The Monetary Authority of Singapore (MAS) has published a consultation paper to subject all REITs at all times to a minimum interest coverage ratio (ICR) threshold of 1.5 times and aggregate leverage limit of 50%, compared to the current rule that only REITs that intend to raise their aggregate leverage from 45% to 50% would need to meet the ICR requirement of at least 2.5 times.
“MAS proposes that a minimum ICR threshold of 1.5 times apply at all times to all REITs. This underscores the responsibility of REIT managers in ensuring that REITs can adequately service debt obligations, including having sufficient earnings to pay their interest expenses as they fall due,” the MAS says in its consultation paper.
The minimum ICR requirement will not be considered breached if a REIT’s ICR falls below the threshold of 1.5 times due to circumstances beyond the manager’s control.
“However, regardless of the circumstances under which the REIT’s ICR has fallen below the threshold of 1.5 times, the REIT should not incur additional borrowings or enter into further deferred payment arrangements,” MAS says.
Despite being viewed as mildly negative based on the market’s response to the announcement, analysts view the move positively.
In addition to a single regulatory boundary for all REITs, the REITs would be required to perform sensitivity analyses on the impact of changes in ebitda and interest rates on their ICRs during their interim results and annual reports. “If implemented, this will be a slight positive for the overall sector and would mainly benefit smaller overseas REITs,” RHB Bank Research says.
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For instance, the three troubled US-office REITs could experience some relief. “The move is more meaningful for smaller overseas S-REITs and all three US office S-REITs — Prime US REIT OXMU , Keppel Pacific Oak US REIT and Manulife US REIT — as asset value fluctuations have highly impacted them,” RHB says. Other beneficiaries include CapitaLand China Trust AU8U , Elite UK REIT, ARA US Hospitality Trust XZL and Lippo Malls Indonesia Trust, RHB adds.
Elsewhere, DBS Group Research expects little change for the S-REIT sector collectively. “These changes are expected to provide relief for S-REITs facing financial challenges due to rising interest rates. Overall, these newly revised rulings will introduce more financial flexibility for S-REITs in a higher and longer-than-expected interest rate environment. Since the start of the Federal Reserve interest rate hike cycle, we have seen S-REITs’ ICRs dipping from a high of more than 5.5 times in 1Q2023 to 3.9 times, with the range at 2.7 times to as high as 7.7 times as of end-March 2024. We expect continued downward pressure, as the loans expiring in 2024 — where the expiring interest rate levels are still below those of current levels — will drive average funding costs higher and ICR ratios lower if cash flows remain stable,” DBS elaborates.
For the time being, DBS does not see average ICR dropping to below 2 times despite a couple of outliers, since it estimates only 13% of the REIT sector’s debt is set to expire for the remainder of FY2024, and interest rate hedges remain high.
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“While the proposal technically provides REITs with more debt headroom without having a higher ICR, we think few REITs would utilise this, given investors’ comfort level of less than 40%, potential rise in the cost of equity (from higher leverage and lower ICRs), and the higher-for-longer interest rate environment (albeit improving with cuts on the horizon). In fact, REITs’ current decent ICR of 3.7x already allows them to have 50% gearing,” says Citigroup Research in an update.
Generally, RHB is mildly positive on the more lenient ICR requirements. “The MAS proposal to simplify and slightly relax gearing and ICR requirements is a positive step and provides greater flexibility and clarity in the current high interest rate environment while ensuring prudence. It also gradually shifts the onus on managing appropriate debt levels to REIT managers and market mechanisms which we see as a progressive step.”
Overall, DBS says it expects S-REITs whose financial ratios are trending closer to the current 2.5 times floor and 45% leverage ratio, such as Lendlease Global Commercial REIT JYEU , Keppel REIT, Suntec REIT, and Mapletree Pan Asia Commercial Trust N2IU , to “benefit” the most.
In general, analysts see limited impact. Citigroup Research says its top picks have not changed. They are: Mapletree Logistics Trust M44U , Mapletree Pan Asia Commercial Trust, CapitaLand Integrated Commercial Trust C38U , Keppel DC REIT, and Digital Core REIT.
The view among most market watchers is that the banks and other lenders already impose their own financial covenants. Additionally, rating agencies are likely to downgrade REITs with more aggressive leverage ratios, ICRs and Net debt/Ebitda ratios.
Since all REITs will be subject to the new regulatory limits, MAS is likely to be agnostic on whether internally managed REITs should face higher hurdles compared to externally managed S-REITs which can rely on their sponsors for financial support.
