OREANDA-NEWS. Fitch Ratings says that Singapore real estate investment trusts (SREITs) are likely to issue more perpetual securities in 2016 to fund asset growth and strengthen their balance sheets. This is because the regulator has tightened the cap on leverage (defined as borrowings / total assets) for rated SREITs, and because asset values are likely to be under pressure in 2016 from weaker operating conditions across most sectors, and a potential rise in long-term interest rates.

More SREITs issued perpetual securities to fund growth in 2015. For example, Ascott Residence Trust issued SGD250m of perpetual securities on 30 June 2015, Ascendas Real Estate Investment Trust issued SGD300m on 14 October, and Keppel REIT issued SGD150m on 2 November. On 2 July 2015, the Monetary Authority of Singapore confirmed that the cap on leverage for SREITs will move to a single-tier 45% from 1 January 2016, compared with the previous 60% for rated SREITs, and 35% for unrated-SREITs. Fitch estimates that the average leverage for the 32 SREITs listed in Singapore was 34% at 30 September 2015.

In order for securities to be excluded from the computation of leverage (that is, to be considered as equity), the regulator requires securities to 1) have a perpetual term, 2) be redeemable at the sole discretion of the REIT, 3) have non-cumulative distributions, 4) have no step-up in interest rates or other features that would incentivise the issuer to redeem the securities, and 5) be deeply subordinated in the event of a liquidation.

Fitch treats perpetual securities and other hybrid instruments either as debt, 50% equity, or 100% equity, depending on the features embedded in such instruments. The five features mentioned above are all considered by Fitch to be equity-like in nature. Perpetual securities issued by SREITs also typically 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.

SREITs are liable to pay income tax unless they distribute at least 90% of profits. A dividend stopper may therefore effectively result in tax leakage from a SREIT, which may discourage a SREIT from deferring or cancelling hybrid payments. However, if an SREIT 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, Fitch will consider a dividend pusher clause (a type of look-back provision) as an impediment to the deferral of distributions on hybrid instruments, because it limits a SREIT's flexibility in deferring hybrid payments if, for example, it has paid distributions to unit holders within a specified time-frame prior to the hybrid payment date. Therefore perpetual notes with a dividend-pusher clause will make the security more debt-like. Fitch 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% equity or 100% equity, respectively.