Singapore REITs - DBS Research 2020-04-17: MAS Throws A Lifeline

Singapore REITs - DBS Research | SGinvestors.io SPH REIT (SGX:SK6U)

Singapore REITs - MAS Throws A Lifeline

  • MAS has given S-REITs additional timeline to qualify for tax transparency status.
  • Gearing limit lifted to 50% but with tighter interest coverage ratio (ICR) requirements, as expected.
  • Near term returns to unitholders impacted which is a negative, but longer term viability of S-REITs is secured.
  • Additional debt headroom is a double-edge sword but S-REITs likely to remain responsible in their capital management approach.

What’s New

  • The Monetary Authority of Singapore (MAS) issued a press release yesterday in view of the operating challenges faced by S-REITs due to the COVID-19 outbreak.

1. Extension of Permissible Period to meet Tax Transparency requirements.

  • The Ministry of Finance (MOF) and Inland Revenue of Singapore (IRAS) will extend the timeline for S-REITs to distribute at least 90% of their taxable income from 3 months to 12 months from the end of FY2020 to qualify for tax transparency. This extension is only applicable for distributions made from taxable income derived by an S-REIT during FY2020.
  • IRAS will provide further details on the extension by early May 2020.

A lesser of two evils; unitholders’ near-term returns may be “deferred”.

  • While some S-REITs have already implemented or may be considering delays in their quarterly dividend payouts (sparked by SPH REIT (SGX:SK6U), the first S-REIT to cut its quarterly dividend payout by over 70%, see report: SPH REIT - DBS Research 2020-04-02: A Long Road To Recovery), the extension of the timeline to meet tax transparency requirements will give them more flexibility and less urgency to raise funds in a less conducive equity and/or debt market environment. We note that this is likely to be one-off given the extraordinary circumstances.
  • While this comes at an expense of S-REIT unitholders in the near-term with a higher possibility of lower and/or delayed dividend payouts in FY2020, this is the “lesser of two evils” if the alternative is a risk of deterioration in balance sheets and cash flows of S-REITs which may require equity issuance to take place at a wrong time.

2. Raising of the aggregate limit (gearing) to 50% from 45%.

  • S-REITs will from immediate effect be allowed a greater gearing headroom of 50% (vs the current 45% limit) to provide S-REITs greater flexibility to manage their capital structure amid the challenging environment created by the COVID-19 pandemic.
  • Given near term pressures on cashflows, MAS will delay implementing the requirement of maintaining an interest coverage ratio (ICR) of 2.5x before being allowed to go beyond the prevailing 45% limit (up to 50%).

Our Thoughts:

  • While the higher headroom gives S-REITs more room optically and wriggle room to manage their capital structure with more flexibility, we believe the original focus is to make S-REITs more competitive in the international scene.

More firepower but focus is not on acquisitions for now.

  • The revised limits will provide S-REITs with additional firepower to debt-fund acquisitions and better compete in the international arena for acquisitions, and merger & acquisitions (M&A) opportunities.
  • That said, we believe that there is minimal appetite from investors and banks to support such acquisition activities in this current climate as the immediate focus is to safeguard portfolios returns in the face of COVID-19 challenges. This allows the S-REITs to remain on the hunt and take on opportunistic deals that emerge from the current economic crisis.
  • With a larger allowable headroom, S-REITs would be able to pounce on these opportunities.

Greater power comes with great responsibilities.

  • While it is still early to gauge how S-REIT managers will utilise this increased gearing headroom, any upcoming deals would enable us (and investors) to discern if the managers will be reckless or disciplined in using these additional “acquisition powers”.
  • We believe that most managers will remain prudent in their capital management approach, though we are likely to see average gearing of c.35% currently head towards the 38%-40% level over time.
  • We believe that investors will accord S-REITs that remain prudent and consistent in their capital management approach with better cost of equity (trade at premiums to NAV, tighter yields) among others.

Tighter ICR ratios a safeguard but we prefer it to be higher.

  • One may argue that higher gearing may benefit S-REITS with too high a cost of equity capital (as most of the large market-cap REITs are trading at levels where they can easily access equity capital). However, we believe the tighter ICR does provide safeguards against careless over leveraging and will benefit unitholders.
  • We found that ICR ratios of 2.5x is typically higher than typical bank covenants of 1.5x- 2.0x but this includes the calculation of perpetual coupons (or interest) in the calculation. Thus, this eliminates the risk of S-REITs “double-dipping” into the higher gearing headroom as perpetual securities are counted as equity rather than debt, as per accounting guidelines.
  • That said, almost all the S-REITs’ have current ICR ratios that are above the 2.5x floor. We believe that a higher floor will be more appropriate to guard against
    1. over leverage, and
    2. the low interest environment may not be representative of a “normalized” ICR ratio if interest rates normalise in the longer term.

Similar ratios to investment grade ratings by credit agencies.

  • The proposed gearing limit of 50% will continue to remain in line with an ‘investment grade’ rating by both Moody’s and S&P. The new minimum interest coverage ratio proposed will only be implemented on 1 Jan 2022, and the new 2.5x minimum interest coverage rating will meet Moody’s and S&P’s minimum ICR of 2.5x and 2.1x respectively.
  • We note that most REITs still have a good buffer in fulfilling both the proposed gearing limit and minimum ICR after earnings cuts.

S-REITs ICR ratios analysis – most pass the revised guidelines.

  • Based on our estimates, S-REITs will be more than able to meet the 2.5x ICR requirement, based on current interest rates, despite our cut in earnings for the Retail and Hospitality sectors. We noted that only two REITs may have to keep within the 45% (rather than revised 50% limit) - Suntec REIT (SGX:T82U) and Mapletree North Asia Commercial Trust (SGX:RW0U) - which reported ICRs of 2.9x and 2.5x recently.

Adjusted ICR analysis shows similar results.

Industrial S-REITs ratios remain the strongest.

  • We note that the industrial S-REITs’ ICR ratios remain the strongest among the S-REITs which once again re-iterates our view that the sector is projected to deliver relatively more stable returns compared to peers. The strong ICR ratios also support potential acquisition activities which at current valuations are accretive for most.

Read also SGX Market Update: New Significant Supportive Measures for S-REITs

Derek TAN DBS Group Research | Rachel TAN DBS Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2020-04-17