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Fitch Ratings on Friday (13 November) said Singapore real estate investment trusts (S-REITs) are likey to issue more perpetual securities next year to strengthen their balance sheets and fund asset growth.
This is because the regulator has tightened the cap on leverage—which is defined as borrowings/total assets—for rated S-REITs, and because asset values are expected to come under pressure in 2016 from weaker operating conditions across most sectors as well as a potential increase in long-term interest rates.
More S-REITs issued perpetual securities in 2015 to fund growth. For instance, Keppel REIT issued S$150 million of perpetual securities on 2 November 2015. Ascendas Real Estate Investment Trust also issued S$300 million on 14 October, while Ascott Residence Trust issued S$250 million on 30 June.
On 2 July, MAS confirmed that the cap on leverage for SREITs will move to a single-tier 45 percent from 1 January 2016, from the previous 60 percent for rated SREITs, and 35 percent for unrated-SREITs.
As at 30 September 2015, the ratings agency estimates that the average leverage for the 32 REITs listed in Singapore stood at 34 percent.
It is noted that for securities to be excluded from the computation of leverage and be considered as equity, the regulator requires securities to have a perpetual term, have non-cumulative distributions, be redeemable at the sole discretion of the REIT, be deeply subordinated in the event of a liquidation and have no step-up in interest rates or other features that would incentivise the issuer to redeem the securities.
Fitch treats perpetual securities and other hybrid instruments either as debt, 50 percent equity, or 100 percent equity, depending on the features embedded in said instruments. The ratings agency considers the features mentioned above as equity-like in nature.
Meanwhile, perpetual securities issued by SREITs usually contain a dividend stopper.
“This means that if a SREIT chooses to defer or cancel a distribution on the hybrid security, then it is also barred from making a distribution to or redeeming more junior securities (common equity) until it resumes distributions on the hybrid instrument,” said Fitch.
It noted that S-REITs are liable to pay income tax unless they distribute at least 90 percent of profits.
As such, a dividend stopper may effectively result in “tax leakage from an S-REIT, which may discourage an S-REIT from deferring or cancelling hybrid payments. However, if an S-REIT is under financial distress to an extent that a deferral or cancellation of a hybrid payment is being considered, it is likely that its earnings would have weakened to the extent that the cost of a tax-leakage would be negligible.”
In comparison, a dividend pusher clause may be considered by Flitch as an impediment to the deferral of distributions on hybrid instruments since it limits the flexibility of SREITs in deferring hybrid payments.
“Therefore perpetual notes with a dividend-pusher clause will make the security more debt-like.”
Fitch revealed that it will typically “notch down the rating of a perpetual instrument by two- or three notches below the REITs Long-Term Issuer Default Rating, depending on whether the instrument is treated as 50 percent equity or 100 percent equity, respectively.”
Nikki De Guzman, Editor at CommercialGuru, wrote this story. To contact her about this or other stories email nikki@propertyguru.com.sg
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