Property Nuggets: A closer look at perpetuals

What’s New

• Mapletree Logistics Trust (MLT) is the first S-REIT to issue perpetual securities (perpetuals), raising S$350m at an interest rate of 5.375%.

• Our view is that this form of fund raising is generally positive for REITs if used to finance accretive acquisitions, but would be expensive to replace debt.

• We anticipate that this may be the beginning of more such issuance to come and highlight some of the implications for REITs.

Essentials

• Avoiding additional leverage. The Monetary Authority of Singapore’s (MAS) guidelines allow REITs to account for perpetuals as equity, as opposed to debt, thus reducing aggregate leverage when used to finance acquisitions. However, credit rating agencies do treat these hybrid securities as 50% debt/ 50% equity in calculating leverage, and excessive levels of perpetuals would trigger a credit downgrade.

• More competitive than equity fund-raising. Given that the cost of debt for REITs ranges from 2-4%, 5-5.5% perpetuals would be an expensive replacement for debt. However, when matched against the cost of equity at between 6-9% for REITs, perpetuals can be a viable alternative to raising equity.

• Essential to acquire properties with funds raised. Due to their costs, REIT managers should only issue perpetuals to fund acquisitions, and our view is that the issuance of perpetuals is a market signal that sizeable acquisitions are forthcoming. REIT managers would likely take care to closely match the timing of acquisitions and the issuance of perpetuals due to their high holding costs.

• Higher likelihood of being used by industrial and hospitality REITs due to higher acquisition NPI yields for industrial (6.5-8.5%) and hospitality (6-6.5%) properties compared against lower NPI yields for office (3.5-4.5%) and retail (5- 6%) properties. This would enable acquisitions financed through the perpetuals to be DPU-accretive to ordinary unitholders. Perpetuals could also be used to fund overseas acquisitions, especially in countries where the cost of debt is high, such as Australia, although this exposes the REIT to exchange rate risk.

• Risk is in fixed payments and higher priority vs ordinary unitholders. The main risk for REITs is in the fixed payout for the perpetuals, which would not change due to shifts in occupancies or rentals. Holders of perpetuals would also rank higher in priority than ordinary unitholders, but would not enjoy potential dividend growth in the longer term.

Action

• Larger REITs with higher exposure to the industrial and hospitality sectors are likely to issue perpetuals to fund yield-accretive acquisitions. Top picks include Ascott Residence Trust, MLT and Mapletree Industrial Trust.

Will the love for perps last?

LAST Thursday, Mapletree Logistics Trust (MLT) sold $350 million worth of perpetual securities, a first for a real estate investment trust.

Naturally, MLT chief executive Richard Lai was happy over the successful sale, though some investors who had bought into Genting’s perps a week earlier were less elated.

Mr Lai said that the firm is very pleased with the strong response received for the securities, a landmark transaction for MLT as well as for the Singapore Reit market. The order book was over three times subscribed or more than $1 billion. The coupon for the MLT perps was 5.375 per cent.

Launched a week after Genting’s $1.8 billion perps issue, it likely caused Genting’s price to slide to $99.70 from $100.61 as some were said to have wanted to switch to a better name. Mapletree Investment Pte Ltd which owns 41 per cent of MLT is 100 per cent owned by Temasek. Both though have a similar Baa3 rating by Moody’s.

Penny stock mentality

Some might have been puzzled by the slide in Genting’s price. After all the deal received massive $6 billion of orders.

In the end it seems not many actually switched because they didn’t want to take a $1,250 loss, said one dealer.

It’s interesting that perps which are sold at $250,000 a pop and targeting rich investors with idle funds, have adopted an almost penny stock mentality.

Perps have become the latest investment fad because of their high yields of 4-7 per cent.

They have resonated with risk averse investors, many who have not touched the stock markets for a few years.

Yet, not all are buying them with a view of their long term income streams, it seems.

Still, a healthy bond market should be actively traded, but it is far from clear how much really is. That is one of the complaints from investors who have to rely on indicative quotes from their dealers or bankers and the spreads can be wide.

It’s also the reason why some private bankers and fund managers say that they dislike the current love affair with perps.

They cite the illiquidity of the instruments and the fact that issuers can redeem them as early as five years, so calling them perpetual securities with no maturity is puzzling.

Some say the current rash of issuance is not well understood by all investors which is unsurprising because the salespeople themselves barely know the instruments.

Many potential investors are sent SMSes the day the issue is launched with the indicative pricing and precious few other details.

In the current hot market, it would be difficult to find out more as the issue is snapped up in a couple of hours.

Many equate perps with plain vanilla bonds. But perps are equities and a major difference lies in the non-payment of the dividend or coupon. If the issuer decides not to pay the dividend of a bond, it is regarded as a default, a very serious event.

But the issuers of a perp can forgo dividend payment without triggering a default though many – not all – have put in features offering some protection in the event of a non-payment.

To be fair when bankers market these deals they do highlight the risks. For instance during the presentation for the sale of Global Logistic Properties perps, it was noted that the company has no track record of paying dividends.

Since listing here in October 2010, the company has yet to declare a dividend though the fact that GLP is linked to the government gives comfort that the perp coupons are likely to be paid.

It’s probably why SingPost perps which offer a lower 4.25 per cent coupon is selling at $101.55 since the company has a steady dividend track record since listing 10 years ago.

Popularity of perps

Even in the midst of perp offerings, a plain vanilla bond of Bank of East Asia (BEA) – also sold last week – attracted 72 per cent interest from the so-called ‘smart money’ or financial institutions. The order book for BEA’s $600 million bonds with 4.25 per cent coupon reached $3.5 billion.

Overall, the popularity of perps has helped Singapore grow its debt market though some observers have wondered if the enthusiasm may be getting a little frothy.

According to Thomson Reuters, year-to-date, the amount of perps sold are $3 billion compared to none same time last year.

Plain vanilla bond issuances so far are $7.5 billion against $4.1 billion in YTD 2011.

Whether the current burst of issuances can be sustained is anybody’s guess. More worrying is how many investors are first-timers, who have yet to see how these instruments will perform in a bear market or when the companies which issue them post losses.

MapletreeLog sells $350m of perpetual

MAPLETREE Logistics Trust yesterday sold $350 million of perpetual securities to pay for acquisitions in South Korea and Japan, the first real estate investment trust to jump onto the perp bandwagon. The money raised will help pay for acquisitions worth $400 million, MLT said.

There was some indication that investor demand was somewhat lukewarm for MLT’s perps following a rash of sales of these securities.

The coupon for the MLT perps was 5.375 per cent following orders which reached over $1 billion.

Richard Lai, chief executive of MLTM, said: ‘We are very pleased with the strong response received for the securities, a landmark transaction for MLT as well as for the Singapore Reit market. The order book was over three times subscribed with participation from more than 60 investors.’

In the past two weeks, there have been several bond issues worth over $3 billion, including Genting’s $1.8 billion whopper and Bank of East Asia’s $600 million.

‘A lot of liquidity was sucked out, so demand for MLT was so-so,’ said one dealer.

MLT’s Temasek parentage has been touted by salespeople. ‘Mapletree Investment Pte Ltd which owns 41 per cent of MLT is 100 per cent owned by Temasek,’ said one relationship manager from a bank.

The net proceeds from the sale of the perps will be used for general corporate funding purposes, including the funding of acquisitions, said MLT. It will also help bring down its gearing of 41.4 per cent. The Reit industry has a benchmark gearing ratio of 40 per cent.

MLT has signed non-binding letters of intent on potential acquisitions in Japan and Korea. In addition to the two acquisitions it announced last month in Malaysia for $24.6 million, the cost of these transactions could reach $400 million, it said.

MLT is rated Baa1 (outlook stable) by Moody’s. The perpetual securities are expected to be assigned an issue rating of Baa3 by Moody’s, it said.

MLT invests in a portfolio of income producing logistics real estate assets in Singapore and the region comprising 98 properties with a book value exceeding $3.7 billion as at Dec 31. About half of its real estate assets are outside Singapore including 25 per cent in Japan and 13 per cent in Hong Kong.

OCBC Investment Research said that MLT’s issue is positive for its unitholders. ‘We view the initiative positively as it provides the much-needed ammunition for its acquisition plans,’ said OCBC analyst Kevin Tan. As the perpetual securities are expected to be fully accounted as equity, the issuance also has the effect of paring down MLT’s aggregate leverage, he said.

Together with an expected positive revaluation of its properties in the coming March quarter, its leverage may be brought down from 41.4 per cent as at Dec 31, 2011, to a more comfortable 36.5-38.5 per cent.

Mr Tan, who has a ‘buy’ call for MLT, said that the firm has a prudent approach towards investments. ‘In particular, MLT reiterated that it has been careful not to rush into investments but rather work closely with its sponsor on various overseas acquisitions – a prudent move in our view, given the current uncertain market conditions.

‘The group also highlighted that there are about $300 million worth of pipeline assets from sponsor that are completed, and that it may acquire some of them during the course of the year.’

He thinks that MLT will be able to continue optimising its portfolio yield, given its disciplined approach towards acquisitions. He noted that MLT’s acquisition of two properties in Malaysia just a week ago were made at attractive initial net potential income yields of 8.7-8.8 per cent, significantly higher than the implied yield of 7.1 per cent for its existing Malaysia portfolio.

MLT closed yesterday unchanged at 90.5 cents.

STRENGTHENING ITS POSITION

•Proposed perpetual securities issuance

•Expecting improved gearing level

•Continued disciplined approach towards Investments

Proposed issuance of perpetual securities

Mapletree Logistics Trust (MLT) announced earlier this week that it is considering the issuance of SGD-denominated perpetual securities. We view the initiative positively as it provides the much-needed ammunition for its acquisition plans. As the perpetual securities are expected to be fully accounted as equity, the issuance also has the effect of paring down MLT’s aggregate leverage. Based on our conversations during an investor presentation held on 6 Mar, we estimate that the aggregate principal amount may fall in the range of S$300-500m, with a five-percent handle for its distribution rate. Together with an expected positive revaluation of its properties in the coming Mar quarter, we believe its leverage may be brought down from 41.4% as at 31 Dec 2011 to a more comfortable 36.5-38.5% level.

Prudent approach towards investments

Management also took the opportunity to share with us its growth plans across different geographical locations during the presentation. In particular, MLT reiterated that it has been careful not to rush into investments but rather work closely with its sponsor on various overseas acquisitions – a prudent move in our view, given the current uncertain market conditions. The group also highlighted that there are ~S$300m worth of pipeline assets from sponsor that are completed, and that it may acquire some of them during the course of the year. We are confident that MLT will be able to continue optimizing its portfolio yield, given its disciplined approach towards acquisitions. We note that its acquisition of two properties in Malaysia just a week ago were made at attractive initial NPI yields of 8.7-8.8%, significantly higher than the implied yield of 7.1% for its existing Malaysia portfolio.

Retain BUY

We will hold off revising our estimates pending more details on the securities issuance. However, as we roll over valuations to FY13 and factor in the recent acquisitions, our fair value is now raised to S$1.18 (S$1.10 previously). Maintain BUY on MLT.

S$ perpetual bond sales at record high

COMPANIES are selling Singapore dollar-denominated bonds with no fixed maturities at the fastest pace on record as low interest rates spur investors to hunt for higher yields.

Mapletree Logistics Trust began marketing a sale of perpetual notes to yield in the mid-5 per cent range, a person familiar with the matter said yesterday, asking not to be identified because the details are private.

Corporates have sold about $2.7 billion of the bonds since December, more than any other year, according to data compiled by Bloomberg which stretches back to 1999.

Falling yields and low benchmark rates are pushing investors seeking higher returns to riskier and longer-maturity assets. Yields on Singapore sovereign debt have dropped 54 basis points since the beginning of July, and the six-month swap offer rate averaged 0.304 per cent over the last 12 months, 20 basis points lower than the previous 12 months.

‘We’ve been in a low interest environment for quite some time, and investors have started to look for higher-yielding alternatives,’ Clifford Lee, head of fixed income at DBS Group Holdings Ltd, said yesterday. ‘This can be achieved by buying bonds from lower-rated companies or by buying notes with longer tenors.’

DBS is helping to arrange Mapletree’s sale, the fifth of such notes denominated in Singapore dollars this year.

Perpetual securities accounted for 34 per cent of all Singapore dollar-denominated bonds sold this year, versus 7.7 per cent in 2011, according to data compiled by Bloomberg. Singapore dollar bond sales more than doubled to $7.8 billion this year compared with $3.7 billion in the same period of 2011.

The notes pay more than securities with a set maturity to compensate investors for the risk that they won’t be called. They are generally senior to equity and subordinated to other types of debt, and may contain terms stipulating that coupons must be paid if a dividend has been declared. Issuers typically retain the right to call the bonds after a set period.

Genting Singapore Plc, which operates one of the country’s two casino resorts, sold the largest Singapore dollar perpetual bond on record when it issued $1.8 billion of 5.125 per cent notes on March 1.

Singapore Post and Olam International, the commodity supplier partly owned by Temasek Holdings, raised $625 million selling perpetual securities last month while Global Logistics Properties increased its 5.5 per cent of existing notes by $250 million in January.

Hyflux Ltd, the country’s biggest provider of water treatment services, became the first company in Singapore to sell perpetual bonds when it issued notes in April last year, bringing the total for 2011 to $1.63 billion.

Singapore Post’s $350 million perpetual bond pays 4.25 per cent until its first call date in March 2022, more than a 10-year bond it sold in March 2010 which has a 3.5 per cent coupon.

‘With high levels of liquidity among private bank investors across Asia and robust conditions in global credit markets, this is a good time to look at perpetuals,’ HSBC Holdings Plc’s Singapore-based managing director for Asia-Pacific debt capital markets, Alexi Chan, said.

‘For many companies, issuing a hybrid instrument can also bring significant benefits to their capital structure.’ – Bloomberg