Scope Ratings ("Scope") has today downgraded the EUR 20m secured corporate bond due 2018 with a coupon of 6.25% of Stern Immobilien AG („STERN“) to BBB- from A- und review for possible downgrade. The rating outlook is stable. STERN is a real estate developer based in Grünwald.

The downgrade was driven by Scope´s change in rating methodology applicable to corporate debt instruments. This rating action follows Scope’s review for a possible downgrade initiated on the 17 September 2014.

The BBB- bond rating is supported by STERN’s solid portfolio diversification with assets held mainly in ‘A’ and ‘B’ locations with positive market perspectives, as well as its relatively high profitability compared to peers. Other positive rating drivers are the moderate LTV and the adequate FFO Fixed Charge Cover.

Negative rating factors include STERN’s concentrated development pipeline, its negligible market shares in core markets, high and volatile Net Debt/EBITDA ratio, and relatively small size.

The bond benefits from a collateral security package. The security package consists of shares in Stern Real Estate AG, a subsidiary of STERN, and valued at EUR 9m at YE2014. It also benefits from a full recourse to STERN whose balance sheet includes high-quality, liquid assets. This security significantly enhances the credit risk of the bond above that of the issuer.

However, in the context of its change of rating methodology for corporate debt instruments, Scope determined that a secured bond can only benefit from a maximum uplift of three notches above the credit risk of its issuer. This is because the value of a security package is tightly linked to the credit quality and the performance of the issuer.

KEY RATING DRIVERS

Small property developer: with am expected total asset volume of EUR 103m at the end of 2014, STERN is a relatively small company in the German real estate sector. This small size constrains the company’s opportunities to benefit from economies of scale and results in volatile cash flow generation. The small size of the company is also evident in its negligible market shares of below 1% in its core markets.

Volatility of cash flows: due to the nature of STERN’s core operation as a property developer and its small size, its cash in- and outflows tend to be very lumpy with free cash flows fluctuating between EUR 4.0m (2011) and expected EUR -22.7m (2014). Scope expects this volatility to continue, triggered by STERN’s concentrated development pipeline with the main project accounting for 12% of total expected exit proceeds.

Solid portfolio diversification: with a development pipeline in Germany generating 54% of total expected exit proceeds, Turkey with 40%, Romania 4%, and Austria 2%, Stern shows a moderate geographical diversification. In these countries STERN focusses on ‘A’ locations such as Munich with 52% of total expected exit proceeds and Istanbul with 40%. Scope believes STERN’s diversification of its development portfolio to be solid, especially as these markets show different demand patterns and positive growth perspectives.

Relatively high profitability: with an expected EBITDA Margin of 26% in 2014 (2013: 31.4%) which is expected to return to around 30% going forward, STERN’s profitability is considerably higher than many of its German peers, most of whom are pure developers.

Adequate leverage: with a moderate LTV that will stand below 50% at YE2014 and is expected to develop in a range between 45% and 55% in the next few years, Scope considers STERN’s leverage to be adequate. Net Debt/EBITDA stood at a very high 22.1x for 2014, but is expected to drop to below 10.0x in 2015. Fluctuation of the latter is typical for a developer which generally suffers from volatility of financial metrics inherent to its business model.

Adequate FFO Fixed Charge Cover: even if exposed to high debt levels as measured by Net Debt/EBITDA, STERN profits from a currently very low weighted average cost of debt. This impacts STERN’s FFO Fixed Charge Cover (x) positively, which stood at an adequate 1.5x in 2014. FFO Fixed Charge Cover is expected to stay above 1.0x at least in the next few years, showing STERN’s strong position to meet its interest obligations.

Liquidity and debt repayments: STERN’s liquidity is forecast at a moderate 1.4x at YE2014 (2013: -1.3x). The ratio is however very volatile and was driven by changes in working capital in previous years due to STERN build up of its development pipeline.

The upcoming debt repayments of EUR 19m in 2015 (2016: EUR 10m) are expected by Scope to be pursued via asset disposals in Munich and Kitzbühel (EUR 17m). The remainder (EUR 2m) is dependent on the extension of overdrafts, which Scope judges to be a manageable risk.

OUTLOOK
The outlook is stable.

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Chief Executive Officer: Torsten Hinrichs.

The rating analysis has been prepared by Philipp Wass, Lead Analyst
Responsible for approving the rating: Guillaume Jolivet, Committee Chair

Rating history of the EUR 20m (2013/18) Corporate Bond of Stern Immobilien AG
13.03.2015 I Downgrade I BBB- I Stable
17.09.2014 I Review for possible downgrade I A- I n/a
26.06.2014 I Affirmation I A- I Stable
30.04.2013 I Initial Rating I A- I Stable

The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Information on interests and conflicts of interest
As at the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of Information for the rating
Valuation reports, other opinions, Annual reports/semi-annual reports of the rated entity/issuer, Detailed information provided on request, Annual financial statements, Data provided by external data providers, Interview with the rated entity, External market reports, Website of the rated entity/issuer, Press reports / other public information

Scope Ratings considers the quality of the available information on the evaluated company to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Examination of the press release by the rated entity prior to publication / Modification of the press release after the examination
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology
The methodology applicable for this rating (Corporate Rating Methodology) is available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

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