of NOI) also exhibit favorable demographics including household incomes and home values that are 63% and 31% above the broader United States, respectively. These favorable qualities mitigate inherent volatility in the RIDEA portfolio and have led to strong quarterly same store net operation income (SSNOI) growth averaging 4% across the aggregate portfolio since 2011.

Modest Government Reimbursement Risk

HCN has a favorable payor mix with private pay sources representing 82% of third quarter (3Q) NOI. As a result, Fitch does not expect that rules by the Centers for Medicare and Medicaid Services (CMS) for fiscal year 2014 will have a material impact on the company's cash flow. Prospective payment system (PPS) payment growth rates for Medicare in skilled nursing facilities are 1.3% for fiscal year (FY) 2014 following 1.8% in FY2013, and 1.3% for long-term acute care hospitals in FY2014 following 1.7% in FY2013. In addition, sequestration that was effective April 1, 2013 lowered Medicare reimbursements by 2% per the Budget Control Act of 2011, but should have an immaterial impact on HCN's tenant's EBITDARM coverage over the near term.

Strong SSNOI Growth to Decelerate in 2014

SSNOI growth has been solid in a range of 3.5%-5% on a quarterly basis since the fourth quarter of 2010 (4Q'10) and up 3.7% in 3Q'13, led by the seniors housing operating portfolio at 9.4%. Fitch expects that SSNOI growth will moderate in 2014-2015 to the low-single digits, driven by deceleration in RIDEA-driven growth to approximately 4-5%.

Appropriate Credit Metrics for 'BBB' Leverage of 6.9x at Sept. 30, 2013 is elevated, yet overstated given timing of the final phase of the Sunrise acquisition, which closed in July 2013. Leverage calculated with 3Q'13 EBITDA is 6.2x and appropriate for the rating. Fitch expects that leverage will stabilize in the 6.3x-6.4x range over the longer term, which is consistent with the 'BBB' IDR.

Fixed charge coverage (FCC) was 2.8x for both the trailing 12 months (TTM) and quarter ended Sept. 30, 2013. Fitch expects that HCN's FCC will remain around this level over the next 12-24 months, as accretive growth from acquisitions and developments is mitigated by increasing capital expenditures and higher cost of capital. Fitch defines fixed-charge coverage as recurring operating EBITDA, less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred dividends. Projected coverage is appropriate for the rating.

Strong Access to Capital

HCN raised approximately $3.6 billion of capital in 2013, including unsecured bonds, term loans, and follow-on common equity. The company also upsized its credit facility while extending the term and lowering the LIBOR spread to 117.5 basis points (bps) from 135 bps.

Robust Financial Flexibility

HCN's liquidity position pro forma for recent capital transactions is adequate, with total sources of liquidity covering uses by 1.5x for the period Oct. 1, 2013 to Dec. 31, 2015. Sources of liquidity include unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flow from operating activities after dividends. Uses of liquidity include pro rata debt maturities, recurring capital expenditures, and remaining development costs. Only 13.9% of pro-rata debt matures through 2015 and no more than 13% of total debt matures in any given year through 2017, limiting refinancing risk. HCN also has strong contingent liquidity with unencumbered asset coverage of unsecured debt (UA/UD) based on a stressed 8.5% capitalization of 2.3x, pro forma for recent unsecured debt transactions and upcoming secured debt repayment.

Elevated AFFO Payout Ratio

Health Care REIT has paid out more than 90% of AFFO as common dividends since 2010, indicating moderate internally generated liquidity. The company's AFFO payout ratio was 94% through Sept. 30, 2013 and Fitch expects the ratio will remain relatively flat over the near term as accretive investments should be offset by the 3.9% dividend increase announced for 2014 and increasing capex from RIDEA investments.

Underperforming Equity

HCN and the broader healthcare REIT sector have underperformed indices over the past 12 months, driven by market factors (sizable NAV premiums beginning to normalize) and fundamental issues (growth deceleration and elevated levels of new supply). HCN has historically taken advantage of richly priced equity to finance its sizable growth, issuing more than $10 billion of common equity since 2006 at an average 28% premium to NAV. The recent underperformance (the company currently trades at a 5% premium) raises uncertainty about future equity financing and whether the company will be able to grow in a leverage-neutral manner without diluting equity holders.

Modest Tenant Concentration

As of Sept. 30, 2013, Sunrise Senior Living was the company's largest tenant at 18% of invested capital, with the five largest tenants representing 43%. This concentration is high relative to other asset classes but strong relative to peers Ventas, Inc. ('BBB+'/Outlook Stable) and HCP, Inc. ('BBB+'/Outlook Stable), whose five largest tenants comprise 56% and 59%, respectively. The concentration is also mitigated by the solid performance of these tenants, which operate in well-diversified, attractive high-barrier-to-entry markets, and with cross-collateralized lease structures.

International Expansion Presents Event Risk

HCN has accelerated its growth in Canada and the United Kingdom via various acquisitions over the past 12 months, highlighted by Revera and the final phase of Sunrise Senior Living. The cash flow diversification and favorable demographics underlying the transactions are credit positives. However, event risk arises from future uncertainties related to regulatory and entitlement risk in these markets. Fitch expects that the company will continue to grow in Canada and the UK and potentially enter new markets over the next 12-24 months, which further exacerbates these risks. That being said, Fitch has a favorable view of HCN's management team, which has prudently entered new markets in a disciplined, well-executed manner.

Stable Outlook

The Stable Outlook centers on HCN's normalized credit metrics that are appropriate for the rating coupled with strong liquidity and access to capital. In addition, Fitch expects healthcare real estate to continue to benefit from positive demographic trends over the near to medium term.

Preferred Stock Notching

The two-notch differential between HCN's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB' IDR. These preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

RATING SENSITIVITIES

The following factors may result in positive momentum in the ratings and/or Outlook:

--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (TTM coverage at 3Q'13 was 2.8x);

--Fitch's expectation of leverage sustaining below 5.5x (3Q'13 annualized leverage was 6.2x);

--Fitch's expectation of unencumbered assets to unsecured debt based on an 8.5% capitalization rate sustaining above 2.5x (pro forma UA/UD is 2.3x).

The following factors may result in negative momentum in the ratings and/or Rating Outlook:

--Fitch's expectation of fixed charge coverage sustaining below 2.5x;

--Fitch's expectation of leverage sustaining above 6.5x;

--Fitch's expectation of unencumbered assets to unsecured debt sustaining below 2.0x.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);

--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013);

--'Corporate Rating Methodology' (Aug. 5, 2013);

--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013);

--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 26, 2013).

Applicable Criteria and Related Research:

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722363

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Parent and Subsidiary Rating Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685552

Criteria for Rating U.S. Equity REITs and REOCs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=700091

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=818436

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Fitch Ratings
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