Credit Ratings for Real Estate
Backed Securities
Diane K.Y. Lam, CFA
Tel: 852-2533-3522
Email: Diane_Lam@standardandpoors.com
Standard & Poor’s
October 2003
Today’s Agenda
•
Trends in debt capital markets for real
estate backed securities
•
Evaluation of REIT
•
Evaluation of commercial mortgage
backed securities (CMBS)
•
What are the implications for Taiwan?
CMBS Rating vs.LPT Corporate
Rating
Credit Risk Spectrum
Unsecured Corporate Debt
(risk is default of entity)
Secured Corporate Debt
Reduced Credit Risk
3
Structured Finance
(insolvency remote
issuer; risk is asset
related)
Debt Capital Markets Offerings for
Real Estate
Real Estate
Structured Finance
REITS
Residential Mortgage
Backed Securities
(RMBS)
Commercial Mortgage
Backed Securities
Pool Transactions
Corporate Issuer
Ratings
Credit Lease
Transactions
Property Specific
Transactions
Single Borrower /
Single Property
Single Borrower /
Multiple Properties
4
Multiple Borrowers /
Multiple Properties
The Value of Credit Ratings
Issuers
•
•
Intermediaries
Enlarge the
universe of
potential
investors
•
More favorable
credit terms
•
Investors
Facilitate the
pricing and
placement of
securities
• Global measure
of credit risk
Monitor
counterparty risk
• Portfolio
monitoring
5
• Benchmark for
risk premium
Performance of REITs in
other Countries
Case Study: US
Real Estate Investment Trusts (REITs) in the United States:
–
–
–
–
–
Created in 1960 to enable small investors to invest in real estate.
Slow start but picked up in the 1990s after tax reforms and
property downturn (companies saw them as an efficient way to
access capital).
There are currently 300 REITs operating in the United States.
Total assets under management currently over US$300 billion.
Approximately two-thirds are trade on the national stock
exchange.
7
Case Study: Australia
Listed Property Trusts (LPT) in Australia:
–
–
–
–
–
Launched in the early 1980s
The LPT sector has been one of the strongest performing
sectors of the Australian Stock Exchange (ASX).
The capitalisation of Australia's listed property trusts
represents seven percent of the ASX.
There are presently more than 38 listed property trusts on the
ASX and these are capitalised at more than A$50 billion.
REITs own around 50% of an estimated A$120 billion of
institutional quality property in Australia
8
Case Study: Asia
Japan
–
–
–
Korea
–
–
–
J-REITs were launched in Japan in 2000
Real estate to account for more than 50% of total assets.
There are currently six registered J-REITs in the market.
Property trusts were launched in Korea in 2001.
There are two types of trust: K-REITs and CR-REITs.
K-REITs are not preferred by investors because dividend
income is taxable (there are some exemptions).
Singapore
– S-REITs were launched in 2002.
– Three S-REITs in the market CapitaMall (retail) and
Ascendas (industrial) and Fortune Reits (retail).
Hong Kong
– Enabling legislation launched in 2003
9
Global REIT Overview
Start Date
Distribution
US
1960
>90%
Netherlands
1970
>80%
<60%
no
Australia
1970
100%
<60%
no
Belgium
1990
>80%
<50%
no
Canada
1994
85% - 100%
<50%
restricted
Singapore
1999
0-100%
<35%
no
Japan
2000
>90%
<25%
no
Korea
2002
[varies]
[varies]
restricted
Hong Kong
2003
>90%
<35%
restricted
France
2003
>85%
no limit
no
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Gearing
Development
restricted
Case Study: Attractive Yield
8.0%
8
7.06%
6
(%)
4.44%
4.01%
4
2.50%
2.83%
3.16%
3.19%
2
0.50%
0
12 Month
CPF (Ordinary
Deposit Rate (1) Account) (2)
SESPROP
Dividend
Yield (3)
STI
Equity
Index (3)
10 Year
Government
Bond (3)
OCBC Sub
due 2011(3)
(5%-BBB+)
Notes:
(1)
Domestic interbank overnight interest rate as at December 27, 2002.
(2)
Based on interest paid on CPF Ordinary Account from Oct 1, 2002 to December 31, 2002.
(3)
Straits Times Index.
11
UOB Sub Notes
due 2016(3)
(4.95% -A-)
CapitaMall
A-REIT
Yield at IPO
Global CMBS Issuance 1985-2002
US$ (bn)
US
Non US
90
80
70
60
50
40
30
20
10
0
85
86
87
88
89
90
91
92
93
94
Year
12
95
96
97
98
99
'00
'01
'02
YTD
CMBS Market in Australia
13
CMBS Market In Japan
•
Growth Factors:
• Corporate restructuring—divesting owned real estate
• Establishment of JREIT market
• Efforts of the RCC to securitise non-performing pools
• Liquidations of real estate portfolios by failed companies
• Emergence of some performing loan conduits—still sporadic
•
Challenges:
• Securitization continues to be lender of last resort
• Still faces competition from direct lending market
14
CMBS Market In Korea
•
Growth Factors:
• Corporate restructuring—divesting owned real estate
• Establishment of REITS enabling legislation
• Securitization of non-performing NPL loans held by private equity
firms
•
Challenges:
• Tenant Rights and Tenant Senior Liens (Chonsae)
• Still faces competition from direct lending market
15
CMBS Market In Hong Kong &
Singapore
•
Growth Factors:
• Corporate restructuring—divesting owned real estate
• Establishment of REITS
•
Challenges:
• Valuation Gap
• Still faces competition from direct lending market
16
What is a REIT?
•
•
•
•
•
Equity - The shares or unit trusts are usually traded on the
stock exchange.
Most REITs remit at least 90% of their income to shareholders.
REITs are usually not required to pay income tax.
A REIT is a company that owns and, in most cases, operates
income producing real estate.
Laws differ across geographic locations, but broad parameters
are similar.
17
Structure of REITs
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The REITS Ratings Approach
Industry Characteristics
Trust Operational Risk
Financial Risk/Flexibility
The company’s business risk profile
determines the level of financial risk
appropriate for a rating category.
19
Degree of
Operating
Risk
Specific trust risk
factors. .
Financial risk is
portrayed largely
through quantitative
ratios.
Rated REITs in Asia Pacific
Rated Property Trusts in Asia Pacific
Credit Rating
Outlook
Business
Singapore
CapitaMall Trust
A-
Stable
Property trust
Australia
AMP Diversified Property Trust
AMP Office Trust
AMP Shopping Centre Trust
CFS Gandel Retail Trust
Commonwealth Property Fund
Deutsche Office Trust
General Property Trust
Macquarie Office Trust (Class-A notes)
Principal Office Fund
Stockland Trust Group
Westfield Trust
A
AA
AABBB+
A+
AAA
AAA
Stable
Stable
Stable
Positive
Stable
Stable
Stable
N.A.
Stable
Stable
Stable
Property trust
Property trust
Property trust
Property trust
Property trust
Property trust
Property trust
Commercial (mortgage-backed securities)
Property trust
Property trust
Property trust
Japan
Japan Real Estate Investment Corp.
Office Building Fund of Japan, Inc.
A+
A
Stable
Stable
Property trust
Property trust
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What is a CMBS
•
•
•
•
•
Debt -- Fixed Income Securities backed by real estate
Issuer contracts to pay a stated coupon to investor
Issuer contracts to repay principal to investor over the tenor of the
bond
Issuer is typically tax neutral
Issuer is a SPV company that either owns operates income
producing real estate or owns a secured loan backed by real estate.
21
CMBS Characteristics
Noteholders
Liquidity
Facility
Security
Trustee
Notes
Issuer
(SPV)
Interest &
Principal
Payments
Secured
Loan
Swap
Counterparty
Capex, Relet &
Other Reserves
Owner/Borrower
(eg. REIT)
Property
Management
Trustee
Property Assets
Lease
Payments ($)
Tenants
22
The CMBS Rating Approach
• Transaction enquiry
• Desk top review of collateral, indicative ranges provided
• Staged engagement entered into
• Detailed review of collateral, site visits, underwriting
• S&P assessed collateral values, stabilised cash flows, loanto-value and debt-service-coverage-ratio’s assigned
• Proceed onto second stage – YES/NO??
• Review of building condition, environmental and general due
diligence information (including requirements for reserves)
• Transaction documents
• Ratings assigned
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Major Issues to Examine
Property industry characteristics:
Cyclical trends
Competition
Economic outlook
Structural Considerations:
Interest rate risks, F/X risk
Insurance requirements
Liquidity Lines, Reserves
Collections Management/Commingling Risks
Refinancing Risk
Amortizing Debt or Bullet Debt
Asset Quality and Stability of Cash Flow:
Diversification
Rent review details
Tenant quality
Asset Valuation Consideration
Stabilized cashflows & yields
Determine valuation
Is loan to value appropriate for the target
rating
Lease maturity profile
Vacancy & Re-letting reserves
Capital expenditures
Management evaluations:
Property Manager’s Expertise
Rental Manager’s Expertise
Credit control and administration
Cash Flow Consideration
Determine refinancing constant
Is the debt service coverage ratio appropriate
for the target rating
Legal Considerations:
Creditor’s rights on real estate security
Liquidation process and timeframe
Bankruptcy remoteness of the Issuer (SPV)
24
Distinction with a CMBS Rating
• Issuer rating vs. issue rating
• Corporate approach incorporates REIT’s business strategy and
asset profile for a rolling five year period. It is our opinion of an
issuers capacity to pay its financial obligations
• CMBS seeks to protect the bondholder from the REIT’s
insolvency risk. CMBS rates to the bond documents
underpinned by income from the rental property. The rating
takes into account recovery prospects
• Default rating vs. ultimate recovery
25
CMBS Rating vs. REIT/Real Estate
Issuer Rating
CMBS
Issuer/CCR
First registered mortgages
Security not required
Detailed analysis of security value and cashflows
Portfolio-wide analysis of assets
Explicit LTV and DSCR thresholds
No LTV and DSCR controls
Finite tenor of bonds
“Reasonable” term (ie open duration)
Liquidity facility (may be required)
No liquidity facility required
Bankruptcy remote SPV issuer
Corporate risk considered
Dealing with assets – prescribed limits and controls
Dealing with assets – corporate strategy related
Predetermined limitations regarding additional debt
Corporate strategy regarding debt considered
Provisioning for potential liabilities (capex and relet)
No cashflow provisioning for potential liabilities
Cashflow and waterfall controls
No cashflow controls required
Rating reflects probability of default (inc. recovery)
Rating reflects probability of default
26
Case Study: CMBS and REITS
27
Case Study: CapitaMall Trust
Trust:
Country:
Type:
Lettable area:
Management:
Sponsor:
Listed:
S&P rating:
Placement:
Listed yield:
CapitaMall
Singapore
Shopping malls
813,352 sq. ft
CapitaMall Trust Management
Subsidiary of CapitaLand
July 2002
A-/stable
60-70% institutional
7.2%
28
Case Study: Silver Maple
Investment Corp. Ltd.
Issuer:
Country:
Sponsor:
Closed:
S&P rating:
Placement:
Coupon:
Maturity:
Silver Maple Investment Corp. Ltd.
Singapore
CapitaMall Trust
February 2002 (class A-1)
June 2003 (class A-2)
class A-1 Sing $ 172MM ‘AAA’
class A-2 US$
73MM ‘AAA’
class B
Sing $ 52MM ‘A’
private, single investor
floating rate
December, 2011
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Outlook for Real Estate Backed
Securities in Asia
•
Diversification in portfolio
•
Can offer high income and stable yields (example: REITS)
•
Can offer bond backed by real estate security which are immune
to event risks (example: CMBS)
•
Demands of investor base (pension funds, insurance companies,
banks)
•
Demographics (aging population seeks income, preservation of
capital)
30
Implications for Taiwan?
Lessons From Global Trends:
•
Capital markets can allocate funds efficiently for real estate assets –
RMBS, CMBS and REITS vs. corporate bond vs. equity
•
Real estate backed securities provide high quality investments for
investors
•
New source of funding for real estate would alleviate the concentrated
risk of Taiwan bank to real estate
•
New source of stable revenue (property management fees) is beneficial
to developers
•
Setting clear legal, security, accounting and tax legislations are critical
to establishing REIT and CMBS markets in Taiwan
•
Capital market transaction propels the industry to higher levels of
standard and accountability (valuation, management and reporting)
•
Capital market is efficient in pricing risk and return (and will differentiate
high quality assets from poor quality assets)
•
Cultivate and educate the investors
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