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Valuing Asset Securitization Transaction

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					Department of Real Estate (DRE) & Centre for Financial Engineering (CFE)
Joint Executive Program on
Real Estate Securitization & Financial Innovations



Asset Backed Securitization in Singapore:
Value of Embedded Buy-back Options



Dr Sing Tien Foo
Department of Real Estate
National University of Singapore
27 July 2001
Email: rststf@nus.edu.sg
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 Foo
                               Real Estate Securitization & Financial Innovations
Real Estate Secondary Markets
 Characteristics 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 Foo
                                   Real 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 Singapore
     Mortgage Backed Bond (MBB)
     Property Funds (Real Estate Investment Trusts REITs)
     Asset/Property Backed Bonds/ Securities

                                                                     Dr Sing Tien Foo
                                    Real Estate Securitization & Financial Innovations
Asset-Backed Securitization in Singapore
  What is Asset-Backed Securitization (ABS)?
  A creative financing arrangement
  Structure of asset-backed securitization
  Embedded options in the deals
  First transaction: Neptune Orient Building,
  Alexander Road
  7 commercial properties have been securitized
  with net asset value of $2.8045 billion
  Significance of the Option Values
                                                            Dr Sing Tien Foo
                           Real Estate Securitization & Financial Innovations
    Recent Asset-Backed Securitization
    Deals in Singapore
Issue     Property                  Owner                       Market Value
Date
Mar 99    Neptune Orient Line HQ    NOL                         $185 mil.

Jun 99    Century Square Shopping   First Capital               $200 mil.
          Mall                      Corporation
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             $984.5 mil.
                                    (CapitaLand)
                                                                           Dr Sing Tien Foo
                                          Real 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 shares
  Securitization is an open market selling of financial
  instrument backed by asset cash flow or asset value
  A 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 Foo
                                   Real Estate Securitization & Financial Innovations
 Types of Securitized Asset in US
  Loans           Leases          Receivables                             Others
Car loans       Vehicle        Credit card                              Subsidies
Commercial      leases         receivables                              Royalty
property        Equipment      Trade receivables                        income
loans           leases         Phone bill                               Ticket
Bank loans      Aircraft       receivable                               income
Project loans   leases         Utilities receivables
Tuition/        Train leases   Toll free receivables
student loans   Ship leases    Insurance
Bad loans       Share leases   receivables
                               Mail order
                               receivables
                                                                    Dr Sing Tien Foo
                                   Real Estate Securitization & Financial Innovations
Why Securitized?
  Lower-cost financing
      In Singapore, the cost of debt is relatively low
      Liquidity crunches?
  Equity saving
      Leverage restrictions
      Reduction of assets – create liquidity to the company
  Matched funding / funding strategy
  Earnings
      Originator capitalizes the future cash flow

 Growing significance as an alternative financing
                      method

                                                                     Dr Sing Tien Foo
                                    Real Estate Securitization & Financial Innovations
Structure of Securitization
 Distinguished from mortgage-backed or collateralized
 loan
 Off-the-balance-sheet sale of property at open market
 value
 Special purpose vehicle (SPV) created as a trustee to
 facilitate the pay-through of receivable to the investor
 Investors are insulated against bankruptcy risks of
 originator
 Improve transparency and enhance credit rating of
 security issues
 Fixed rate bonds - pay-through structure
 Claim on rental flow and partial share of price
 appreciation                                      Dr Sing Tien Foo
                                    Real Estate Securitization & Financial Innovations
Securitization Process
 Open market valuation of property to be securitized
 Off-the-balance-sheet transfer of ownership rights to the
 SPV – an enbloc sales
 Embedded 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 shares
 Fixed coupon payment to investors from rental & other
 revenues generated from the building
 Partial sharing of capital appreciation if option is
 exercised within the maturity period
                                                                      Dr Sing Tien Foo
                                     Real Estate Securitization & Financial Innovations
Schematic Diagrams of ABS




                                                    Dr Sing Tien Foo
                   Real 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 securities
  Sell assets to a special purpose vehicle (SPV) or a trustee
  to remove the assets from its balance sheet
  Off-balance-sheet securitization vs on-balance sheet
  securitization
  Involves in collection of payments of the assets & passing
  of payments to the SPV at fees
  Off-balance-sheet – legal costs in conveying assets to
  SPV
  Credit risks of originator are insulated/separated
  On-balance-sheet – Lionie Condotel Bond
                                                                Dr Sing Tien Foo
                               Real Estate Securitization & Financial Innovations
Parties in securitization (II): SPV
   Purchase assets or receivables from the originator
   Create “bankruptcy remote” structure
   Protect ABS investors against the default of
   originator
   Higher credit rating for the issuing securities
   Two types of structure for SPV
       Pass-through
       Pay-through
   Depending on nature of receivable & funding
   requirement of originator
                                                             Dr Sing Tien Foo
                            Real Estate Securitization & Financial Innovations
Parties in Securitization (III):
Underwritter & Investors
   Underwritter bridges cash flows between investors and
   originators
   Roles of underwritter
       Indetification of securitization structure
       Pricing of issues
       Placement capacity – optimal issuance size
   Investors – insurance companies, pension funds, mutual
   funds and hedge funds
   Attraction of ABS to investors
       High credit quality
       High yield
       Liquidity                                                     Dr Sing Tien Foo
                                    Real Estate Securitization & Financial Innovations
Potential Benefits/Motivations
  To owner/originator
     Alternative financing instruments
     Improve liquidity in the balance sheet
     Reinvestment and freeing up the low-yield assets
     Transfer the interest rate risks to SPV
  To bondholders/investors
     New Investment opportunities for diversification
     Direct participation in real estate market by small investors
     Partial sharing of future capital gain through preference shares
     Building as collateral
  To Real Estate Market
     An active secondary capital market for institutional investment
     Alternative Financing Options
                                                                      Dr Sing Tien Foo
                                     Real Estate Securitization & Financial Innovations
Why Securitization?
 In US, rising cost of originating loan and tight liquidity in
 debt market
 In Singapore, different motivation driving the
 securitization market
 Liberalization and depleting of liquidity in debt market
 Alternative source of financing at attractive terms
 Reducing corporate gearing
 Diversifying financing risks
 Protected against floating rate risks when term structure
 of interest rates is volatile
 Low rental yield of holding property
 Re-investment return & improve efficiency of capital
                                                                 Dr Sing Tien Foo
                                Real Estate Securitization & Financial Innovations
Attractive Yields
 ABS 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 originator
 ABS investors have priority on the assets in the case of
 financial distress
 ABS is backed by securitized property
 Lower risk & tradability of the ABS bonds
 Lower transaction fees compared with direct sale of
 property                                           Dr Sing Tien Foo
                                   Real 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 Foo
                           Real Estate Securitization & Financial Innovations
                                                     Embedded Options in a
 Real Estate Holdings                              typical Securitization deal
       Pte Ltd
(wholly owned subsidiary of DBS Land)      Originates the                                   Investors
                                           securitization Process               Share of certain
A Put Options to sell back
property at a strike price                                             percentage of the capital
equivalent to original price plus                                       Appreciation, when the
35% of capital appreciation             Baronet Limited                     call/put options are
                                        (Special Purpose Vehicle)                     exercised
               A Call Option to buy-back the               Rental and other income
               Property at an exercise price,              equivalent to or exceed interest
               equivalent to original sale Price           payments to bondhodlers
               plus a percentage of capital
               appreciation (25%-35%)                      RE Properties
   Birchvest                                                 Pre Ltd
  Investments                An option to lease
    Pte Ltd                 back the Property for            268 Orchard
                                   10-year
(wholly owned subsidiary                                        Road
     of DBS Land)
                                                                                         Dr Sing Tien Foo
                                                        Real Estate Securitization & Financial Innovations
Pricing Embedded Options

 Option Pricing Theory
 Case Illustration – 268 Robinson Point
 Theoretical Framework
     Binomial Option Pricing Methdology
 Estimation Results
 Sensitivity Analysis



                                                            Dr Sing Tien Foo
                           Real Estate Securitization & Financial Innovations
Case Illustration
  268 Orchard Road – 10 year bond issues
  Explicit 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
     bondholders
     Call options can only be exercised after three years
     Exercised 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 Foo
                             Real Estate Securitization & Financial Innovations
Theoretical Framework
  Binomial Tree Option Pricing Model
  Discrete Price Change – by u and d
  Risk-neutral probability p
  Determining the strike price
     Percentage sharing of the capital appreciation
  Payoff function
     Difference between market and strike prices
  Option types
  Option formulas

                                                              Dr Sing Tien Foo
                             Real 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$8.15
 Price movement follow a binomial tree as follows
                    q       Pt+dt = uPt           ($9.00) and q =0.5
    ($8.15) Pt
                   1-q
                            Pt+dt = dPt         ($7.00) and 1-q =0.5

 At risk free rate of 5%, risk neutral probability is computed
 as p= [(1+0.05)*$8.15-$7.00]/($9.00 - $7.00) = 0.704
 Option premium =($0.50 *0.704)/(1.05) = $0.34
                                                                 Dr Sing Tien Foo
                                Real Estate Securitization & Financial Innovations
              Option Formulas
                  European Options, EC(T1,0, 0, PS1) =
               n                                                                      rndt
              
                            n!
                                    p (1  p)
                                     j
                                                     
                                              ( n j )          j ( n j )
                                                       Max( P0 u d          S t , 0)  * e       
              t , j 0 j!(n  j )!                                                   
                  American Options, AC (Tk+1, Tk, n, 0, PSk) =
                                                                                                                
 n     n i

 Max Pk , 0 u j d n i  j  S t ,  pC (n, i  1, j  1)  (1  p )C (n, i  1, j )* e  rdt
i 1 t , j  0


                  Compound Options
CO (TN ,0, PS k )                   
                               Max EC (T1 ,0, PS 1 )  E 0 , AC (Ti 1 , Ti , PS i ) * e  r (Ti / dt )  Ei       

                                                                                               Dr Sing Tien Foo
                                                              Real Estate Securitization & Financial Innovations
Characteristics of Embedded Options
     The date of exercising the call option                % Share of                    Type of
                                                            capital                      Option
                                                          appreciation
From the date of origination to      t=0 to t=3                  25%                    European
the last day of the 3rd year                                                              Call

From the first day of the 4th year   t=4 to t=5                  25%                    American
to the last day of the 5th year                                                           Call

From the first day of the 6th year   t=6 to t =7                 30%                    American
to the last day 7th year                                                                  Call

From the first day of the 8th year    t=8 to t                   35%                    American
to the last day of the 9.5th year      =9.5                                               Call

From the first day of the 9.6th       t=9.6 to                   35%                    American
year to the 30th day after the        t=10.08                                             Put
maturity of the bonds
                                                                                  Dr Sing Tien Foo
                                                 Real Estate Securitization & Financial Innovations
Estimation Results
 Securitization of 268 Orchard Road
 Input parameters/assumptions
     Unit Price (P) = $1,392 per net floor area
     Risk free rate (rf) = 5% p.a.
     Price volatility (s) = 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 Foo
                                  Real Estate Securitization & Financial Innovations
Sensitivity of Option Premiums

                                                                450

                                                                400

                                                               350

                                                               300

                                                               250

                                                               200
 8%                                                           150
   6%
     4%                                                       100




                                                      32%
                                              28%
                                      24%
                            20%
      2%
                      16%
                12%
           8%




                                                                   Dr Sing Tien Foo
                                  Real Estate Securitization & Financial Innovations
Tax Implications

   Have these embedded options been priced in the
   open market valuation?
   Stamp duty
      At the date of transaction
      When the options are exercised
      Moral Hazard problem
   Property tax valuation for comparable buildings
      Lease back options at guaranteed rental income
      Hypothetical Annual Value estimation when market
      rental is higher?
                                                               Dr Sing Tien Foo
                              Real 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 agreement
     Mainly to facilitate the transfer of the ownership back to the
     originator
     Redundant in an upmarket
 Retention of major share by the originator via Junior bond
 tranches? Moral hazard

                                                                      Dr Sing Tien Foo
                                     Real Estate Securitization & Financial Innovations
Market Impact
Potential and Importance of Asset-Backed Securitization in
Singapore
Developers should better utilize capital in development
activities than locking-in the capital in low-yield prime
properties
Rejecting of productive capital into real estate market
Investors are open to more avenue to diversify into
property market
Practical and institutional problems
Valuation of embedded options
Impact on Property Taxation and Efficiency of Market
Asymmetry of Information
                                                               Dr Sing Tien Foo
                              Real 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 Foo
                          Real 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.

                                                               Dr Sing Tien Foo
                              Real Estate Securitization & Financial Innovations
 End of Presentation


                                                Thank you

Presentation slides are available at my homepage:
http://www.sde.nus.edu.sg/~rststf/
Click “My ECA” and then “Others”

				
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