OREANDA-NEWS. Fitch Ratings has assigned a 'BBB-' credit rating to the \$300 million unsecured notes issued by Corporate Office Properties, L.P., a subsidiary of Corporate Office Properties Trust (COPT; NYSE: OFC). The 2025 notes were priced at 99.510% of par, or at 5.063%, a 270 basis point spread to the benchmark treasury.

OFC intends to use the net proceeds to repay borrowings under its unsecured revolving credit facility and for general corporate purposes.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Strong Franchise/Defense-Driven Portfolio
COPT generates 79% of net operating income (NOI) from its strategic tenant niche, which includes properties occupied primarily by government agencies or defense contractors. As a result, COPT's assets are generally located near strategic defense locations (e.g. Fort Meade, Redstone Arsenal), which drives geographic concentration in the Washington, DC and Baltimore region. These strategic locations drive strong tenant investment in the assets and create stickiness, as retention rates have approximated 70% historically.

Tenant missions also center on R&D and high-tech areas that are critical to national cyber security in the United States. Together with COPT's long-standing relationships with the federal government and contractors, these strategic locations create meaningful barriers to entry.

Portfolio Realignment Complete
COPT completed its strategic reallocation plan that commenced in 2011 via the sale of non-core assets which, when combined with follow-on equity issuance improved its balance sheet to levels consistent with investment-grade office REITs. The remaining transaction is the conveyance of a \$132 million encumbered portfolio (\$150 million of secured debt) to the special servicer during 2015. This transaction will further improve financial flexibility, lower headline corporate leverage, and facilitate reinvestment in the company's strategic niche properties.

Uneven Operating Fundamentals
Defense contractor downsizing, offset by good leasing activity, held same-store occupancy roughly flat since the beginning of 2014 at 90.7% as of March 31, 2015. Fundamentals remain uneven across its markets; the Baltimore/Washington Corridor and Northern Virginia markets, which collectively comprise 67% of portfolio square feet, had soft leasing indicators evidenced by negative cash leasing spreads in 2014 and first quarter 2015 (1Q15). Favorably though, GAAP leasing spreads continue to be positive across the portfolio and accelerated to 7.3% in 2014 and 2.7% in 1Q15. Fitch expects that occupancy will remain unchanged as new leasing activity offsets known upcoming vacancies.

Informed Demand Mitigates Development Risk
COPT's growth strategy centers primarily on new development given the company's strong relationship with, and insights regarding demand from, the U.S. Government for new space requirements. The (re)development pipeline totaled \$294 million at March 31, 2015 and the development pipeline was 65% pre-leased to both government agencies and defense contractors supporting these entities. The cost to complete the pipeline is modest at 3.2% and despite potential growth toward 5%, Fitch expects development risk will continue to be mitigated by COPT's unique relationships which provide implicit pre-leasing.

The company remains well-positioned to capture future demand from cyber security-driven growth, which should offset weakness in regional markets and potential future downsizing from defense contractors. COPT leased approximately 900,000 square feet of first generation development and redevelopment space in 2014, which follows 900,000 in 2013 and a record 1.2 million in 2012.

Conveyances Improve Credit Profile
In December 2013, the company sold its 15-asset Colorado Springs portfolio for \$133.9 million and conveyed 14 properties for \$146.9 million in December 2013, reflecting the value of in-place debt and accrued interest. COPT anticipates conveying a separate \$132 million portfolio to the special servicer in 2015 following vacancies by Northrop Grumman and CSC in April 2014, which will facilitate further headline de-levering. Fitch is not concerned about potential franchise risk at this time; however, additional conveyances would be viewed negatively (there are none expected) given the potential for weakened access to mortgage debt.

Elevated Leverage Expected to Improve
Leverage (pro forma for the conveyance of assets encumbered by \$150 million of secured debt) was 7.0x as of March 31, 2015, up from 6.5x as of both Dec. 31 2014 and 2013. March 31, 2015 leverage would have been 6.8x when excluding the debt incurred with an acquisition that occurred at the end of March 2015. Fitch expects leverage will remain in the high 6's for 2015-2016 before declining to the low 6's by 2017 due to development assets coming on line and contributing to NOI. Projected leverage is appropriate for the 'BBB-' Issuer Default Rating.

Fixed charge coverage (FCC; pro forma for the conveyance of assets encumbered by \$150 million of secured debt) was 2.3x for the trailing 12 months (TTM) ended March 31, 2015 and Dec. 31, 2014, an increase from 2.1x in 2013. Fitch expects that coverage will approach 2.6x over the next 12-24 months, driven by recurring operating EBITDA growth via developments and continued access to debt capital at favorable rates. Projected coverage is good for the rating.

Adequate Financial Liquidity
COPT has a strong liquidity profile with total sources of liquidity covering total uses of liquidity by 1.7x for the April 1, 2015 - Dec. 31, 2016 period.

Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources of liquidity include unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flow from operating activities after dividends. Uses of liquidity include pro rata debt maturities, expected recurring capital expenditures, and remaining development costs.

Weak Unencumbered Asset Coverage of Unsecured Debt
The company's unencumbered asset coverage of unsecured debt (using a stressed 9.0% capitalization rate) was 1.7x as of March 31, 2015, down from 2.2x as of Dec. 31, 2013. Fitch expects this ratio to improve to around 2.0x over the next several years.

Conservative AFFO Payout Ratio
COPT's AFFO payout ratio was 77% in 2014, which allows the company to generate approximately \$30 million of internal liquidity to fund growth and repay debt. Fitch expects the company to increase the dividend over the next 12-24 months; however, Fitch expects the AFFO ratio to remain below 80%.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for OFC include:
--Development spending of \$200 million in both 2015 and 2016;
--\$200 million of common equity and dispositions over the period to finance development;
--Recurring capital expenditures of \$50 million in 2015,
growing to \$55 million by 2016.

RATING SENSITIVITIES
The following factors may have a positive impact on COPT's ratings and/or Outlook:

--Fitch's expectation of net debt-to-recurring operating EBITDA sustaining below 6.0x (adjusted leverage was 7.0x as of March 31, 2015);
--Fitch's expectation of FCC maintaining above 2.5x (adjusted FCC was 2.3x for the TTM ended March 31, 2015);
--Fitch's expectation of unencumbered asset coverage of net unsecured debt (UA/UD) maintaining above 2.5x (coverage was 1.7x as of March 31, 2015).

The following factors may have a negative impact on the company's ratings and/or Outlook:

--Fitch's expectation of leverage sustaining above 7.0x;
--Fitch's expectation of FCC sustaining below 1.8x;
--Fitch's expectation of UA/UD sustaining below 1.8x;
--Material macroeconomic weakness affecting the defense industry, such that a larger portion of COPT's portfolio would consist of standard suburban office assets.