Fitch Affirms Omega Healthcare's 'BBB-' IDR Following Aviv Merger Announcement

Fitch Ratings has affirmed the 'BBB-' Issuer Default Rating (IDR) of Omega Healthcare Investors, Inc. (NYSE: OHI; Omega) and maintained the Rating Outlook at Stable following its announced merger agreement with Aviv REIT, Inc. (NYSE: AVIV), a skilled-nursing-focused peer in an all equity transaction. A full list of rating actions follows at the end of the press release.

KEY RATING DRIVERS

The affirmation of OHI's ratings reflects the transaction's negligible effects on leverage and fixed-charge coverage and the incremental improvements in the combined company's portfolio diversification and quality. Moreover, OHI's essentially undrawn $1 billion revolving credit facility and lack of debt maturities until 2019 afford the company flexibility as to how and when it refinances AVIV's debt.

Of interest to Fitch will be the transaction's effect on OHI's equity valuation given management's track record of using issuances to fund acquisitions on a leverage-neutral basis. Fitch estimates the transaction values AVIV at a 6.5% property net operating income (NOI) yield as compared to OHI's past acquisitions which ranged from 8%-10%.

KEY METRICS REMAIN APPROPRIATE FOR THE RATING

Fitch estimates pro forma leverage for the combined company at 4.7x for the annualized quarter ended Sept. 30, 3014 compared to 4.6x for stand-alone OHI. OHI has consistently maintained quarterly leverage between 4.2x and 5.1x since 2011 (the agency views quarterly leverage as more meaningful than trailing 12 months for OHI given the lack of seasonality in reported earnings and timing effects of acquisitions).

Fitch forecasts that leverage will remain between 4x-5x over the next 12-to-24 months. Fitch defines leverage as debt net of readily available cash divided by recurring operating EBITDA.

Fixed-charge coverage is strong for the rating at 3.4x pro forma, compared with 3x and 3.5x for the years 2012 and 2013, respectively. Fitch expects OHI's fixed-charge coverage will continue to improve driven by contractual rental escalators and reduced fixed charges as OHI refinances AVIV's senior unsecured notes and OHI's 2022 6.75% notes become callable. AVIV's senior unsecured notes have a weighted average coupon of 7.1% as compared to OHI's most recent issuance at 4.5% in September 2014. Fitch defines fixed-charge coverage as recurring operating EBITDA less straight-line rents divided by total interest incurred.

CORPORATE LIQUIDITY PROVIDES FUNDING FLEXIBILITY

Fitch sees some scope for the merger to pressure OHI's liquidity in the near term. Fitch expects OHI will repay AVIV's secured and bank facility debt when the merger closes. In addition, OHI may consider using its revolving credit facility as a bridge before permanently refinancing AVIV's high-cost senior unsecured debt.

However, OHI's lack of near-term debt maturities and capital expenditures, coupled with nearly full availability under its $1 billion revolving credit facility offset financing/liquidity concerns. Moreover, Fitch believes there are alternative avenues for OHI to address the refinancing of AVIV's bonds that would not require the company to draw heavily on its revolver, such as pre-funding, in whole or in part, by way of an unsecured bond and/or equity issuance. Fitch may become increasingly concerned by a high line balance should it persist.

DEBT-MATURITY STAGGERING SHOULD BENEFIT REFINANCING

The transaction reduces the largest percentage of OHI's debt due in any one year, which is a credit positive. Fitch has previously highlighted OHI's concentrated (albeit long-dated) debt maturities as a key concern. Longer-term, Fitch expects OHI will seek to lengthen and stagger its debt maturities into 2025 and 2026 as it refinances AVIV's debt and its 2022 notes become callable.

MARGINALLY STRONGER PORTFOLIO QUALITY

The transaction reduces OHI's reimbursement exposure and tenant concentration and has no affect on operator coverage, all credit positives. Concentration of OHI's three largest tenant operators will decline to 22% from 29%, while the 10 largest will decline to 52% from 69%.

However, the magnitude of the benefit from reduced concentration is limited by the commonality of tenant revenue sources, in Fitch's view. Operator coverage will be unaffected at 1.8x and 1.4x for EBITDARM and EBITDAR, respectively, and Fitch estimates OHI's tenants will reduce their reliance on federal and state reimbursements to 88% from 92%. The outsized financial volatility for OHI's operator tenants during periods when reimbursement rates have changed is the largest constraint on OHI's ratings. Healthcare legislation, together with budgetary concerns at both the federal and state levels will likely continue to pressure operator margins and operators' capacity to honor lease obligations.

OHI and AVIV sourced much of their acquisitions from their operators, thus the expanded relationships (33 new operators) should increase OHI's pipeline of opportunities.

FAIR CONTINGENT LIQUIDITY UNAFFECTED

The majority of OHI's assets are unencumbered and Fitch estimates pro forma unencumbered asset coverage of unsecured debt ranges from 1.7x to 2.2x based on a stressed capitalization range of 9%-12%.

SUBORDINATED DEBT NOTCHING

The one-notch differential between OHI's IDR and the subordinated debt assumed as part of the CapitalSource transaction considers the relative subordination within OHI's capital structure. The interest is due and payable only to the extent that there is rent being received from the tenants of the acquired properties to cover the interest expense related to the debt, and the principal is due only to the extent that all rent has been paid for the term of the debt.

STABLE OUTLOOK

The Stable Outlook reflects Fitch's expectation that metrics will remain appropriate for the rating and OHI will lengthen and stagger its forward debt maturities over the next 12-to-24 months. Additionally, Fitch expects that any reimbursement pressures at the operator level would have a minimal impact on OHI cash flows given lease length, covenants and coverage.

Fitch has affirmed Omega's ratings as follows:

--IDR at 'BBB-';

--Unsecured revolving credit facility at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Senior unsecured term loan at 'BBB-';

--Subordinated debt at 'BB+'.

The Rating Outlook is Stable.

RATING SENSITIVITIES

Fitch does not expect management to operate the company consistent with those factors that could otherwise result in positive momentum in OHI's ratings and/or Outlook:

--Increased scale and diversification;

--Fitch's expectation of net debt-to-recurring operating EBITDA sustaining below 4x (leverage was 4.7x pro forma);

--Fitch's expectation of fixed-charge coverage sustaining above 3.5x (coverage was 3.4x pro forma).

The following factors may result in negative momentum in OHI's ratings and/or Outlook:

--Further pressure on operators through reimbursement cuts;

--Fitch's expectation of leverage sustaining above 5.5x;

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

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' May 28, 2014;

--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' Feb. 26, 2014;

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

Applicable Criteria and Related Research:

Recovery Ratings and Notching Criteria for Equity REITs

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=912974

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