The December Exchange Newsletter is out now! The newsletter covers new membership fees and a feature blog from our very own FTA President.
When the cycle turns
REITs around the world are braced for rising rates, tighter funding conditions
Written by Craig Parker, Senior Director, Corporate Ratings – S&P Global Ratings
While the risk of rising borrowing costs and tighter funding conditions grow across a number of major property markets–and for the real estate investment trusts (REITs) whose income depends on these markets–the REITS rated by S&P Global Ratings are generally well positioned to withstand a gradual rise in interest rates as their capital structures are largely fixed or hedged.
In the U.S. the world’s biggest market for REITs, at roughly the size of Europe and Asia combined–these entities have shored up their balance sheets against the backdrop of a Federal Reserve that is steadily raising interest rates as it normalizes monetary policy, and yields on benchmark Treasuries look set to rise accordingly. S&P Global Ratings economists forecast one final quarter-point rate increase from Fed policymakers this year (for a total of four) and three in 2019, which would bring the benchmark federal funds rate to 3.0%-3.125%, up from effectively zero in the aftermath of the
Great Recession. We expect the 10-year yield to reach 3.2% by year-end, 3.4% at the end of next year, and 3.5% in 2020. While these increases could weaken REITs’ EBITDA interest coverage and fixed-charge coverage ratios, the fact that our rated REIT universe consists largely of fixed-rate debt mitigates this risk. As it stands, fewer than 20% of U.S. REITs we rate have debt structures with more than 25% exposure to variable-rate debt.
Moreover, debt maturities appear manageable, in our view, with just 3% of outstanding debt coming due before year-end, followed by 7% and 11% in 2019 and 2020, respectively. Furthermore, cash flows are rising and debt levels are falling. As a result, the total debt to EBITDA ratio in the sector has improved to the lowest levels since the financial crisis, declining to less than 6x last year, from a peak of almost 8x in 2010.
Similarly, rising interest rates and tighter funding conditions pose key risks across the AsiaPacific real estate markets. Indeed, borrowing costs and spreads are increasing, and investor sentiment points to a potential turn in the U.S. credit cycle late next year that would likely have repercussions around the world. Still, most Asia-Pacific REITs we rate can absorb a gradual increase in rates, given their robust interest coverage metrics, limited amount of floating rate debt, and modest upcoming maturities. But a sudden and sharp rise could affect the credit quality of the region’s REITs.
When we looked at how three levels of interest rate increases–100 basis points (bps), 200 bps, and 300 bps–would affect REITs’ various credit measures, we found that rated Asia-Pacific REITs are well-positioned to cope because they have fixed a greater portion of their debt book amid low-interest rates, and their liquidity positions are either strong or adequate. Under the more severe stress scenarios, a small number of entities that have significant exposure to floating rates would face ratings pressures.
At any rate, Asia-Pacific REITs have reduced overall debt levels and kept debt-to-EBITDA leverage (excluding Japan) under 5.0x in recent years, from a peak of 5.6x in 2008. In particular, the Australian and New Zealand REITs largely sit at the lower end of their targeted gearing ranges (debt to assets), providing a buffer in their balance sheets (see chart below).
Likewise, most REITs in Europe have fixed or hedged their debt for the next 3-4 years, and the direct effects on funding costs and interest expense coverage ratios appear limited and unlikely to be the sole trigger of negative rating actions. A more significant side effect in Europe could be that limited increases in rates, if unaccompanied by higher inflation, would depress asset values.
To gauge how lower asset values could affect the asset-based credit metrics of European REITs we rate, we ran a second round of stress scenarios, incorporating arbitrary drops in portfolio value over the next two years. Across our sample, a 5% drop in portfolio value is unlikely to trigger rating actions; a 10% fall would likely cause at least a few outlook changes and a handful of downgrades; a 20% drop could trigger downgrades for several
However, we believe there are several buffers protecting real estate asset values in Europe against rising interest rates. These include the widespread indexation of rents to inflation, a high-risk premium between discount rates and risk-free rates, and generally prudent assumptions that independent appraisers use in their line-by-line valuation process. All told we expect global REITs we rate to be able to withstand a moderate pace of rate increases, with debt coverage ratios such as fixed charge coverage and EBITDA interest coverage weakening only modestly.
The October edition of the Exchange Newsletter
An update from the CEO, Business in Treasury report, and spotlight on cross-border payment challenges.
The business of treasury 2018
Every organisation needs the ability to understand the future and, treasurers are increasingly working with colleagues to develop ‘predictive insights’. In early 2018, treasurers were interviewed in the UK, the rest of the EU, the Middle East, North America, Asia-Pacific, and Africa, as part of an ongoing programme of annual research.
This report forms the most detailed set of insights available into treasury’s role within global business revealing a continuing, palpable shift in the role of treasurer from finance specialist and information provider to collaborator in strategic decision-making.
Trends in Technology & Treasury
If a treasurer wants to be the go-to person for cash forecasting, financial planning, analysis and risk reporting, a modern TMS, efficient interfaces and best practice reporting will make the difference for efficiency, quality and timeliness of analysis.
Enterprise Integration, Business Intelligence and Big Data
Across all industries and professions, technological advances have made business and market data increasingly available to support strategic decision making. Corporate treasurers, armed with fit for purpose tools, have an opportunity to play a key role in data analysis to better manage liquidity and financial risks, in addition to supporting business partnering activities such as pricing and M&A.
Middleware Technology helps with the extraction and aggregation of granular datasets stored in enterprise systems and can deliver them to your TMS to generate tailored reporting dashboards. Key treasury metrics can be monitored and made available quickly and in user friendly formats for decision support. Examples include performance vs budget rates, hedging ratios, what-if scenario analysis and cash forecasts.
The diagram below shows an example of a corporate reporting dashboard for their cash position.
New data parsing and BI tools are also rapidly becoming a core part of enterprise wide reporting frameworks, whereby treasury data is consumed alongside other functions’ data by the CFO, the FP&A team and other stakeholders. By providing a single location to view critical metrics they offer excellent opportunities for sharing information across the organisation. This is a requirement that is simply not served by Excel in a robust and scalable way, and many companies are developing capabilities with such platforms. The key for TMS providers is to make their calculated core data available directly to users via a data warehouse solution.
This diagram shows how data flows in to and out of a data warehouse in the form of raw data in and reports out to multiple platforms which is the standard for the new BI tools.
Straight through processing
What can be automated, will be automated. With the technology focus on workflow and multi-platform availability, the scope for true straight through processing (STP) is increasing. STP can improve efficiency, processes, controls and reduce scope for fraud and errors. The TMS has the ability to provide messaging and notification functionality, allowing the payments and approval processes to be much more streamlined. Automated emailing and alerts enables approvals and limits checking to be done with ease. Deals can then flow through automatically to risk reporting and GL output.
Interfaces to external dealing and payments systems is another aspect of STP. In an ideal world, a treasury dealer will look at their risk position in the TMS and action a deal. The TMS can check dealing limits and any other restrictions and if everything is okay, the TMS will send a request for an FX or other deal type to an external dealing platform for transacting. Once the deal has been transacted, the TMS can load the confirmation and the payment advice will be automatically generated. Following approval, the deal can be automatically loaded to the payments platform for settlement. Deal intervention is only required when actioning, confirming and approving the deal, the rest flows automatically via STP.
No technology article is complete without mentioning the cloud. Deploying applications in the cloud can enhance security and allow the above workflows to happen more efficiently. Users don’t need to be in the office to approve deals or to view a risk report, business units don’t need to send forecast spreadsheets through to treasury for collation. Access to the most recent available business and markets data will lead to better and timely decision making and a more successful treasury can drive it all.
The combination of new software tools, advanced interfaces between applications and cloud computing can lead to a higher level of automation, real time reporting and better workflows. All of these technologies can be harnessed by a treasurer using a modern TMS as the analytical engine to drive the treasury function forward.
These developments represent an opportunity for treasury to have greater access to internal and external data, and increases the profile of treasury within the firm, setting the groundwork for a more successful treasury function.
Deloitte Biennial Global Corporate Treasury Survey 2017
5 September 2017: Deloitte surveyed more than 200 global companies across all industries to determine the current challenges treasurers and their teams face, and consider the changes since the last global survey undertaken in 2015. Questions included how tax and banking regulations are impacting the Treasury teams, whether their function is evolving strategically and how it is organised to manage ongoing market volatility.
XVA – Issue Snapshot by Cale Bennett
What is XVA?
Why is XVA important for Treasurers?
Will this have a positive or negative impact?
How can the impact be reduced?
When did this become an issue?
Bitcoin, Blockchain & Distributed Ledgers: Caught Between Promise & Reality
Blockchain’s genesis in Bitcoin: in October 2008, Satoshi Nakamoto proposed a combined digital asset and peer- to-peer payments system in his paper, Bitcoin: A Peer-to-Peer Electronic Cash System. The first Bitcoin was minted on January 4th 2009, the first payment occurred on January 11th, and the software was released as open source on the 15th, enabling anyone with the required technical skills to get involved.