There are different views on this, but on the whole the move to Sora is meant to be neutral with reference to SOR. On the other hand, it appears that S-REITs, corporates and any entity or consumer with a loan are likely to face higher funding costs. That impact has not yet been fully felt because the surge in rates took place in June and July.
The US Federal Reserve raised the US Federal Funds Rate by 25 bps in March, 50 bps in May, 75 bps in June and 75 bps in July. In an update on Aug 30, JP Morgan has reiterated its view that the full impact of the Fed’s rate hike cycle has yet to be fully felt by the S-REITs, in particular for those with relatively higher floating rate debt.
“The transition from SOR (three-month forward) to Sora (three-month lag) benchmark rates further explains the muted influence of higher rates in 2Q2022 results,” JP Morgan suggests. Its premise appears to be that Sora is backward looking, and has been lower, and slower to react to the Fed’s rate hike cycle than SOR, which is forward-looking. Industry experts say this should not make a difference to customer loan costs.
Andrew Ng, group head, treasury and markets, DBS Bank, says banks are required to ensure their customers should not be worse (or better) off using the new benchmark.
At present, banks are required to use the MAS Recommended Rate (MRR) to add onto Sora as an adjustment spread. Customers are charged a margin (depending on their credit risk) on Sora + adjustment spread. A steering committee has included the calculation method for the adjustment spreads.
“The conversion of a legacy Sor contract in wholesale markets to a Sora-based contract requires an adjustment spread, which represents the price that a SOR borrower transitioning to Sora would pay over the Sora benchmark rate. The adjustment spreads account for structural differences between Sor and Compounded Sora, such as the credit and term premia absent in Sora,” MAS says in a media release on May 18 this year.
For the switch from Libor to SOFR, a five-year average of the spread of Libor above SOFR is used to obtain the adjustment spread. For local Singapore loans, by December 2024, regulators will introduce the MAS Administered Rate as the adjustment spread for Singapore-dollar loans. “On mortgage loans, customers should switch. They will be paying higher mortgage rates [anyway],” Ng says. “This year [banks] may only see a bit of the impact. Next year banks will experience the full impact.”
While Ng is viewing interest rate trends and their impact on banks’ portfolios, his reasoning is likely to apply to customer loans as well. In that aspect, JP Morgan’s Aug 30 report has a point. “We believe the impact of rate hikes continues to be underestimated by the market and remain cautious on SREITs with weaker capital structures, notably Suntec REIT, with 43% gearing and low 56% fixed-rate debt,” JP Morgan says.
The report points out that the rate hike impact is likely to be “back-end loaded into 3Q2022 and 4Q2022” for S-REITs. “Benchmark one-month and three-month Sora rates of 1.2% and 1.8% respectively are significantly lagging three-month SOR rates of 2.7% and the effective Fed Funds Rate of 2.3% as at end-July,” JP Morgan says.
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Actually, Sora has traditionally been lower than SOR. For banks and customers, switching to Sora will not make a difference to their cost of funds and cost of debt (respectively) because of the adjustment spread. However, the Fed has accelerated its rate hikes and most of the S-REITs will not have captured the upward acceleration of 75 bps each month which took place in June and July.
“We estimate that S-REITs only experienced a 20–30 bps rise in floating rates in 2Q2022, with the increase accelerating to 80–100 bps in each of 3Q2022 and 4Q2022,” JP Morgan continues. To be sure, the 2Q2022 results for S-REITs will probably have reflected only the 75 bps hike the Fed announced in March and May this year. The 150 bps hike that occurred in June and July is likely to have an impact in 3Q2022 and 2H2022 performance.
Hence, JP Morgan’s conclusion is spot on. REITs with a higher proportion of fixed debt and strong capital management capabilities will be able to perform better than those REITs with higher floating rate debt, and where their total cost of debt is at a relatively low level.
“We prefer S-REITs with structural growth exposures and/or high proportion of fixed-rate debt,” JP Morgan says. These include Ascendas REIT, Frasers Logistics and Commercial REIT, Mapletree Industrial Trust and CapitaLand Integrated Commercial Trust.
It adds Suntec REIT is most vulnerable to higher floating rates with an 8.4% impact on DPU for every 100 bps rise in rates. This is followed by Far East Hospitality Trust with a 4.7% impact, Keppel REIT with a 4.2% impact and CDL Hospitality Trusts with a 3.5% hit to its distributions per stapled security. Inflation in the US could stall by 4Q2022.
If so, S-REITs with long weighted average debt tenor and a large proportion of fixed rates may be able to sidestep the worst of the rate hike cycle
