Fixed-interest debt fortifies S-Reits against chill from rising rates

Singapore

RISING interest rates are known to hurt Real Estate Investment Trusts - but in the latest round of hikes, Singapore-listed Reits (S-Reits) appear to have rate-proofed themselves well.

Analysts tracking the sector point to several factors why they are in better shape to weather the interest rate headwind this time round - the chief reason being their hedging foresight in opting for fixed-rate financing.

DBS Bank property research head Derek Tan told The Business Times that though debt is a major source of financing for Reits, the impact from rising rates would be "minimised" by the refuge offered by fixed-rate loans, which now make up 85 per cent of their total debt.

Post-Great Recession, the three-month swap offer rate (SOR), a benchmark used mainly for commercial loans, hit a seven-year high at 1.762 in early 2016. It now hovers at 1.698, having risen over 55 basis points (bps) year-to-date.

Research analyst at Phillip Securities Research Tara Wong said that while rising rates will impact yield and interest costs, "it does not necessarily lead to a bearish state as rental growth can be a mitigating tailwind".

Ms Wong said the Reits that can overcome the rising rates climate would be those with a low gearing, a high-interest coverage (the ratio of earnings-to-interest expense), a long weighted average debt to maturity, and a high proportion of debt on fixed interest rates.

Reits in this league include Frasers Logistics & Industrial Trust, Keppel DC Reit, Keppel-KBS US Reit and CapitaLand Retail China Trust, Ms Wong said.

In a recent report, RHB Research Institute Singapore analyst Vijay Natarajan cited similar reasons why selective S-Reits still offer value.

"On average, close to 80 per cent of Reit debts are hedged, with only less than 20 per cent of total debt due for renewal up until 2020. Consequently, rising interest rates should not have a significant impact on interest expenses.

"Overall, sector gearing also remains modest at 36 per cent, well below the 45 per cent maximum threshold." Under Monetary Authority of Singapore rules, S-Reits are subject to a leverage limit of 45 per cent.

In addition to hedging and low sector gearing, Mr Natarajan said Singapore Reits have also diversified their funding options to include perpetual securities, retail bonds and medium-term notes, and preferential offerings.

The industry's resilience today is a far cry from a decade ago when ratings agency Moody's downgraded the sector to a negative outlook, flagging "short-term refinancing risks", among other factors. Moody's had pointed out then that the sector was cash-weak and tended to rely on a relatively high proportion of short-dated bank facilities instead of long-term funds.

On the other side from S-Reits, banks are expected to not only weather but benefit from rising interest rates.

Phillip Securities Research's Tin Min Ying said: "As interest rates increase, banks can profit by charging higher interest rates on loans." She believes lenders can keep their rising cost of funds low enough to boost sequential net interest margin (NIM) in the next few years.

Ms Tin noted that while average three-month SOR year-to-date has increased 78.6 per cent year-on-year, the bank savings rate remains unchanged at 0.16 per cent. In this respect, she believes DBS will benefit most.

This is mainly because it has the most substantial current and savings account (CASA) base - amounting to 60 per cent of its total deposits, with pricier fixed and other deposits accounting for the rest. CASA is the cheapest source of funds for a bank.

"With a large bulk of low-cost funds already on hand, DBS has the upper hand by keeping funding costs low while charging higher interest rates on its loans, resulting in broader NIM expansion."

Ms Tin added that last quarter, DBS' management increased its NIM guidance by one to two basis points above its previous guidance of 1.85 per cent.

Higher interest costs can be a double-edged sword for banks, although Ms Tin is sanguine, arguing that despite the increases, current rates are still relatively low compared to historical trends. Notably, loans growth for the past three quarters increased despite a 52-bp increase in the three-month Singapore Interbank Offered Rate (Sibor), she said.

Regional equity strategist at DBS Joanne Goh noted that local interest rates continue to feel the upward pressure from the US Federal Reserve's rate increases. While deposit rates have risen by more than 20 bps in 1H18 from the more intense deposit competition among Singapore banks, this was offset by 20-30 bps higher loan yields.

Ms Goh said: "We estimate that 70-90 per cent of Singapore banks' loan portfolios are variable-rate loans. Also, it may take up to three months for loans to fully re-price...

Based on our sensitivity analysis, every 25-bp increase in interest rates that re-prices the Singdollar, Hong Kong dollar and US dollar loan book would translate into a 3-bp improvement in NIM and 2 per cent accretion to sector earnings."

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