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HCP spinoff issues debt on time, but pays for its tenant's troubles

In raising $1.75 billion in debt capital, Quality Care Properties Inc. took a major step in its planned spinoff from HCP Inc., but paid a price for uncertainty surrounding its portfolio, observers say.

The skilled nursing unit, which will have troubled operator HCR ManorCare as its sole tenant after it is spun off into a standalone REIT, priced $750 million of seven-year secured bonds at 8.125% and agreed to a six-year, $1.0 billion, first-lien term loan and a five-year, first-lien revolving credit facility, both at the LIBOR plus 5.25%. All the proceeds will go to HCP in exchange for the assets and properties being transferred to Quality Care.

Analysts said the debt transactions represented a milestone in the process leading up to the spinoff, which is expected to be complete in the fourth quarter. Still, the company "didn't achieve great pricing" on the deals, Moody's analyst Ranjini Venkatesan said in an interview.

The bond offering comes at a time when the best-positioned REITs continue to issue unsecured debt at very low rates. Equity Residential, which carries investment-grade ratings from Moody's, Fitch and S&P, said in an Oct. 5 filing that it is planning to issue 10-year notes at 2.850%.

Quality Care's situation, of course, is different. The company is being spun off explicitly to remove a worrisome collection of skilled nursing properties, and HCR ManorCare, from HCP's portfolio. Quality Care is not an investment-grade issuer, and may not even remain a REIT. Further, the company was aiming to raise capital within a relatively narrow window of time to keep the spinoff on track to close.

The company's debt offering, then, was a rare animal.

"This is a pretty unique debt offering in the REIT universe," Fitch Ratings analyst Britton Costa said in an interview. "We don't see REITs typically issue this type of debt at these prices, so it probably speaks more to the story about having a single-tenant REIT in a less-favored asset class, with investors trying to figure out, 'Are there any big transactions coming?'"

Venkatesan, at Moody's, said lender concerns likely stemmed from the company's concentration with one tenant, from HCR ManorCare's weak rent coverage, and from the regulatory concerns that plague the broader skilled nursing property sector. She added that Moody's was comfortable with the issuance, assigning ratings of B2 to the term loan and credit facility and B3 to the bonds, because of the company's modest leverage, good liquidity and lack of immediate capital needs. (Fitch does not rate the company or its debt.)

Still, lenders may have needed some persuading, in the form of extra yield, to complete the Quality Care transactions. Initial discussions on the term loan reportedly involved a 4.75% spread above the LIBOR, meaning Quality Care ultimately had to promise an additional 50 basis points of yield, Mizuho Securities USA Inc. analyst Richard Anderson said in an Oct. 4 note.

Similarly, with the high-yield market trading at roughly 6.3%, the bond deal, at 8.125%, also "looks like it took an extra effort to finish," Anderson added.

Debt investors' wariness may stem from several peculiarities in the ManorCare relationship, including the possibility that the REIT and the tenant could negotiate a rent reduction.

If Quality Care took a larger ownership stake in ManorCare as part of a deal to reduce rent, it could eventually be forced to give up its REIT status. While executives at both HCP and Quality Care have been circumspect in discussing the various possibilities, they also emphasize that flexibility — to negotiate with ManorCare, and to follow the talks wherever they lead — is one of the main drivers behind the spinoff.

The high yields the company is paying on the debt, then, are "a reflection of the complications of the underlying situation," Anderson said. Analysts said the company likely opted for secured, rather than unsecured, debt as a means of providing investors with greater security without having to increase interest payments even further.

In the end, the important thing about the debt deals may be that they are complete. Evercore ISI analysts called the transactions an overall positive in an Oct. 4 note, adding that the proceeds were "precisely in line" with expectations and management's goals, despite the higher rates.

The Moody's analysts agreed, calling the company's ability to stick to its plan a good sign.

"After the first quarter, the markets for REIT debt at all levels have been very good, so if you can't execute in this market, there would be bigger issues," Philip Kibel, the rating agency's head of REITs, said in an interview.

"So," he added, "it was a good thing that they executed."