DBRS Confirms Morguard Corporation’s Senior Unsecured Debentures at BBB (low) with a Stable Trend

DBRS Limited (DBRS) confirmed the Senior Unsecured Debentures rating of Morguard Corporation (Morguard or the Company) at BBB (low) with a Stable trend. DBRS assesses Morguard’s credit risk profile on a non-consolidated basis and attributes material benefits to Morguard’s holdings in Morguard Real Estate Investment Trust (REIT) (MRT) and Morguard North American Residential REIT (MRG; together, the REITs). Thus, DBRS’s EBITDA calculations exclude REIT distributions received. DBRS is of the view that ownership in the REITs, forming core long-term investment holdings of Morguard, provides the Company with reliable quarterly cash distributions (combined $47.7 million for the last 12 months (LTM) ended June 30, 2018) that it can use for debt service, which, in turn, enhances the diversification and stability of Morguard’s cash flows and is a positive consideration in Morguard’s credit risk profile, thus warranting some rating uplift. This uplift to the rating places the Company firmly in the BBB (low) rating category for reasons discussed below.

The credit risk profile continues to be supported by Morguard’s quality portfolio with strong tenant profile, favourable asset type diversification, and benefits from the strong market position of the Morguard Group of Companies (Morguard, MRT, MRG, Morguard Investments Limited and Temple Hotels Inc. (Temple)), providing Morguard with opportunities for management and advisory fee income. The rating is limited by deteriorating leverage metrics considered an outlier for the rating category (total debt-to-EBITDA of 10.4 times (x) LTM June 30, 2018), a relatively smaller real estate portfolio ($182.2 million net operating income LTM June 30, 2018), high proportion of secured debt in the capital structure (secured debt-to-total debt ratio of 68.6% at June 30, 2018) and uncertainty around the future of Temple as it relates to the Morguard Group of Companies.

DBRS is mindful of Morguard’s growing investment in Temple (58.7% ownership share at June 30, 2018), a publicly traded real estate entity owning a portfolio of 28 value-priced hotel properties across Canada. Temple has run into challenges in recent years resulting from proportionately high exposure to Alberta’s constrained oil & gas markets combined with high leverage (DBRS-estimated total debt-to-EBITDA of 12.8x, annualized at June 30, 2018). Indeed, Temple is currently non-compliant with covenants affecting seven mortgage loans and has drawn increasing amounts ($72.0 million at Q2 2018) on credit lines with Morguard. DBRS is of the view that Morguard’s longer-term strategy vis-à-vis Temple will need to be solidified in the near to medium term, which may be detrimental to Morguard’s credit risk profile, depending on the outcome.

The Stable trend reflects the incremental improvements in key business risk factors, as Morguard’s portfolio continues to grow and diversify, DBRS’s anticipation for Morguard’s total debt-to-EBITDA remaining elevated in the near to medium term (2019E of 10.0x), the outlook for continued stable cash distributions from the REITs, and continued uncertainty surrounding the future of Temple and its relation to the Morguard Group of Companies.

A positive rating action could result if Morguard’s total debt-to-EBITDA improves below 8.6x, on a sustained basis, all else equal. A negative rating action could occur if operating performance of Morguard’s U.S. retail assets continues to decline, or leverage continues to deteriorate such that total debt-to-EBITDA deteriorates above 11.0x, and EBITDA interest coverage (including capitalized interest) deteriorates below 2.30x on a sustained basis, all else equal.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is Rating Entities in the Real Estate Industry (April 2018), which can be found on dbrs.com under Methodologies.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.