SINGAPORE (May 22): On May 13, during a 1HFY2020 results briefing by Frasers Property’s (FPL) management, there were some questions on the company’s higher gearing, which had risen to 106.8% by March 31, 2020, from 85.9% as at Sept 30, 2019. The company’s net gearing rose partly because of a redemption of $700 million of perpetual securities or perps.
FPL announced that its net debt had in-creased by $2,242 million to $15.76 billion by March 31, from $13.81 billion as at Sept 30, 2019. Of this, $700 million was due to the redemption of perpetual securities. The remainder comprised of the net drawdown of bank borrowings for the acquisitions of properties in Australia and the UK, the development of properties in Australia and Thailand, and the redemption of shares in PGIM ARF.
The redemption of the perpetual securities had the twin effect of raising debt, and low-ering the company’s total equity. Hence FPL’s total equity fell to $14.75 billion on March 31, from $16.09 billion on Sept 30, 2020.
“We took the decision in early March with full knowledge of the impact on our gearing,” says Loo Choo Leong, FPL’s CFO. The coupon rate on the perpetual securities was 5%, and FPL had access to cheaper debt.
FPL is taking steps to cut costs, and conserve capital. The company announced it will not be paying an interim dividend. In addition, effective from May 1, 2020, board members of FPL and its subsidiaries which are managers of its listed REITs and stapled trust will take a voluntary 10% reduction in their directors’ fees.
CEO Panote Sirivadhanab-hakdi will take a 25% reduction in his base salary, while other members of senior management will take base salary reductions of up to 10%. The directors’ fees and salary reduc-tions will be reviewed at the end of FY2020, the company says in a statement.
“The board suspended our interim dividend because of an unforeseen future. It is prudent to take early precautions. We’ve taken fee cuts and salary cuts to set the right tone for areas of cost to preserve cash and prepare for the worse. We hope to eventually normal-ise,” Sirivadhanabhakdi says.
“’Business as usual’ is not an option,”he warns, “Along with many businesses around the world, we are facing an unprecedented crisis that has greatly disrupted the business environment and operating conditions in all our markets. FPL’s 1H FY20 results reflected only the initial impact of the Covid-19 outbreak on the group’s financial performance. Until there is clarity on the duration, severity and consequences of this pandemic, significant uncertainties will persist and the operating environ-ment of the group’s various businesses will remain challenging.”
One of FPL’s priorities is to lower gearing. “Gearing mitigation is a top priority and the best way is our core strategy of injecting assets into our REITs but we must protect the valuation of the REIT and its ability to absorb assets. We wait to see how the market devel-ops,” Sirivadhanabhakdi says. “The target of net gearing is below 1 times. It is prudent to mitigate this rather quickly. An active review of assets that are suitable for our REITs or other capital partners structures are being reviewed and being prioritised,” he adds.
In a recent update, Credit Suisse expects that commercial and logistics assets are pos-sible candidates for asset sales, or better still, sales to third parties, if preserving value is a priority. “As FPL’s REITs are consolidated, we think third party sales could better facilitate gearing reduction,” Credit Suisse suggests.
If FPL had refinanced its perpetual securities with a new tranche of perpetual securities its gearing would be lower. “If our perpetual securities were refinanced with perpetual securities, our gearing would be 0.97%,” Loo says.
Distributions at discretion of issuer
Perpetual securities sit somewhere between equity and debt. In general, they are subordinated to debt, but sit above equity. Like equity, the issuer is not duty bound to provided securityholders with distributions. Listed issuers of perpetual securities usually state this in their annual reports and offer documents. “As the perpetual securities have no fixed maturity date and the payment of distributions is at the discretion of the Issuers, the Issuers are considered to have no contractual obligations to repay the principal or to pay any distributions,” FPL’s annual report states.
The whole instrument is presented within equity, and distributions are treated as divi-dends, FPL says. The perpetual securities constitute direct, unconditional, subordinated and unsecured obligations of the Issuers. They may be redeemed at the option of the issuers on any distribution payment date, according to its annual report.
FPL still holds $1.2 billion of perpetual securities including $100 million perpetual securities at 4.45% issued by Frasers Hospitality Trust. FPL consolidates its REITs. In addition, FPL issued $400 million of perpetual securities in April last year, and $200 million of perpetual securities in July 2019 both at 4.98%. In 2018, FPL issued $300 million of perpetual securities at 4.38%, and $340 million in 2017, at 3.95%.
Following the redemption of the $700 million tranche of perpetual securities, in which the Sirivadhanabhakdi family owned $300 million, they now own $250 million perpetual securities. “The perpetual securities came at a cost. Its coupon was 5%. We are open to various ways of managing our capital and perpetual securities is one of the ways we consider. It’s a matter of pricing, market capacity and organisational structure. In our view it remains one of the many instruments in our arsenal for capital management,” Loo explains. FPL’s average cost of debt in 1HFY2020 was 2.6%.
FPL is not alone in using perpetual securities. Last October, CapitaLand issued $500 million of perpetual securities at 3.65% compared to its average cost of debt of 3%. CapitaLand has a higher cost of debt than FPL because the debt of some of its REITs have very long dated debt, and their weighted average debt maturities range from four years to five years. CapitaLand’s debt maturity profile is 3.4 years compared to FPL’s 2.6 years.
Like FPL, CapitaLand consolidates its REITs. Included in its almost $900 million of perpetual securities are two tranches issued by Ascott Residence Trust. The older $250 million 4.68% perpetual security tranche was issued on June 30, 2015, and this may well be redeemed next month. The second $150 million tranche was cheaper, at 3.88%, issued in Sept last year.
Are perpetual securities equity or debt?
“Perpetual securities (perps) are a hybrid instru-ment that incorporates features of both bonds and equity. As its name suggests, it is helpful to remember that perps do not have maturity dates so investors should be prepared to hold on to them indefinitely, even though different perps may have features that may allow for an earlier redemption at specified periods, should an issuer choose to do so,” explains Andrew Lim, CFO of CapitaLand.
“Within CapitaLand group, perps are accounted for as equity, which is in accordance with accounting standards and consistent with our peers. Consistent with its treatment as a hybrid instrument, interest on our perpetual securities is paid after we service our debt obligations, but before any dividends can be paid to our equity shareholders,” Lim continues.
Why would companies use perpetual securities given their higher cost vis-a-vis debt? “As part of our capital management strategy, we look to diversify our sources of funding to optimise our capital structure. With its distinctive features, perpetual securities can play a useful role as a funding source. When the need arises, we will decide on the most appropriate fund raising mechanism based on our funding requirements, as well as other important factors such as the macroeconomic environment and investor appetite,” Lim answers.
At any rate, CapitaLand’s net debt-to-equity ratio including its perpetual securities and ART’s perpetual securities is 0.64 times as at Mar 31, 2020. As at Dec 31, 2019, when its gearing was 62.9% (0.63 times), CapitaLand’s net debt to equity would have been 0.64 times excluding its perpetual securities. If its perpetual securities were replaced with debt, CapitaLand’s gearing would be a little higher, at 0.65 times. CapitaLand consolidates its REITs, and hence its net debt of around $25.2 billion includes the debt of its REITs.
What are preference shares?
Both perpetual securities and preference shares were the subject of much angst when Hyflux announced in May 2018 that it was seeking court protection from its debtors as it restruc-tured its debt. As part of the restructuring, it had $900 million of perpetual securities and preference shares which were issued to finance Tuaspring. Unfortunately, Hyflux’s perpetual securities were a retail issue, managed by DBS Bank, and they are now either worthless or worth a few cents to the dollar.
“After investing in Hyflux’s perpetual securities where I got burned, no more perps for me,” says an investor who wants to be known only as Mr Wong. “I applied for $10,000 worth and I got $3,000.”
Interestingly, another major developer, City Developments, has as part of its capital structure, 330.9 million non-redeemable, convertible, non-cumulative preference shares. CDL says its preference shares are classified as equity, because they bear discretionary dividends, do not contain any obligations to deliver cash or other financial assets and ‘do not require settlement in a variable number of the Group’s equity instruments’. Dividends are recognised as distributions within equity, CDL’s annual report says.
Unlike the perpetual securities issued by FPL and CapitaLand, CDL’s preference shares are convertible into ordinary shares at the option of the company. The conversion ratio is 0.136 ordinary share for each preference share. In the event that CDL exercises its right of conversion, preference shareholders will get paid a one-off preference cash dividend at the fixed rate of 64% (net) of the issue price for each preference share and any preference dividend accrued but unpaid. The maximum number of ordinary CDL shares issuable on full conversion is around 45 million.
Hunt for yield
As some REITs cut their distributions per unit in order to conserve cash as a result of government stimulus measures and rent rebates, investors may be tempted to turn to other yield instruments. Of these, perpetual securities are indeed yield instruments in a sense, but as they are equity-like, the issuers have the option of withholding distributions at their discretion.
A particular drawback for these securities is their lack of liquidity. The perpetual securities issued by FPL, FHT, CapitaLand and ART are targeted at either institutions, or private banking clients. And so far they are likely to continue with their distributions.
For instance, CapitaLand’s interest coverage ratio as at March 31 this year was 7 times. Moreover, CapitaLand’s REIT managers have said that their ratings are important to them. Hence they are more than likely to honour their obligations.
FPL’s interest coverage ratio is also healthy, at 4 times. “We have every reason to honour our obligations with regards to the perps for now,” CFO Loo says.
