(The following statement was released by the rating agency) Fitch Ratings-Sydney-May 12: Fitch Ratings has revised the Outlook on Scentre Group Limited's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative, from Stable, and has affirmed the rating at 'A'. Fitch has also affirmed Scentre's Short-Term IDR at 'F1' and senior unsecured rating of 'A'. The senior unsecured rating is at the same level as the Long-Term IDR, as the debt is guaranteed jointly and severally by Scentre, Scentre Management Limited in its capacity as the responsible entity and trustee of Scentre Group Trust 1, RE1 Limited in its capacity as responsible entity and trustee of Scentre Group Trust 2, and RE2 Limited in its capacity as responsible entity and trustee of Scentre Group Trust 3. The revision of the Outlook reflects Scentre's exposure to risks of structural changes in the Australian retailing sector following severe economic disruption caused by the spread of COVID-19. Australia has started to ease restrictions related to social distancing, but we believe that the growth in online retailing seen during the pandemic will continue and will lead to a permanent reduction in retail spend in traditional bricks and mortar stores. In response, retailers are likely to reduce their footprints across the country and, hence, demand for space in malls, leading to lower rents and occupancy levels across the industry. We expect the effect on Scentre to be lower than for lower-grade mall operators due to its position as a market leader in Australia, and be mainly felt in lower leasing spreads and contracted rent escalations of CPI plus 2%. Key Rating Drivers ESG - Exposure to Social Impact: Scentre has an ESG Relevance Score of 5 for exposure to social impacts. Retailers in many markets - including Australia - were combating challenges from e-commerce and shifts in customer spending, however, ecommerce market share gains accelerated amid the pandemic as consumers were encouraged by government restrictions to avoid brick and mortar stores. We do not expect all retailers to recoup lost sales post-pandemic and some retailers may not survive the period of social distancing, despite aid from governments and landlords. The market weakness will most acutely affect lower-grade malls, which typically host more vulnerable retailers, but all market participants are likely to be affected. Retail Landscape Changes: We expect structural change in the retail landscape to lower occupancy levels and rents across the industry once pandemic-related restrictions are relaxed. This is likely to weaken Scentre's historically strong visibility over rental income and is reflected in the Negative Outlook. We expect occupancy levels to remain strong for the REIT over the medium- to long-term as retailers seek destination centres for their remaining footprint, but believe that leasing spreads and contracted rent escalations will weaken and remain subdued as retailers seek more favourable terms. Scentre has historically had strong visibility over rental income, driven by high occupancy levels that have exceeded 99% for the past 25 years, lease tenure of around 15-20 years for anchor tenants and five to seven years for specialty tenants, weighted-average lease expiries of around six years, around 10% of leases expiring annually and over 99% of rental income being derived from minimum base rents. This allowed the REIT to report comparable net operating income growth of between 2%-3% since 2014, with around 75% of rental growth driven by contractual annual rent escalation; typically CPI plus 2%. Drop in EBITDA on Pandemic: Fitch expects Scentre's EBITDA to decline in 2020 due to the rental relief provided to tenants under the government's guidelines for commercial tenancies - with around 30% of Scentre's portfolio meeting the guidelines. We expect some rent to be recouped via higher lease payments for the remainder of the tenancies or through extensions to lease contracts. However, a portion will be unable to be recouped by the REIT. As a result, Scentre's leverage is likely to rise temporarily to around 10x by end-2020, above the level at which we would consider taking negative rating action, before moderating towards historical levels in 2021 as conditions normalise. Australia's Largest Retail REIT: Scentre's portfolio of Australian premier shopping centres was valued at around AUD54 billion at end-2019, of which its share was around AUD38 billion. The portfolio contains seven of the country's top-10 retail malls and four of the top five in New Zealand - and captures over 7.5% of total Australian retail sales and over 548 million customer visits a year. Over 80% of capital is located in Sydney, Melbourne and Brisbane; cities that drove economic growth in 2019. Scentre's portfolio mix had changed to comprise 43% experiential stores at end-2019 - such as food and beverage, health and beauty and entertainment - to reflect the changing retail landscape and consumer preferences. Prudent Development Exposure: Scentre has limited development exposure, with its five-year plan focusing on optimising its current portfolio to meet changing consumer preferences. It has also deferred some capex in light of the current environment and continues to review is plan. Scentre had active development projects worth AUD0.2 billion (both past and future cash flow) at end-2019, of which its share was AUD0.1 billion, or around 0.3% of the value of its investment properties; the company typically invests around AUD500 million on development each year. Market-Leading Capital Access: Fitch sees Scentre as having sector-leading and durable access to capital, including debt capital, demonstrated by the diversity of its capital sources and its ability to secure around AUD1.9 billion in additional facilities to shore up its liquidity at the onset of Australia's pandemic-related restrictions. The company has also issued debt in multiple currencies, including the US dollar, euro, pound sterling and Australian dollar, and across a wide range of tenors. It also benefits from its ability to recycle capital through sell-down and entering into joint ventures on its properties. Derivation Summary Scentre's rating is well positioned compared with US peer, Simon Property Group (NYSE:SPG), Inc. (A/Negative). The ratings of both REITs reflect their high-quality retail real-estate portfolios - being among the world's largest REITs and market leaders - cycle-tested management teams, market-leading capital access, conservative financial policies and significant scale, which helps efficiencies. However, both REITs are exposed to the changing retail landscape, particularly following pandemic-related restrictions in Australia and the US, which may lower profitability and ability to manage leverage at levels below their respective negative rating sensitivities. The Outlook on Simon was revised to Negative to reflect weaker credit metrics stemming from its debt-funded acquisition of 80% of TRG and the challenges Simon faces to reduce leverage due to moderating operating performance and elevated capital needs as it navigates the changing retail landscape. The quality of Scentre's portfolio is comparable with that of European peer, Unibail-Rodamco-Westfield SE (BBB+/Negative). The two-notch difference reflects Unibail's elevated leverage following its acquisition of Westfield's international operations and delays in its ability to delever to a level commensurate with its rating. The Negative Outlooks for both entities also reflect their exposure to the changing retail landscape post-pandemic and ability to manage leverage or delever to a level commensurate with their ratings. The one-notch difference between Scentre and Australian peer, Mirvac Limited (A-/Stable), reflects Scentre's larger scale and limited development exposure as well as Mirvac having a homebuilding business. These factors offset Mirvac's more conservative financial profile as it looks to manage its development exposure risk. The Stable Outlook on Mirvac reflects the diversification in its REIT portfolio between office, industrial and retail, compared with the Negative Outlook on Scentre reflecting its exposure solely to the retail industry. Key Assumptions Fitch's Key Assumptions Within Our Rating Case for the Issuer - Re-leasing spreads of around -7.5% in 2020 and -10% in 2021 to 2023, with average contracted annual rent escalations of CPI plus 2% - Rent per square metre to increase by around 1.0% in 2020, excluding pandemic-related rental relief provided, before declining by around 4.0% in 2021 and increasing by between 4.0%-5.0% in 2022 and 2023 (2019: -1.6%) - Capital expenditure of AUD500 million a year in 2020-2023 - No interim dividend to be paid in 2020; from 2021, dividend payout ratio to revert to 85% of funds from operations RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: Fitch may revise the Outlook to Stable if one or more of the following are achieved: -Net debt/operating EBITDA remaining below 7.5x on a sustained basis (2019: 6.7x). -Operating EBITDA/interest paid remaining above 3.0x on a sustained basis (2019: 4.0x). Factors that could, individually or collectively, lead to negative rating action/downgrade: -Net debt/operating EBITDA deteriorating to above 7.5x for a sustained period. -Operating EBITDA/interest paid deteriorating to below 3.0x for a sustained period -Sustained weakening of the retail sector or indicators of structural change in the retail landscape, as indicated by occupancy falling below 95%, weaker average rent per square metre or a higher variable rental component. Best/Worst Case Rating Scenario International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579. Liquidity and Debt Structure Strong Liquidity and Asset-Liability Management: Scentre announced that it had available liquidity of AUD3.1 billion at 1 April 2020 (2019: AUD1.8 billion) after it secured additional unsecured bank facilities with a tenor of two years in light of the pandemic and its effect on global capital markets. Scentre has also since issued a HKD400 million (AUD80 million) private placement under its euro medium-term note programme. The REIT has around AUD1.9 billion in bonds maturing by end-2021 and no bank debt maturing prior to January 2022. Scentre's average debt maturity was 4.2 years at end-2019, compared with weighted-average lease expiries of 6.0 years. The company's funding comprises bonds and bank facilities and it has access to global markets with outstanding bonds denominated in US dollars, euros, pound sterling or Australian dollars. Scentre swaps all of its foreign-currency debt into floating Australian dollars to minimise foreign-exchange risk, then manages its interest-rate risk on a portfolio basis, where typically more than 75% of its interest rates are fixed (2019: 85%, 2018: 69%). Summary of Financial Adjustments Fitch treats Scentre's property-linked notes as an effective sale of the underlying assets, based on the note holders having no recourse to its other assets, annual returns being determined by the notes' proportionate interest in the underlying asset and the noteholders being unable to elect to have the property-linked notes redeemed for cash. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations Scentre has an ESG Relevance Score of 5 for exposure to social impacts, reflecting the risk to its business from a move to online shopping, particularly following a change in consumer behaviour during the pandemic-related social distancing measures. This has a negative impact on the company's credit profile and is highly relevant to the rating. Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. RE2 Limited ----senior unsecured; Long Term Rating; Affirmed; A Scentre Group Limited; Long Term Issuer Default Rating; Affirmed; A; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F1 ----senior unsecured; Long Term Rating; Affirmed; A RE1 Limited ----senior unsecured; Long Term Rating; Affirmed; A Scentre Management Limited ----senior unsecured; Long Term Rating; Affirmed; A ----senior unsecured; Long Term Rating; Affirmed; A ----senior unsecured; Short Term Rating; Affirmed; F1 Contacts: Primary Rating Analyst Kelly Amato, CFA Director +61 2 8256 0348 Fitch Australia Pty Ltd Level 15 77 King Street Sydney NSW 2000 Secondary Rating Analyst Leo Park, Associate Director +61 2 8256 0323 Committee Chairperson Vicky Melbourne, Senior Director +61 2 8256 0325
Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com; Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 01 May 2020) (including rating assumption sensitivity) https://www.fitchratings.com/site/re/10120170 Corporates Notching and Recovery Ratings Criteria (pub. 14 Oct 2019) (including rating assumption sensitivity) https://www.fitchratings.com/site/re/10090792 Sector Navigators: Addendum to the Corporate Rating Criteria (pub. 01 May 2020) https://www.fitchratings.com/site/re/10120367 Short-Term Ratings Criteria (pub. 06 Mar 2020) https://www.fitchratings.com/site/re/10112342 Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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