Commentary - The Dubai Crisis and Risk Aversion

I was rather shocked when I read the Straits Times headlines today about the Dubai Debt Crisis. I was not entirely surprised to see market react negatively, but was rather shock by the extent of sell-off in some market, especially Hong Kong. We have not seen a more than 1000 points drop in HSCI for quite sometime. Of course the drop in HSCI was probably linked to HSBC bank's large exposure to the middle east market. I was also shocked that some in the market has referred this as the "Financial Crisis Part II".

Of course some has argued that this is Dubai, and the USD80 billion is nothing compared to the losses during the Financial Crisis. While some has argued on the other hand that when the subprime crisis first surfaced in US, many have not believed it would lead to such extent of damage in Global financial systems and the economy.

The purpose of this posting is not to debate on whether the sell-down is overdone and we should make use of the opportunity to buy on dips, or whether there is going to be a big correction and we should turn towards risk aversion. Rather, as this is a blog about REITs, I will be touching on some of the possible things we can look out for if we want to assess the risk level of a particular REIT.

So what are the things to look out for if we want to assess how risky the REIT is?

Gearing
I have written something about gearing and gearing limit previously. REITs with high gearing, especially those very near the gearing limit, tend to be punished more by the market in times of crisis. Note also that low gearing does not mean the REIT is low risk as gearing is just one part of the picture. But high gearing is definitely link to high risk.

Short Term Debt vs Cash Level
Short term debt refers to debt that needs to be returned within one year. Cash level here refers to amount of cash or cash equivalent the REIT is holding. Comparison of these 2 figures is a good way to assess the risk level.

To find out short term debt, we can refer to the Aggregate amount of borrowings and debt securities section of the earnings report. Here we use the CMT Q3 2009 report for illustration:



For secured borrowings, the amount repayable within one year is S$125,000. For unsecured borrowings, the amount repayable within one year is S$315,000. So the total short term borrowings here is S$125,000 + S$315,000 = S$440,000.

The cash and cash equivalent can be found in the cash flow statement in the quarterly report. Again, using the CMT Q3 2009 report for illustration:



The last line of the cash flow statement will tell you the cash and cash equivalent at the end of the quarter, in this case it is S$363,736. If this figure is much less than the short term borrowing, it means that the REIT has to either refinance or raise equity via rights issue before the borrowing is due within a year. We know that in the time of crisis, both refinancing and equity raising are going to be difficult. Here we can also see that even if a REIT is low in gearing, if it has very low cash level and a very large short term borrowing, it will still run into serious problems in times of crisis.

Strength of the Sponsor
It will be advantageous for the REIT if it has a strong sponsor, whether in helping to source for refinancing or helping to support the equity raising directly by subscribing to the new shares. Sometimes the sponsor may also provide bridging loan directly to the REIT. For example, F&N Treasury provided a bridging loan to Frasers Commercial Trust earlier part of the year when its short term borrowing was due, and it has not come up with a sound recapitalization plan. If possible, we should also look at the financial status of the Sponsor, whether its cash level is able to support the REIT if there is really a need. For example, we know that Capitaland has its own rights issue to raise cash earlier this year. Recently, it has managed to raise some more cash through the listing of it subsidiary Capitamall Asia.

Sector
Currently the SREITs can be basically classified under the following sectors:
Hospitality, Office, Industrial, Retail, Healthcare.
In terms of risk level, usually the Hospitality sector will rank the highest, followed by Office and Industrial sectors, followed by Retail and Healthcare sectors.

Of course there may be other things to look into not mentioned here, and different investors may place emphasis in different things base on how they view the crisis. Some may even brush it off as a small blip. Anyway just to highlight again that this posting is not suggesting that this is going to be financial crisis part II, but rather it is just some suggestions on how to assess the risk level.