DBRS confirms Petro-Canada Centre at A (low)

DBRS has today confirmed the rating of the First Mortgage Bonds of Petro-Canada Centre (PC Centre) at A (low) with a Stable trend.

PC Centre’s credit profile remains solid, supported by a continued improvement in financial performance driven by robust demand for office space in Calgary. PC Centre experienced 7.2% growth in net operating income (NOI) in 2006 and ended the year with 100% occupancy. Interest-coverage ratios continued an upward trend in 2006 with coverage for the First Mortgage Bonds increasing to 3.5 times (from 3.2x), while debt-service coverage was strong at 2.4x, a level that compares well with other properties rated by DBRS. However, tenant-concentration risk is a constraining factor for the rating with Petro-Canada occupying 51.5% of PC Centre.

Looking ahead, DBRS expects NOI and interest coverage in 2007 and 2008 to continue an upward trend, due to higher net rents on modest leasing activity over the past two years in a strong office market, combined with rent steps from existing leases in 2006 and 2007. In 2006, average in-place net rents for PC Centre’s office space grew by 4%. The rents remain well below market, providing upside potential and mitigating some of the risk from any potential future market weakness.

PC Centre’s lease maturities are expected to be manageable through the remaining life of the bonds, with 4.4% of space turning over in 2007 and 13.7% in 2008. This reflects Bell Canada/Bell West’s plans to accelerate its lease termination to December 31, 2008 (from 2012) for 158,563 square feet (9.2% of total leasable area). DBRS does not foresee significant releasing risk in the context of the current market, especially given the in-place net rent of $23.00 per square foot, which is well below market.

The downtown Calgary office market continues to experience excess demand, resulting in almost full occupancy (99.6% at end of Q1 2007) and accelerating growth in market net-rental rates. In 2006, asking net-rental rates in Calgary’s downtown core increased between 30% and 35% year-over-year to a level in excess of $35 per square foot for Class A space. The favourable conditions will likely continue until new development projects are completed over the next two to three years, satisfying the pent-up demand. Current new projects underway in downtown Calgary are expected to add 6.7 million square feet (an increase of 22%), although the space is 80% to 90% pre-leased. While speculative developments has been manageable, there are additional projects in planning that could add up to five million square feet of office space in downtown Calgary. New supply represents a longer-term challenge that could negatively impact the market depending on conditions at the time.

The rights of the First Mortgage Bonds are protected by a Subordination Agreement and Lock Box Agreement between the First and Second Mortgage Bondholders. First Mortgage Bondholders are well-secured, given a loan-to-value (LTV) estimated at under 30%, based on current market values. The total debt outstanding at maturity will be $240 million, including $174 million of First Mortgage Bonds and $66 million of Second Mortgage Bonds. DBRS does not expect any difficulties refinancing at that time.

Note:
All figures are in Canadian dollars unless otherwise noted.