Fitch Ratings has revised Singapore-based Ascott Real Estate Investment Trust's (Ascott REIT) Outlook to Negative from Stable and affirmed the trust's Long-Term Issuer Default Rating (IDR) at 'BBB'.

The agency has also affirmed the REIT's 'BBB' senior unsecured debt rating, as well as the 'BBB' long-term ratings on the REIT's SGD2 billion multicurrency medium-term note programme and the outstanding senior unsecured notes under the programme. The notes are issued by the trust's wholly owned subsidiary, Ascott REIT MTN Pte. Ltd., and guaranteed by DBS Trustee Limited in its capacity as trustee of Ascott REIT.

The Negative Outlook reflects the challenges facing the global travel, hospitality and lodging industry over the next 12-24 months, which are likely to constrain Ascott REIT's operating cash flows and keep leverage elevated.

Ascott REIT was reconstituted as a stapled group - Ascott Residence Trust - following its merger with Ascendas Hospitality Trust (AH-Trust) at end-2019. The rating on Ascott REIT is based on the consolidated profile of Ascott REIT and Ascott Business Trust in light of Fitch's view that there are strong operating and strategic linkages and complete cash fungibility between the two trusts, which the stapling deed provides. The IDR, however, applies specifically to Ascott REIT.

KEY RATING DRIVERS

Uncertain Recovery: The unprecedented severity of the downturn is creating uncertainty in terms of the timing and trajectory of recovery in lodging fundamentals, especially amid the possibility of a second wave of infections and the risk of a return to lockdown measures, which add risks to our estimates. International air travel volume - a key driver of lodging-sector earnings - is not expected to recover completely until 2024, according to the International Air Transport Association, although improvement is likely towards end-2021 and 2022.

Strong Liquidity Supports Affirmation: Ascott REIT has sufficient revolving credit lines and cash available to cover debt maturing in 2020 and 2021. We expect the trust to be able to maintain a robust liquidity buffer of cash and undrawn revolving credit facilities to refinance its upcoming maturities, underpinned by its strong access to domestic credit and capital markets.

Temporary Leverage Increase: We expect Ascott REIT's FFO net leverage to rise to around 11x by end-2020 (end-2019: 9.2x), before recovering to around 8.5x in 2021, the appropriate level for its 'BBB' rating. We believe the deleveraging pace would pick up if the trust completes the sale of two of its properties in France and China in 4Q20 and 1Q21, respectively, for SGD191 million as announced on 27 July 2020. Nevertheless, a deeper or more prolonged decline in trading conditions for the trust's properties poses a meaningful risk to our forecasts and could lead to leverage remaining higher than 8.5x beyond 2021, which could result in a downgrade.

We have not incorporated a market value decline in its property portfolio, but we estimate Ascott REIT's assets will have to decline by about 30% in market value before it breaches the regulatory gearing threshold of 50% (end-June 2020: 36%).

Master-Lease, Long-Stay Challenges: We expect master-lease contracts expiring in the next 12-18 months to be renewed on variable-rent terms given the current environment. We also believe Ascott REIT's long-stay tenant mix will drop on weak business travel. Around 18% and 9% of master-leased income expire in 2020 and 2021, respectively, which is a manageable exposure. However, we do not rule out master lessees renegotiating contracts prior to expiry if the downturn is prolonged.

Nevertheless, existing master-lease contracts, which accounted for 59% of the trust's gross profit in 1H20, should continue to provide a significant buffer to the REIT's operating cash flows. The trust's cash flows are also buttressed by its geographical diversification because different markets are affected by the pandemic to varying degrees and at different points in time.

Ascendas Merger Strengthens Profile: The trust's merger with AH-Trust on 31 December 2019, whereby it absorbed AH-Trust's 14 hotels across Australia, Singapore, Japan and South Korea, increased its portfolio to a total of 87 properties in 15 countries valued at SGD6.7 billion. The new portfolio includes a higher mix of gross profit from master-lease contracts, a significantly larger unencumbered asset pool, and the potential to strengthen the trust's consolidated financial metrics further once the pandemic eases, providing more rating headroom.

Hybrids Treated as Equity: Fitch has assigned 100% equity credit to the trust's SGD400 million outstanding perpetual securities issued in 2015 and 2019. The securities provide strong going-concern and gone-concern loss-absorption features such as no maturity date, deep subordination, and full issuer flexibility to cancel coupons on a non-cumulative basis. We believe the trust is committed to maintaining perpetual securities as a permanent part of its capital structure. The 2019 instrument replaced a 2014 perpetual security at its first optional call date, while Ascott REIT did not call the 2015 instrument at the first optional call date in June 2020. The trust expects to replace the 2015 instrument with a new perpetual security issuance when hybrid markets are more conducive.

DERIVATION SUMMARY

Ascott REIT's rating can be compared with that of Singapore-based CDL Hospitality Real Estate Investment Trust (CDLREIT, BBB-/Negative), US-based Host Hotels & Resorts, Inc. (BBB-/Stable), and UK-based Whitbread PLC (BBB/Negative).

Ascott REIT has a stronger business risk profile than CDLREIT, characterised by a substantially larger and more geographically diversified portfolio of properties than CDLREIT. This, together with Ascott REIT's larger share of gross profit than CDLREIT stemming from master-leased properties, properties with minimum guaranteed rents, and longer-stay clientele, provides Ascott REIT with substantially more cash flow stability during economic downturns. These factors, and stronger capital and credit market access than CDLREIT, support Ascott REIT's higher rating.

Ascott REIT is rated one-notch higher than Host to reflect its substantially greater cash flow stability through economic downturns due to Ascott REIT's master-lease income and tenants' longer length of stay. Host is subject to a greater degree of near-term repricing of its room rates, exposed to a greater degree of fixed costs, which is driving a sharper decline in its EBITDA margins in the current environment than Ascott REIT, and is geographically concentrated to the US. Both trusts maintain large pools of unencumbered assets that serve as contingent liquidity sources and have demonstrated strong access to credit markets during all points in the cycle.

Whitbread is rated the same as Ascott REIT to reflect Fitch's view that the current downturn will only have a limited and temporary impact on the UK-based lodging operator, and also reflects the issuers' strong liquidity. Whitbread is the UK's largest budget-hotel operator with 804 hotels across the country, and a limited diversification into Germany. Whitebread has a larger and more granular property portfolio than Ascott REIT but is geographically concentrated in the UK. Ascott also benefits from stronger EBITDA margins, which is a function of a high mix of revenue from master-lease contracts. The Negative Outlook on Whitbread also reflects the risk of a prolonged post-Brexit economic disruption, in addition to the effects of the pandemic on the lodging sector.

KEY ASSUMPTIONS

Key assumptions in our rating case include:

Like-for-like revenue drop of around 40% in 2020, followed by a 30% and 35% increase in 2021 and 2022, respectively, translating to 2020 revenue that will be around 60% of 2019's level, 2021 revenue at 75%, and 2022 at 100%

EBITDA falling to around SGD175 million in 2020, and rebound to around SGD240 million in 2021

Extended working-capital cycle as operators re-negotiate leases and delay payments

Capex of around SGD80 million per year in 2020-2021, mainly from ongoing developments

Dividend payout to remain in line with historical trends

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

FFO net leverage remaining above 8.5x beyond 2021, or loan-to-value ratio sustained above 40%

FFO interest coverage sustained below 3.0x

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The Outlook may be revised to Stable if Ascott REIT does not trigger the negative sensitivities

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: Ascott REIT had aggregate liquidity in terms of cash, and undrawn committed and uncommitted revolving facilities with banks of SGD620 million as of end-June 2020, sufficient to cover SGD571 million in near-term maturities. Fitch expects the trust's lenders to continue to honour uncommitted undrawn facilities in light of its healthy credit profile and affiliation with its sponsor, The Ascott Limited, which is in turn affiliated with the Singapore sovereign's (AAA/Stable) investment fund, Temasek Holdings Private Limited.

The trust also completed the divestment of Somerset Liang Court on 15 July 2020 for SGD163 million, which boosts liquidity further, and plans to divest two additional properties for SGD191.4 million in 4Q20 and 1Q21. We expect Ascott REIT to be able to refinance its upcoming maturities, leaving its liquidity buffer largely untapped in the current economic downturn.

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

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 to 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.

RATING ACTIONS

ENTITY/DEBT	RATING		PRIOR
Ascott Real Estate Investment Trust	LT IDR	BBB 	Affirmed		BBB

senior unsecured

LT	BBB 	Affirmed		BBB

Ascott REIT MTN Pte. Ltd.

senior unsecured

LT	BBB 	Affirmed		BBB

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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