Asset Backed Securitization in Singapore: Value of Embedded Buy-back Options Department of Real...
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Transcript of Asset Backed Securitization in Singapore: Value of Embedded Buy-back Options Department of Real...
Asset Backed Securitization in Singapore: Value of Embedded Buy-back Options
Department of Real Estate (DRE) & Centre for Financial Engineering (CFE)Joint Executive Program on
Real Estate Securitization & Financial Innovations
Dr Sing Tien Foo
Department of Real Estate
National University of Singapore
27 July 2001
Email: [email protected]
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Lecture Outline
Development of real estate securitization market in Singapore
Asset backed securitization in Singapore
Securitization structure and process
Potential benefits & investment motivations
Embedded options and their pricing implications
Pricing the embedded options
Effects of embedded options on the risk structure
Market impact & conclusion
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Real Estate Secondary MarketsCharacteristics of real estate investment: lumpy, illiquid, large capital outlays Real estate equity market is an active secondary real estate investment in Singapore Development in secondary real estate market
In UK: Single Asset Property Company (SAPCO), Single Property Ownership Trusts (SPOT), Property Income Certificate (PINCs)In US: Real Estate Investment Trusts (REITs), Mortgage backed securities (MBSs)In Australia: Listed and unlisted property trusts
Property related securitization surfaced in Singapore in 1986 with the first mortgage backed bond (MBB) on Hong Leong Building.
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Development of Securitization Market in Singapore
Capital market in Singapore
Development of bond market has been slow and dominated by government bonds
In 1993 bond market share is 56.3%, and it drops to 46% in 1999. The value of bond issues has however increased from S$171 billion to S$327 billion
Three vehicle for securitizing real estate in SingaporeMortgage Backed Bond (MBB)
Property Funds (Real Estate Investment Trusts REITs)
Asset/Property Backed Bonds/ Securities
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Asset-Backed Securitization in Singapore
What is Asset-Backed Securitization (ABS)?A creative financing arrangementStructure of asset-backed securitizationEmbedded options in the dealsFirst transaction: Neptune Orient Building, Alexander Road7 commercial properties have been securitized with net asset value of $2.8045 billionSignificance of the Option Values
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Recent Asset-Backed Securitization Deals in Singapore
Issue
Date
Property Owner Market Value
Mar 99 Neptune Orient Line HQ NOL $185 mil.
Jun 99 Century Square Shopping Mall
First Capital Corporation
$200 mil.
Jul 99 Robinson Point DBS Land $193 mil.
Sep 99 268 Orchard Road DBS Land $184 mil.
Nov 99 Tampines Centre DBS Land $180 mil.
Nov 99 Six Battery Road DBS Land $878 mil.
June 01 Raffles City Raffles Holding (CapitaLand)
$984.5 mil.
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
What is Asset-backed Securitization?
Securitization is a process of turning equity interest in real estate, which is illiquid and lumpy, into tradable securities such as bonds and sharesSecuritization is an open market selling of financial instrument backed by asset cash flow or asset valueA contractual arrangement whereby real estate owners sell their real estate asset(s) to a special purpose vehicle (SPV) SPV issues debt instruments (bonds) to finance the purchase Structure of SPV
Pass-through vs. Pay-through instrument
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Types of Securitized Asset in USLoans Leases Receivables Others
Car loansCommercial property loansBank loansProject loansTuition/ student loansBad loans
Vehicle leasesEquipment leasesAircraft leasesTrain leasesShip leasesShare leases
Credit card receivablesTrade receivablesPhone bill receivableUtilities receivablesToll free receivablesInsurance receivablesMail order receivables
SubsidiesRoyalty incomeTicket income
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Why Securitized?
Lower-cost financingIn Singapore, the cost of debt is relatively lowLiquidity crunches?
Equity savingLeverage restrictionsReduction of assets – create liquidity to the company
Matched funding / funding strategyEarnings
Originator capitalizes the future cash flow
Growing significance as an alternative financing Growing significance as an alternative financing methodmethod
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Structure of SecuritizationDistinguished from mortgage-backed or collateralized loanOff-the-balance-sheet sale of property at open market valueSpecial purpose vehicle (SPV) created as a trustee to facilitate the pay-through of receivable to the investorInvestors are insulated against bankruptcy risks of originatorImprove transparency and enhance credit rating of security issuesFixed rate bonds - pay-through structureClaim on rental flow and partial share of price appreciation
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Securitization ProcessOpen market valuation of property to be securitized Off-the-balance-sheet transfer of ownership rights to the SPV – an enbloc salesEmbedded options:
Lease back option Buy-back option (65-75% off market value)Put-option to sell back property to originator
SPV finances the purchase by issuing secondary market instruments: bonds and preferential sharesFixed coupon payment to investors from rental & other revenues generated from the buildingPartial sharing of capital appreciation if option is exercised within the maturity period
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
InvestorsInvestors
(Purchasing (Purchasing ABS bonds ABS bonds
for fixed for fixed returns)returns)
Originator Originator (Company (Company securitizingsecuritizing
its real its real estate)estate)
Special Purchase
Vehicle (SPV)
Investments in secondary market
instrument
Rental Cash Flow received from the securitized real
estate leases
Sale Proceeds from the sale of
securitized real estate
Bond/ Dividend Yield
Real Estate Market
Secondary Market
Lease-back option
Buy-back option
Exchange of cash flows between originator and investors via SPV
Transfer of embedded options
Boundaries between primary and secondary markets
Notes:
Source: The Authors
Schematic Diagrams of ABS
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Parties in Securitization (I): Originator
A company or an organization that has assets generating cash flows which are used as payment of securitiesSell assets to a special purpose vehicle (SPV) or a trustee to remove the assets from its balance sheetOff-balance-sheet securitization vs on-balance sheet securitizationInvolves in collection of payments of the assets & passing of payments to the SPV at feesOff-balance-sheet – legal costs in conveying assets to SPV Credit risks of originator are insulated/separatedOn-balance-sheet – Lionie Condotel Bond
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Parties in securitization (II): SPV
Purchase assets or receivables from the originatorCreate “bankruptcy remote” structureProtect ABS investors against the default of originatorHigher credit rating for the issuing securitiesTwo types of structure for SPV
Pass-throughPay-through
Depending on nature of receivable & funding requirement of originator
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Parties in Securitization (III): Underwritter & Investors
Underwritter bridges cash flows between investors and originatorsRoles of underwritter
Indetification of securitization structure Pricing of issuesPlacement capacity – optimal issuance size
Investors – insurance companies, pension funds, mutual funds and hedge fundsAttraction of ABS to investors
High credit qualityHigh yieldLiquidity
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Potential Benefits/MotivationsTo owner/originator
Alternative financing instrumentsImprove liquidity in the balance sheetReinvestment and freeing up the low-yield assetsTransfer the interest rate risks to SPV
To bondholders/investorsNew Investment opportunities for diversificationDirect participation in real estate market by small investorsPartial sharing of future capital gain through preference sharesBuilding as collateral
To Real Estate Market An active secondary capital market for institutional investmentAlternative Financing Options
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Why Securitization? In US, rising cost of originating loan and tight liquidity in debt marketIn Singapore, different motivation driving the securitization marketLiberalization and depleting of liquidity in debt marketAlternative source of financing at attractive termsReducing corporate gearing Diversifying financing risksProtected against floating rate risks when term structure of interest rates is volatileLow rental yield of holding propertyRe-investment return & improve efficiency of capital
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Attractive YieldsABS bond yields: 5.5% to 6.75% JTC and HDB fixed coupon bond yields : 3.875% to 5.0%Based URA’s office index (Q178-Q399), annualized growth rate of 9.88%Share of capital appreciation 30%*9.88% = 2.96%Compared to equity holder, ABS investors are protected against credit and financial liability of originatorABS investors have priority on the assets in the case of financial distressABS is backed by securitized propertyLower risk & tradability of the ABS bonds Lower transaction fees compared with direct sale of property
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Embedded Options
Sale & Leaseback Option
Call Option for vendor to buy back property
Put Option for SPV to sell back property
Equity participation in capital appreciation for mortgage-backed bond holders.
Embedded options in 268 Orchard Road Securitization
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Embedded Options in a Embedded Options in a typical Securitization dealtypical Securitization deal
Baronet Limited(Special Purpose Vehicle)
RE Properties Pre Ltd
268 Orchard Road
Birchvest Investments
Pte Ltd(wholly owned subsidiary
of DBS Land)
Investors
A Put Options to sell back property at a strike price equivalent to original price plus 35% of capital appreciation
A Call Option to buy-back the Property at an exercise price, equivalent to original sale Price plus a percentage of capital appreciation (25%-35%)
An option to lease back the Property for
10-year
Rental and other income equivalent to or exceed interest payments to bondhodlers
Share of certain percentage of the capital Appreciation, when the
call/put options are exercised
Real Estate Holdings Pte Ltd
(wholly owned subsidiary of DBS Land) Originates the securitization Process
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Pricing Embedded Options
Option Pricing Theory
Case Illustration – 268 Robinson Point
Theoretical FrameworkBinomial Option Pricing Methdology
Estimation Results
Sensitivity Analysis
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Case Illustration268 Orchard Road – 10 year bond issuesExplicit call option agreements
Upon exercised, entitle the owner to re-possess the building from the SPV at the original issue price, plus % of capital appreciation to be distributed to bondholdersCall options can only be exercised after three yearsExercised anytime from year four to year 9.5 year
Put option If exercised, requires the owner to buy back the building from the SPV at original issue price% Capital appreciation sharing = 35% (redundant)
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Theoretical Framework
Binomial Tree Option Pricing ModelDiscrete Price Change – by u and d Risk-neutral probability p Determining the strike price
Percentage sharing of the capital appreciation
Payoff functionDifference between market and strike prices
Option typesOption formulas
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Option Pricing Analogy
Let say an call option is underwritten on a unit of City Development Limited (CDL) share at an exercise price of $8.50 exercisable only in a year time.Current CDL share price is S$8.15Price movement follow a binomial tree as follows
At risk free rate of 5%, risk neutral probability is computed as p= [(1+0.05)*$8.15-$7.00]/($9.00 - $7.00) = 0.704Option premium =($0.50 *0.704)/(1.05) = $0.34
Pt
Pt+dt = dPt
Pt+dt = uPtq
1-q
($9.00) and q =0.5
($7.00) and 1-q =0.5
($8.15)
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Option Formulas
European Options, EC(T1,0, 0, PS1) =
American Options, AC (Tk+1, Tk, n, 0, PSk) =
Compound Options
rndtn
jtt
jnjjnj eSduPMaxppjnj
n
*)0,()1(
)!(!
!
0,
)(0
)(
n
i
in
jt
rdtt
jinjk ejinCpjinpCSduPMax
1 0,0, *),1,()1()1,1,(,
idtTr
iiikN EePSTTACEPSTECMaxPSTCO i
)/(1011 *),,(,),0,(),0,(
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Characteristics of Embedded Options
The date of exercising the call option % Share of capital
appreciation
Type of Option
From the date of origination to the last day of the 3rd year
t=0 to t=3 25% European Call
From the first day of the 4th year to the last day of the 5th year
t=4 to t=5 25% American Call
From the first day of the 6th year to the last day 7th year
t=6 to t =7 30% American Call
From the first day of the 8th year to the last day of the 9.5th year
t=8 to t =9.5
35% American Call
From the first day of the 9.6th year to the 30th day after the maturity of the bonds
t=9.6 to t=10.08
35% American Put
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Estimation Results
Securitization of 268 Orchard Road
Input parameters/assumptionsUnit Price (P) = $1,392 per net floor area
Risk free rate (rf) = 5% p.a.
Price volatility () = 20%
Growth rate (g) = 2.0%
Frequency of adjustment (dt) = 0.25 (quarterly)
Premium of embedded options:
$33 million or equivalent of $250.36 per sf.
Approx. 18% of total bond value ($184 million)
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
8%
12
%
16
%
20
%
24
%
28
%
32
%
2%
4%
6%8%
100
150
200
250
300
350
400
450
Price Volatility
Risk-Free Rate
Op
tion
Pre
miu
m
Sensitivity of Option Premiums
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Tax Implications
Have these embedded options been priced in the open market valuation?Stamp duty
At the date of transactionWhen the options are exercisedMoral Hazard problem
Property tax valuation for comparable buildingsLease back options at guaranteed rental incomeHypothetical Annual Value estimation when market rental is higher?
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Effects on Risk Structure
Are bondholders subsidizing the originator by giving the options worth $28.5million free?Lemon Market – negative signals
JTC 10year fixed rate bond yields 4.75% to 5.00%Asset-backed securitization 5.50% to 7.00%
Put option agreementMainly to facilitate the transfer of the ownership back to the originatorRedundant in an upmarket
Retention of major share by the originator via Junior bond tranches? Moral hazard
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Market ImpactPotential and Importance of Asset-Backed Securitization in SingaporeDevelopers should better utilize capital in development activities than locking-in the capital in low-yield prime propertiesRejecting of productive capital into real estate marketInvestors are open to more avenue to diversify into property marketPractical and institutional problemsValuation of embedded optionsImpact on Property Taxation and Efficiency of MarketAsymmetry of Information
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
Conclusion
Securitization would be an important financing instrument when interest rate is more volatile
Transparent and fair valuation of securitizatin deal is important
Contributing to the efficient pricing and structuring of future securitization deals
Advancing the valuation and pricing techniques that are applicable for the asset securitization
Dr Sing Tien FooReal Estate Securitization & Financial Innovations
References:
Kendall, Leon T., “Securitization: A New Era in American Finance, in Kendall, Leon T.and Fishman, Michael J. (eds.) A Primer on Securitization, 1996, pp 11-16.*Ong, Seow Eng, Ooi, Joseph and Sing, Tien Foo, (2000) “Asset Securitization in Singapore: A Tale of Three Vehicles,” Real Estate Finance, Summer 2000, pp 47-56.Sing, Tien Foo, (December 2000), “Opening New Doors,” Property Review, December 2000. Sing, Tien Foo and Ong, Seow Eng, (1999) “Valuing Asset Backed Securitization Transactions,” NUS-CRES working paper #CRES:1999-017.
End of Presentation
Thank you
Presentation slides are available at my homepage: http://www.sde.nus.edu.sg/~rststf/Click “My ECAMy ECA” and then “OthersOthers”