Credit Ratings for Real Estate Backed Securities

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• Credit Ratings for Real Estate Backed Securities
• Diane K.Y. Lam, CFA
• Tel [phone]
• Email Diane_Lam_at_standardandpoors.com
• Standard Poors
• October 2003

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Todays 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?

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CMBS Rating vs.LPT Corporate Rating
Structured Finance (insolvency remote issuer
risk is asset related)
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Debt Capital Markets Offerings forReal Estate
REITS
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The Value of Credit Ratings
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• Performance of REITs in other Countries

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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
  US300 billion.
• Approximately two-thirds are trade on the
  national stock exchange.

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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 A50 billion.
• REITs own around 50 of an estimated A120
  billion of institutional quality property in
  Australia

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Case Study Asia

• Japan
• 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.
• Korea
• 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

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Global REIT Overview
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Case Study Attractive Yield
8.0
8
6
4.44
4.01
4
()
3.19
3.16
2.50
2
0.50
0
UOB Sub Notes due 2016(3)(4.95 -A-)
OCBC Sub due 2011(3) (5-BBB)
A-REIT Yield at IPO
10 YearGovernmentBond (3)
STIEquity Index (3)
12 Month Deposit Rate (1)
CPF (Ordinary Account) (2)

• 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.

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Global CMBS Issuance 1985-2002
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CMBS Market in Australia

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CMBS Market In Japan

• Growth Factors
• Corporate restructuringdivesting 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 conduitsstill
  sporadic
• Challenges
• Securitization continues to be lender of last
  resort
• Still faces competition from direct lending
  market

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CMBS Market In Korea

• Growth Factors
• Corporate restructuringdivesting 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

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CMBS Market In Hong Kong Singapore

• Growth Factors
• Corporate restructuringdivesting owned real
  estate
• Establishment of REITS
• Challenges
• Valuation Gap
• Still faces competition from direct lending
  market

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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.

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Structure of REITs
   
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The REITS Ratings Approach
Industry Characteristics
Degree of Operating Risk
Trust Operational Risk
Specific trust risk factors. .
Financial risk is portrayed largely through
quantitative ratios.
Financial Risk/Flexibility
The companys business risk profile determines
the level of financial risk appropriate for a
rating category.
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Rated REITs in Asia Pacific
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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.

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CMBS Characteristics
Noteholders
Notes
SecurityTrustee
LiquidityFacility
Issuer(SPV)
SecuredLoan
Interest PrincipalPayments
Capex, Relet Other Reserves
SwapCounterparty
Owner/Borrower (eg. REIT)
Trustee
PropertyManagement
Property Assets
LeasePayments ()
Tenants
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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
• SP assessed collateral values, stabilised cash
  flows, loan-to-value and debt-service-coverage-rat
  ios 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 Structural
  Considerations
• Cyclical trends Interest rate risks, F/X risk
• Competition Insurance requirements
• Economic outlook Liquidity Lines, Reserves
• Collections Management/Commingling Risks
• Refinancing Risk
• Amortizing Debt or Bullet Debt
• Asset Quality and Stability of Cash Flow Asset
  Valuation Consideration
• Diversification Stabilized cashflows yields
• Rent review details Determine valuation
• Tenant quality Is loan to value appropriate for
  the target rating
• Lease maturity profile
• Vacancy Re-letting reserves Cash Flow
  Consideration
• Capital expenditures Determine refinancing
  constant
• Is the debt service coverage ratio
  appropriate for the target rating
• Management evaluations Legal Considerations
• Property Managers Expertise Creditors rights
  on real estate security

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Distinction with a CMBS Rating

• Issuer rating vs. issue rating
• Corporate approach incorporates REITs 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
  REITs 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

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CMBS Rating vs. REIT/Real Estate Issuer Rating
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Case Study CMBS and REITS

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Case Study CapitaMall Trust
Trust                  CapitaMall
Country                Singapore
Type                   Shopping malls
Lettable area 813,352 sq. ft Management      
CapitaMall Trust Management Sponsor            
    Subsidiary of CapitaLand Listed            
     July 2002 SP rating            A-/stable
Placement 60-70 institutional Listed
yield 7.2
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Case Study Silver Maple Investment Corp. Ltd.
Issuer                  Silver Maple Investment
Corp. Ltd. Country                Singapore
Sponsor                CapitaMall
TrustClosed                 February 2002
(class A-1) June 2003 (class A-2) SP
rating            class A-1 Sing 172MM
AAA class A-2 US 73MM AAA class
B Sing 52MM A Placement private,
single investor Coupon floating
rate Maturity 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)

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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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uestions
nswers