Views on MAS Proposed Amendments to REITs Gearing

gearing mas reits stocks Jul 29, 2019

by: Tam Ging Wien


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Monetary Authority of Singapore (MAS) in early-July-2019 published a consultation paper proposing changes to their current leverage limit of 45%. The objective of the consultation paper is to seek the public views on these propose amendments in order to provide Singapore listed REITs with more flexibility to manage their capital structure and to streamline the fundraising process for REITs. 

The MAS is inviting views and suggestions on possible ways that the leverage limit can be recalibrated. The written comments and feedback should be submitted to MAS using the suggested template format and emailed to [email protected] by Aug 1, 2019.

Singapore and Hong Kong impose a leverage limit of 45% while Malaysia imposes a 50% limit. Thailand allows REITs to leverage up to 60% if they have an investment grade credit rating. Belgium, Germany and Netherlands have limits ranging from 60% to 66.25%. The US, Canada, Australia, France and Japan, on the other hand, do not impose any leverage limit. The UK also does not impose any leverage limit but requires REITs to maintain a minimum ICR of 1.25 times. 

ProButterfly.com and REITScreener.com has submitted our views on the consultation paper to the MAS expressing our opinions and suggestions.

In general, we welcome the flexibility for REITs to manage their capital structure and gearing with a higher leverage limit up to 60% on condition that the ICR requirements are pushed much higher (e.g. above 6.0x) subject to a clear and standardised definition of the ICR formula used. More importantly, the calculations of the ICR must take into account perpetual securities and convertible perpetual securities distributions as part of interest expenses.

In this article, we address a summary of our views expressed in our submissions to the MAS.

Question 1. (a) MAS seeks views on whether the use of ICR in combination with leverage limit is appropriate; (b) Are there any other approaches or credit metrics that could be considered in determining the amount of leverage?

Response to Q1a:

We are of the opinion that the use of ICR in combination with the leverage limit is appropriate subject to a clear and standardised definition of the ICR formula used. Presently, the definition and formula used for leverage ratio is standard while ICR is not. The ICR figure quoted by the REITs should also be an auditable figure by the appointed auditors.

We support the provision of leverage limit flexibility in order to provide REIT managers to better manage their capital structures, for example open up the option to temporarily raise their gearing ratios during opportunistic and tactical acquisitions both local or overseas while giving them time to redeem those debt via alternative financing means be it through lower cost debt instruments or equity based financing.

ICR is a good measure as it considers also the cost of debt. Two REITs could have similar gearing yet have different ICR due to the all-in-interest-cost or different income efficiency and could differ widely in their ability to service the debt obligations.

Response to Q1b:

Total Interest Expense generally is taken to exclude distributions made to perpetual securities and convertible perpetual securities which can be viewed as “interest expense” from the point of view of REIT unitholders at they are on-going obligations to service.

Therefore, the ICR formula must be well defined and standardised across all REITs listed on the SGX and subjected to audits and must take into account perpetual securities and convertible perpetual securities distributions as part of interest expenses.

Furthermore, REITs should be obligated to report their debt maturity profile for a minimum of 5 years forward to provide transparency of debts that are coming due. These debt maturity profile should also clearly state that the equity of the REIT contains perpetual securities or convertible perpetual securities.

Question 2. MAS seeks views on the option of allowing a REIT’s leverage to exceed 45% but not more than 50% if the REIT has a minimum ICR of 2.5 times after taking into account the interest payments arising from the new debt.

We are of the opinion that REITs are given a progressive tiering flexibility using a combination of leverage ratio and ICR subjected to clear and standardised definition of the ICR formula used with consideration for cash-based income and cash-based interest expenses including perpetual security distributions.

Creating a 50% gearing ceiling may not provide sufficient flexibility for REITs that have shown good financial discipline. An ICR of 2.5x may also be too low in today’s context of low interest rate environment where there exist a possibility of interest rates normalising to historical median levels. We think that a higher 3.0x ICR would be more appropriate.

MAS could also consider the idea of progressive gearing tiers which is determined by ICR of the REIT, for instance:

  • 40% leverage limit with no minimum ICR requirement
  • 50% leverage limit with minimum of 5.0x ICR
  • 60% leverage limit with minimum of 6.0x ICR

In cases where the ICR is no longer met due to factors not directly in control of the REIT manager (e.g. sudden spike in interest rates), REITs should be given a 12-month grace period to re-adjust their leverage ratio to the appropriate tier as defined by the ICR constraint. An appropriate public announcement should be made by the REIT manager should such an event occur as to ensure unitholders are notified.

We hope MAS would consider the idea of progressive tiering with leverage limit not exceeding 60% subjected to conservative ICR requirements.

It is not unreasonable to see some REITs able to achieve and some far exceed the 6.0x ICR, some examples include Keppel DC REIT, Parkway Life REIT, Frasers Centrepoint Trust and Mapletree Industrial Trust. Such REITs should be given the opportunity to flexibility manage their debt by having an increased leverage limit.

Question 3. MAS seeks views on whether it is appropriate for a REIT that has demonstrated good financial discipline, such as having a higher ICR Threshold, to be allowed a higher leverage, say 55%.

We are of the opinion that REITs that have demonstrated good financial discipline should be be allowed higher leverage. As proposed and elaborated in Question 2, a progressive leverage limit their based on ICR multiples could be considered.

Question 4. MAS seeks views on the proposal to require REITs to disclose both their leverage ratios and interest coverage ratios in interim financial results and annual reports.

We are of the opinion that the leverage ratio and interest coverage ratio should be disclosed in the financial results and also audited for the annual reports.

Question 5. MAS seeks views on the proposal to define the interest coverage ratio as earnings before interest, tax, depreciation and amortisation (EBITDA) (excluding effects of any fair value changes) divided by interest expense.

We are of the opinion that this formula does not take into account the effects of cash outflow from perpetual securities and convertible perpetual securities and therefore may not be truly reflective of the debt-servicing ability of a REIT. In the interest of safeguarding the unitholders and encouraging financial prudence among REITs, regular and obligatory distributions from perpetual securities and convertible perpetual should be considered as interest expenses for REITs.

Therefore, a more appropriate definition would be as follows:

Question 6. MAS seeks views on the proposed removal of the requirement for REITs to comply with the Notification Requirements when they rely on the section 305 exemption.

We recognise that the removal of the requirement for REITs to comply with the Notification Requirements when they rely on the section 305 exemption would provide REITs with a more streamlined approach during fund-raising.

Conclusion

We welcome the flexibility for REITs to manage their capital structure and gearing with a higher leverage limit up to 60% on condition that the ICR requirements are pushed much higher (e.g. above 6.0x) subject to a clear and standardised definition of the ICR formula used. More importantly, the calculations of the ICR must take into account perpetual securities and convertible perpetual securities distributions as part of interest expenses.

An ICR of 2.5x may also be too low in today’s context of low interest rate environment where there exist a possibility of interest rates normalising to historical median levels.

The ICR should be audited annually and the disclosed in management slides and the quarterly reports.

Furthermore, REITs should be obligated to report their debt maturity profile for a minimum of 5 years forward to provide transparency of debts that are coming due. These debt maturity profile should also clearly state that the equity of the REIT contains perpetual securities or convertible perpetual securities.

In the end, we welcome the flexibility for REITs that have shown good financial management and prudence by maintaining a conservative ICR (e.g. above 6.0x) to flexibly manage its gearing limit.

 

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