Description

2022.10.22 Writeup of 4.25% OPI 5/15/2024 Bonds ($91.01 last; 10.7% YTM; 11.9% YTC)

I think the OPI 4.25% Senior Notes due 5/15/2024 are an attractive long.  OPI is an office REIT externally managed by RMR.  I see this particular $350mm bond issue as highly attractive as a very short duration fixed income investment with minimal risk.

With only ~1.5 years to maturity and under 1.5 years of duration, it will be hard to get hurt here if rates continue to rise.

The portfolio as of the end of Q2 was over 89% leased (and the SS portfolio 94.3% leased as a large redevelopment in DC that comes online in April 2023 has significant lease up remaining).  The portfolio has 6 years of weighted average lease term remaining with 63% leased to investment grade tenants (including 18% to the Federal government).

Office is clearly out of favor and facing real longer term struggles and questions around future economics in the post-Covid world.  But given the current portfolio’s existing leases and reasonably well staggered debt maturities, I don’t see that impacting this particular bond issue (longer dated maturities or the equity might be a different question over time).

Debt metrics themselves look fine for now and through the maturity of this bond.  At the end of Q2, OPI had a leverage ratio of 7.1x net debt / LTM EBITDA and a weighted average debt maturity of 5.4 years.  Only 3% of the debt is secured debt today.  Of greatest relevance on that score, the public debt covenant restricting secured debt to 40% or less of adjusted total assets was at just 1.4% at quarter end, leaving lots of room to refinance maturing debt into secured debt as necessary.

In fact, the current revolver is still unsecured.  While it currently matures in early 2024 (assuming extensions at OPI’s option), it shouldn’t be difficult to extend that maturity over time.  Other RMR REITs have converted unsecured revolvers to secured revolvers in times of stress, so that is a possibility if necessary.  In any event, I’d fully expect the revolver to be utilized to take out our bonds in the short term if the bond markets remain closed or uneconomic.  The revolver had $520mm of availability at the end of Q2 as compared to our bond issue being $350mm.  (It would also not surprise me to see the revolver actually upsized when extended, particularly if OPI ends up granting security such that the new revolver is secured.)  Ultimately, I expect these bonds to be refinanced with more permanent debt in the form of a term loan (whether secured or unsecured) or bonds.

Another possibility would be for OPI to refinance these bonds into new unsecured bonds that have subsidiary guarantees – this tactic was successful in enabling other RMR REITs to access the unsecured bond market at a time when their operations were under materially more stress than OPI’s are today without using up any secured debt capacity.

Asset sales are another avenue that OPI and other RMR REITs have successfully used to defend their credits.  On a gross basis, OPI sold ~$1B of assets in 2019-2020 and another $227mm in 2021 and $88mm YTD’2022 with another $110mm under contract for sale.

Other RMR REITs have raised equity and liquidity by selling wholly owned assets into JVs.  That would seem to be another avenue for OPI to consider over time, especially with some of its larger and newer assets – including Google’s “Midwest HQ” building in Chicago acquired last year, or the Insight Global HQ building in Atlanta acquired last year with 14 years of lease term remaining.  The 2 major redevelopment projects coming online in April in Seattle and DC could also be prospects for sale into a JV.

Finally, the common stock is yielding 15.5% and the latest quarterly dividend was just declared to holders of record as of 10/24/22.  While the other RMR REITs had each cut their dividends to $0.01 per quarter due to Covid stresses (or self-imposed leverage issues at ILPT), OPI has not cut its dividend as of yet.  While OPI strenuously argues there is no need to and that its dividend payout ratio has remained below its 75% target for several years, a dividend cut remains yet another credit-positive lever that could be pulled as needed – both to improve liquidity but also to offer to the banks in connection with extending and potentially upsizing the revolver.

In summary, while OPI’s asset pool may be subject to stress over time given its focus on office assets, this nearest dated bond maturity is of a size at $350mm that is small and manageable relative to OPI’s total debt balance and liquidity.  OPI does not appear to be under major stress today (despite its yields suggesting significant stress) and this bond should have long since matured by the time acute stress arrives at OPI, if it does in fact arrive in the future.

These bonds have a YTM of 10.7% until they mature in just over 18 months on 5/15/24 or a YTC of 11.9% in just over 15 months (callable at par on 2/15/24).  I think the base case is a ~13% return in 12 months or so with minimal risk.  Specifically, if the bonds trade up to 99 in 12 months, they would represent a YTM of 6.1% on 6 month paper or a YTC of 7.6% on 3 month paper at that point.  Trading up to 99 would imply 8 points of capital appreciation plus the 4.25 points of interest income, for a total of 12.25 points of upside on the 91% current price.

Risks

The bonds are currently rated BBB- / Baa3 with negative outlooks so likely to be cut to junk.  This risk is mitigated by the short maturity and the current spread that is already far in excess of average HY spreads suggesting such a cut has already been priced in.

Catalysts

Time passes and we approach maturity.

Revolver gets extended and likely upsized.

Refinancing in advance of call date in 15 months.

Catalyst

Time passes and we approach maturity.

Revolver gets extended and likely upsized.

Refinancing in advance of call date in 15 months.