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Rating action

Scope Ratings GmbH (Scope) has today affirmed its issuer rating of BBB-/Stable on Norwegian Property ASA (NPRO).

Rating rationale

The affirmation of the rating is based on the company’s strong operating result in 2022, with high like-for-like rental growth and decreasing vacancies demonstrating good asset quality. This is counterbalanced by a challenging market environment exemplified by rapidly increasing interest rates and negative fair-value adjustments. Operational improvements and the hedging of around 70 % of interest rates lead to stable credit ratios in line with the rating.

NPRO’s business risk profile (assessed at BBB-) remains supported by its large market share of office space in sought-after grade-A locations in greater Oslo, good asset quality supported by low vacancies (6% as at Q1 2023), a young portfolio and a stable and relatively high WAULT of 5.0 years. High profitability, as measured by a Scope-adjusted EBITDA margin of around 80% (LTM Q1 2023) showing low volatility, is a further support.

Limited geographic diversification remains a constraint despite a slight improvement factored in through joint-venture exposure to NORDR (a residential real estate developer; JV partners are Fredensborg and Union Real Estate Fund III), which will generate its first cash flows for NPRO in Q2 2023. High tenant concentration, with top three and top 10 tenants accounting for 31% and 48% of total rental income respectively, remains adversely affected by the dominant tenant Telenor (21%). Tenant concentration is partially mitigated by Telenor’s strong credit quality (high investment-grade) and an implied investment-grade tenant base, based on historical bad-debt statistics and broad tenant industry diversification.

NPRO’s financial risk profile (assessed at BBB-) has been affected by a large increase in rental income of 10.8% YoY as of Q1 2023. This has been counterbalanced by fair-value depreciations of 3.4% over the same period and a drastic headline interest rate increase, which was softened by NPRO’s hedging ratio of around 70%.

Scope-adjusted EBITDA interest cover of around 2.2x (LTM Q1 2023), has only fallen by 0.1x YoY. This is despite the average interest rate increasing to 3.48% as of Q1 2023 from 2.84% YoY and thanks to the strong EBITDA growth. Scope expects interest cover to reduce slightly to below 2.2x during 2023 based on further rate hikes, before recovering to above 2.2x in 2024. This recovery will be helped by expected reversals in interest rates, while already signed rents (e.g. with Norwegian National Security Authority starting in January 2024) and expected CPI feed-through on rental levels elevate rental income further. The company’s free operating cash flow remains positive and covers assumed dividends with good headroom. In Q2 2023 NPRO will receive the first dividend payments from its 42.5% preference share stake in the NORDR joint venture. This should contribute significantly to cash flow in 2024 and beyond.

NPRO’s leverage, as measured by the Scope-adjusted loan-to-value (LTV) ratio, fell below 50% in 2016 and has remained there ever since (Q1 2023: 45%). Scope’s base case expects the company’s LTV ratio to remain around 45% going forward based on: i) the company’s target of an LTV ratio of 45%-55% through the cycle; ii) no property acquisitions expected; iii) positive like-for-like rental income growth; and iv) a reduction in the company’s indebtedness thanks to positive discretionary cash flow that will balance pressure on properties fair values. The Scope-adjusted debt/EBITDA ratio hovered around 13x-14x before the large acquisitions in 2020 and has fallen back to 15x in 2022. Given strong expected cash flows from rentals and dividend income from the NORDR JV, Scope expects deleveraging towards 12x in 2024. While this is elevated, the impact on NPRO’s financial risk assessment remains limited due to the prime characteristics of the buy-and-hold CRE portfolio. Here, sought-after central locations and the decreasing nature of Scope-adjusted debt/EBITDA balance some uncertainty in the medium term.

The company’s liquidity is assessed as adequate, despite ratios historically below par. They are expected to remain at this level due to: i) relatively low amounts of cash on the balance sheet; and ii) half of revolving credit facilities being annual rolling and therefore not included. However, Scope believes liquidity to be a manageable risk thanks to: i) all outstanding debt being secured in properties with a current average LTV ratio of 45% and a maximum LTV ratio allowance of 65%-75%, providing ample headroom; ii) the company’s proven access to capital and bank markets through frequent issuances of debt instruments and a willingness to raise equity if needed; and iii) a spread-out maturity profile and the company’s financial policy of not allowing more than 20% of total loans to mature over the following 12 months on a rolling basis.

Several new ESG reporting requirements were put into legislation in Norway in 2022. NPRO reports according to the Transparency Act and the Equality and Anti-Discrimination Act, the social conditions of which are expected to be in line with the EU Taxonomy. NPRO has already defined environmental targets according to the UN SDGs, with a base year of 2019 and goal year of 2025, although its overall ESG strategy is still under development. As part of its ESG strategy, NPRO intends to have all properties certified ‘very good’ or better with BREEAM or BREEAM In-Use by 2025. Some 66% of all office, retail and restaurant space is certified already, increasing the attractiveness and of its portfolio and strengthening asset quality which will support rental growth and stable cash flow going forward (positive ESG factor).

One or more key drivers of the credit rating action are considered an ESG factor.

Outlook and rating-change drivers

The Outlook for NPRO is Stable and incorporates Scope’s expectation of a stable property portfolio given current market dynamics, with very few transactions. Scope’s rating case therefore includes no acquisitions or disposals of properties. This results in a Scope-adjusted LTV ratio of around 45%. Interest coverage is expected to drop to 2.1x due to increasing rates, before recovering above 2.2x thereafter. Scope does not include the expected dividends of the NORDR joint venture in the issuers EBITDA for the time being, as the joint venture's ability to pay a relevant amount of dividends on a permanent basis has not yet been proven.

A negative rating action could occur if the Scope-adjusted loan/value ratio climbed significantly above 50% or Scope-adjusted EBITDA interest cover fell below 2.2x on a sustained basis. This could be caused by a severe reduction in the fair value of properties compared to Scope’s base case, a large drop in achievable rents due to new regulations, drastically different demand patterns or an unexpected economic downturn. The Scope-adjusted loan/value ratio could also increase due to a large debt-financed acquisition.

A positive rating action would require a Scope-adjusted loan/value ratio below 40% and significant growth in assets leading to better diversification of cash flow. The loan/value trigger could be driven by a lower proportion of debt-funded capex, lower refinancing needs through stronger-than-anticipated portfolio cash flow, a substantial improvement in market sentiment resulting in strong fair-value appreciation, or a change in the funding mix. Cash flow diversification could be driven by renting out the part of the Telenor property that is currently vacant but guaranteed or by broadening geographies and tenants.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for this Credit Rating and Outlook, (General Corporate Rating Methodology, 15 July 2022; European Real Estate Rating Methodology, 25 January 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Rating if the Credit Rating was to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Rating: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Rating originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Rating and Outlook and the principal grounds on which the Credit Rating and Outlook are based. Following that review, the Credit Rating was not amended before being issued.

Regulatory disclosures
This Credit Rating and Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating and Outlook are UK-endorsed.
Lead analyst: Thomas Faeh, Executive Director
Person responsible for approval of the Credit Rating: Philipp Wass, Executive Director
The Credit Rating/Outlook were first released by Scope Ratings on 28 April 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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