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Shipping Trusts and Reits - Understanding the Risks

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Real estate and shipping trusts are often viewed as a safe-haven investments, but developments in the past one year have shown that the risks of investing such trusts are not as low as they may seem at first glance.

In simple terms, a business trust is a legal entity through which investors pool their money to invest in income-generating assets, which are then managed on their behalf by trust managers. Trust managers are appointed by sponsors who are, more often than not, the majority investors of the trust.

There are several major types of risks associated with business trust operations.

Counter-party risks

Risks for Real Estate Investment Trusts (Reits) mainly relate to arrears in rental paid by tenants, while those for shipping trusts relate to charterers’ defaulting or reneging on charter contracts. This is especially true when contracts were written at a time when rates were buoyant.

Cyclical and leveraging risks

Business trusts often return what appear to be compelling yields because they are leveraged, such that assets are financed not only by unit holders, but by loans as well. Such loans are often governed by loan-to-value (LTV) covenants, whereby borrowers have to top up their loan facilities, should underlying asset values fall below a certain point.

This was the predicament faced by shipping trusts when they found their assets decline sharply in value in 2009 amid a double whammy of the drying up of trade and a glut of new vessels on the market. Waivers to these covenants, if they could be obtained at all, were often subject to the trusts agreeing to higher interest rates.

Financing risks

The recent financial crisis also exposed a new type of risk, related to liquidity of the banking system. Many banks were simply unwilling to rollover loans, leaving trusts (and businesses in general) to scramble for alternative sources of funding or even having to let purchase options expire with penalties.

Conclusion: Finding a balance between risks and returns

Well-run business trusts usually try to manage their risks by diversifying their counter-parties across sectors. They also rely on a variety of financing options beyond loans, such as the issuing of bonds, rights or new units. Just as importantly, fundamentally sound trusts maintain a low gearing to avoid being over-leveraged.

By studying the annual reports, the sponsors and past track records of these trusts, it is possible for investors to identify good investment targets which have yields commensurate with the risks that these trusts are exposing themselves to.

If a trust appears to have a higher yield than its peers, it is a reflection that the market perceives the trust to carry higher risks.

Annex: The Troubles with Trusts

The following is a list of troubles faced by Singapore-listed shipping trusts and Reits, which makes for somber reading. Some trusts came close to collapse while others remain in the doldrums.

First Shipping Lease Trust (FSLT)

  • In September 2009, FSLT announced it has been successfully granted a waiver on a LTV covenant (which it had breached months earlier) by its banks. The waiver however came with higher interest charges.
  • In May 2010, FSLT announced that the charterers (affiliated to Groda Shipping) for 2 of its vessels signaled their intention to renege on their chartering agreements. The 2 vessels in question accounted for 15% of FSLT’s revenues and had their charters fixed when rates were some 50% higher than current market rates. FSLT had however collected upfront security deposits worth nearly 5 months of charter and had an assignment of the long-term Contract of Affreightment between each of the two Charterers and the ultimate employer of the ships.

Rickmers Maritime Trust

  • In early 2009, Rickmers breached the loan-to-value (LTV) covenants when the value of its chartering fleet fell with the collapse of world trade. Rickmers began negotiations for a waiver from its banks. Subsequently, it had insufficient funds to take delivery of several containers ships.
  • In August 2009, Rickmer's negotiations with banks remained unfruitful. Auditors for Rickmers added an emphasis of matter, expressing doubt on the trust’s ability to carry on as a going concern.
  • In March 2010, auditors again added an emphasis of matter, pointing out that Rickmers had total liabilities and commitments of more than US$1 billion, comprising bank borrowings of up to US$128.7mil, unfulfilled capital commitments of US$128mil for not taking delivery of certain vessels and an existing capital commitment of US$780.7mil. All of these commitments were due within the next 12 months.
  • In April 2010, Rickmers was finally able to secure an extension on its loans and a waiver of covenants. At the same time, it was discharged from its obligation of having to purchase 7 ships from Polaris Ship Management Company, though the discharge carried a significant penalty.

Pacific Shipping Trust (PST)

  • In April 2009, CSAV, a Chilean charterer of 2 of PST’s ships, encountered severe financial problems and was on the brink of collapse. CSAV unilaterally sought a temporary 30% reduction to previously agreed charter rates. At the time, CSAV was PST’s second largest customer and its charters made up 30% of PST’s revenue.

Frasers Commercial Trust (FCOT)

  • In 2008, a significant tenant of FCOT's Cosmo Plaza in Osaka, Japan went into financial difficulties. The tenancy deposit was insufficient to cover arrears and subsequently FCOT had to made allowances of S$2mil for arrears between Jan to Sep 2009 and S$1.3mil for arrears between Sep 2009 and Mar 2010. Eventually, FCOT decided to divest of Cosmo Plaza.
  • In August 2009, FCOT had to issue CPPUs (an instrument similar to convertible bonds) for the purchase of Alexandra Techno Park. It had earlier committed to the acquisition but was unable to fund the purchase due to tightening credit in the aftermath of the financial crisis.

Capital Commercial Trust (CCT)

  • In 3Q2009, Starhub, the major tenant for CCT’s Starhub Centre vacated the premises and CCT had problems finding a replacement tenant. As a result, Starhub Centre’s occupancy rate declined markedly and adversely affected CCT’s distribution per unit (DPU). CCT subsequently announced intentions to convert Starhub Centre into a residential development.

Suntec Real Estate Investment Trust

  • In May 2010, Suntec applied for a winding up petition against Picket & Rail Asia Pacific, presumably for unpaid rental.
  • In 2005, Suntec was also infamously rapped for attempting to issue deferred units for the purchase of new assets, so as to boost short terms returns (and thus unit price). This episode contributed to Singapore-based Reits being banned from the issuing of new deferred units.

Ascendas Reit

  • In late 2008, TT International, which leased a six-storey office and warehousing building from Ascendas, defaulted on some of its creditors. Ascendas however had a security deposit which covered nearly a year of rental, but the space occupied by TT International was subsequently left vacant for quite some time.

Macarthurcook Industrial Reit (MI-Reit)

  • In June 2009, auditors flagged the Reit's going-concern status in an emphasis of matter. The trust had interest-bearing borrowings of $201.3mil due for repayment within the next 12 months as well as a capital commitment of $91mil.
  • In November 2009, MI Reit narrowly avoid a collapse when unit-holders approved a highly dilution recapitalization exercise which included issuing 975.6 million rights and 221 million shares to a group of investors at a 32-per-cent discount to its traded price before the announcement.

Lippo-Mapletree Indonesia Retail Trust (LMIR)

  • In Q4 2008, LMIR made a S$7mil provision for outstanding rents from wholesaler tenants, who were not only in arrears but had also terminated their leases. This provision made up some 25% of revenues for the quarter. Interestingly, LMIR were said to have not collected any security deposits from these wholesalers, rendering the arrears practically irrecoverable

Saizen Reit

  • In early 2009, Saizen Reit, which owns a portfolio of properties in Japan, abruptly stopped cash distributions to unit-holders in order to preserve cash to repay loans.
  • Nonetheless, in November 2009, Saizen announced that it had defaulted on a S$119mil loan. Cash dividends to unit-holders have yet to resume.

 

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Last Updated ( Friday, 04 June 2010 17:44 )  
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