Why does Covid-19 get the blame when Eagle Hospitality Trust's woes predate it?

URBAN COMMONS (UC), the sponsor of Eagle Hospitality Trust (EHT) and master lessee for all of the Reit's hotels, has reneged on its latest monthly fixed rent payment to EHT, barely 10 months after selling its assets into the Reit last May.

UC is blaming the Covid-19 pandemic for reducing the income productivity of EHT's 18 hotels in the US.

But the fact that UC was unable to dip into its own pockets to make up for the payment shortfall - which occurred before US hotel occupancies had suffered the full impact of virus control measures - deserves further scrutiny.

Market concerns about UC's strength as a Reit sponsor have long been an overhang for EHT.

During EHT's initial public offering (IPO), UC inked master lease agreements with EHT for each of its properties, and agreed to make fixed rent payments to EHT regardless of the hotels' profitability.

Master lease agreements are commonly used to protect hotel Reit investors from fluctuating income.

UC's fixed payments were supposed to account for 66 per cent of EHT's projected rental income in 2020, though the US lodging market began to weaken in the second half of last year. EHT's revenue for 2019 came in 10 per cent lower than forecast. On Feb 17, 2020, a week before the US confirmed its first case of local Covid-19 transmission, UC amended the master lease agreements to allow EHT to receive more rent from any hotels that produce excess cash flow, to make up for shortfalls in any underperforming hotels.

The master lease agreements also formed the basis for EHT's adopted valuations of its hotels.

According to EHT's offer document, UC was required to hand over a US$43.7 million security deposit to EHT during the IPO, equivalent to nine months of fixed rent.

UC funded US$23.7 million in cash, and indicated in the offer document that it would provide the balance of US$20 million by way of a letter of credit on or around EHT's listing on May 24, 2019.

After EHT's IPO, most investors assumed that the full US$43.7 million was safely in escrow, until they were told differently on March 19, 2020.

What they learnt is that UC had used US$5 million in cash to top up its security deposit to US$28.7 million, though it still had not managed to procure a letter of credit for the remaining US$15 million of the US$43.7 million.

All that the sponsor had was a non-binding "executed term sheet" from an unnamed "A" rated bank. EHT said in the announcement that it has agreed to give UC up to June 8, 2020 to produce a letter of credit.

Multiple lapses

There are a few problems with this sequence of events.

First of all, if the purpose of a letter of credit is to back up a counterparty's ability to satisfy its obligations, then UC has failed to deliver.

So why was the deal executed even though the letter of credit was never produced?

Second, if the Reit expects to face a one-year delay before receiving the full security deposit stipulated in its IPO offer document, isn't this something that should have been made known to investors sooner?

Any clues investors can get about UC's current financial standing would be price and trade-sensitive information, especially since very little is known about UC or the size of its equity base, which was never discussed in EHT's offer document.

In fact, when The Business Times pressed for more details about the sponsor's track record and financial resources last year, EHT would only say that UC has landbanks in the US, and that the owners of the sponsor own 13.7 per cent of EHT. Requests to speak to UC directly were not entertained.

Asked by BT if it believes any disclosure breaches have taken place with respect to the letter of credit, a Singapore Exchange spokesman said: "We note that the issuer is currently in urgent negotiations with its banks. SGX RegCo is closely monitoring the company's disclosures and will be requesting more information on these, including a detailed timeline of events. We will review all of these and where warranted, take the necessary action which may include further public queries or investigations."

The Monetary Authority of Singapore is also following up with the Reit manager, its board and the trustee on the issues relating to EHT. It told BT: "These entities are required to act in the best interests of unitholders. MAS will investigate and take appropriate enforcement actions should we uncover grounds to suspect that relevant laws and regulations have been breached."

This isn't the first time that EHT has been slow to disclose information that may be negatively perceived.

EHT's senior vice-president of finance resigned on June 30 last year citing personal reasons, just one month after EHT's IPO. This was disclosed only in December last year.

EHT replaced him with a chief financial officer who resigned in March this year. EHT's original head of investor relations also quit a few months after the IPO last year.

More recently, independent director Ng Kheng Choo resigned two weeks ago to pursue personal interests. She is believed to be a proxy for billionaire Gordon Tang, who became EHT's largest unit holder with an 11.51 per cent stake after other placees sold off theirs.

The bankers and the board

BT asked DBS Bank, the sole financial adviser and issue manager for EHT's IPO, what due diligence it had done to satisfy itself that UC had the wherewithal to meet its obligations under the master lease agreements.

DBS replied: "The due diligence carried out for the listing of business trusts and Reits, which includes work in relation to the cash flows generated by the underlying assets, is rigorous and in accordance with market best practices and in line with advice provided by external professional parties."

DBS did not directly address the issue of the missing letter of credit. "Given the recent announcements and the units in EHT are currently suspended, it would not be appropriate for us to comment further at this stage."

The board of directors of EHT's Reit manager also owe unit holders a duty of care.

However, potential conflicts of interest could arise here given that Howard Wu, the non-independent, non-executive chairman of the Reit manager and Taylor Woods, its non-independent, non-executive deputy chairman, each own a 50 per cent interest in UC, the Reit sponsor, along with a 50 per cent interest in the Reit manager.

The issue of whether the interests of the Reit sponsor are aligned with minority investors came up last year amid a massive sell-down in EHT units. BT identified the biggest sellers of EHT units as Frank and Norbert Yuan, whose family office ASAP sold UC six of the 18 hotels that eventually formed its IPO portfolio two months later.

Since then, the Yuan family's combined stake in EHT has fallen from 33.4 per cent to under 5 per cent, though they continue to earn 3.7 per cent interest from EHT each year, under a US$89 million unsecured loan.

Regulators as gatekeepers

In less than one year from the date of its IPO, EHT's market cap has collapsed from US$677 million to US$120 million.

Trading in EHT units has been suspended without it having paid a cent to investors because its syndicate lenders, including DBS Bank, served it with a notice of default exactly one business day before EHT had planned to transfer the dividend monies to the Central Depository. The default was triggered when UC came up short on its rent payments.

That's a lot of value destroyed in a very short time.

Given the clear limitations of independent directors and investment bankers to act as gatekeepers (since they are all compensated by the Reit), the regulators need to step up and exercise their own judgement when assessing prospective IPOs in the future.

As BT reader Bobby Jayaraman pointed out last year, one tell-tale sign during EHT's IPO was that the cap rates used by the valuers were much lower than actual market transactions for hotels of similar quality.

Some basic research could have alerted the regulators to this fact, which they should have questioned EHT about, along with the robustness of its master lease agreements.

Read more: Eagle Hospitality Trust's saga raises question mark over adequacy of IPO disclosure rules