Fitch Downgrades Caparra Hills' IDR to 'B+' & Secured Debt to 'BB'; Outlook to Stable

Fitch Ratings has downgraded Caparra Hills, Inc.'s (Caparra Hills) Issuer Default Rating (IDR) to 'B+' from 'BB-'. Fitch has also downgraded the company's USD59.3 million secured debt bond rating to 'BB' from 'BB+'.

The Rating Outlook has been revised to Stable from Negative.

The 'BB' rating for the secured bond reflects Caparra Hill's limited property diversification, loan to value of 77% based on a property value of USD73.5 million (66% based on net debt), and Fitch's expectation that debt service coverage measured as EBITDA over interest and principal will be at about 1.1x-1.2x over the next 18 months. Fitch expects Caparra Hills leverage to increase over the next 18 months due to lower revenues, higher vacancy rates and investments as the company is progressively replacing two major tenants in a more price competitive environment.

Caparra Hills' Stable Outlook reflects the company's comfortable liquidity and manageable debt repayment schedule. The rating also incorporates Caparra Hills' revenue stream from its lease portfolio. The lease revenues are predominately fixed in nature and also provide for the pass-through of ongoing maintenance and operating expenses for Caparra Hills' properties.

The 'BB' rating for the secured bonds positively incorporates the collateral support included in the transaction structure. The payments of the bonds are secured by a first mortgage on the company's real estate properties and the assignment of leases. The transaction structure includes a debt-service reserve fund, estimated at USD7 million, which covers the equivalent of 18-month debt service for the secured bonds.

The secured bonds are payable solely from payments made to the Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (AFICA) by Caparra Hills. AFICA serves solely as an issuing conduit for local qualified borrowers for the purpose of issuing bonds pursuant to a trust agreement between AFICA and the trustee. The secured bonds are not guaranteed by AFICA, do not constitute a charge against the general credit of AFICA, and do not constitute an indebtedness of the Commonwealth of Puerto Rico or any of its political subdivisions.

Rising Vacancy Rates Hurt Cash Flow:

Fitch expects Caparra Hills, Inc.'s vacancy rates to increase at about 32% as of June 2015 (11.4% in June 2014), which will reduce the company's cash flow generation. However, Fitch anticipates that vacancy will then gradually decline as the company is negotiating new rents for the available space at Santander Tower. The company will have to increase tenant improvement allowances and pay commissions in order to attract new tenants because of the price competitive and difficult market environment in Puerto Rico.

Concentration and Contracts Risk:

The ratings factor in the concentration risk in Caparra Hills' operations related to its three contiguous properties, which limits the company's diversification and growth strategies. Further risks include Caparra Hills' high counterparty risk with three tenants representing approximately 49% of the company's total revenues as of September 2014. The contract maturity profile of the company's lease portfolio remains high over the next 18 months. As of September 2014, 59.4% of the contract matured over the next 12 months. Fitch expects the counterparty and contract maturity risk to decline due to the gradual replacement of its main tenants

Secured Bond Enhances Recovery Prospects:

The 'BB' rating for the secured bonds positively incorporates the collateral support included in the transaction structure. The payments on the bonds are secured by a first mortgage on the company's real estate properties and the assignment of leases. The transaction structure includes a debt service reserve fund, estimated at about USD7 million, which covers the equivalent of 18 months' debt service for the secured bonds. Caparra Hills conducts its operations in Puerto Rico, which Fitch views as a positive in terms of enforceability of the company's secured debt in the event of default. The relationship between the United States and Puerto Rico is referred to as commonwealth status. Puerto Rico's constitutional status is that of a territory of the United States, and, pursuant to the territorial clause of the U.S. Constitution, the ultimate source of power over Puerto Rico is the U.S. Congress.

Rising Leverage:

Caparra Hills had USD56.7 million of total debt as of Sept. 30, 2014, which was composed entirely of the secured bonds. Fitch expects Caparra Hills' leverage, as measured by debt/EBITDA to increase to about 10x FYE15 from 8.7x as of June 14 due to the increase of vacancy rates. The secured debt requires approximately USD4.7 million of annual debt service.

Strong Liquidity:

Caparra Hills' ability to generate positive cash flow from operations (CFFO) in combination with its high cash position relative to its short-term debt makes its debt payment schedule manageable. During the last three years, Caparra Hills' CFFO averaged about USD3 million annually. As of Sept. 30, 2014, Caparra Hills' cash position was USD8.5 million. In addition, the company maintains a debt service reserve fund of approximately USD8.5 million, covering 18 months of debt service.

RATING SENSITIVITIES

A downgrade could be triggered due to a lack of a rapid improvement of the company's vacancy rates, contract maturity schedule coupled with declining cash flow generation, measured as EBITDA, resulting in weaker credit metrics. Higher LTV and weaken debt service coverage ratio could impact negatively the rating

Conversely, lower business risks in terms of contract maturity schedule, concentration risk while improving cash flow generation resulting in lower gross leverage, LTV and improved debt service coverage could trigger a positive rating action.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=934295

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