week 6 capital rasing

Question 1

Define and describe the terms ‘fixed charge’ and ‘floating charge’ in relation to security on a bank loan.

Answer 1

Fixed charge – loan is secured against an individual property

Floating charge – loan secured against a pool of properties

Question 2

What is a ‘negative pledge’ clause? Why would an investor want such a clause in a property trust bond?

Answer 2

A negative pledge clause is a covenant in a debt contract that restricts the borrower from taking out further loans without approval by the original lender. Lenders use this as a form of protection of the assets of the borrower in case of default.

Question 3

When rating agencies assess a Commercial Mortgage Backed Security (CMBS), what is the major determinant of their credit rating?

Answer 3

The ratings by credit agencies are based on the underlying properties in the CMBS, not the property fund themselves

Question 4

What is a BAB? How is the interest cost determined?

Answer 4

BAB – Banks Accepted Bill is a short-term debt security issued by a trust (or company) that is guaranteed by a bank. They typically have 90 or 180 maturities. BABs are issued at a discount to their face value. The difference between the issue value and face value is the interest cost.

Question 5

Describe the characteristics of a convertible debt security

Answer 5

A convertible debt security is a hybrid security. The security is issued by a trust or company. Similar to a regular (plain vanilla) bond, the bonds pays fixed coupons (interest) for a set period (generally around 5 years).
However, unlike a regular bond, the security can be converted into ordinary equity in the trust or company. The conversion price is determined by a formula set in the contract at the beginning

Question 6

Investment banks are often employed to act as an underwriter in a capital raising. What is the role of the underwriter and what is the fee structure?

Answer 6

The role of an underwriter is to assist a trust or company in the sale of financial securities. The underwriter will use their relationships with investors to help sell the securities, they will also advertise the offering to retail investors.
The underwriter fees are derived from the spread between the price units are sold to investors and the price the investment bank pays the fund.

Question 7

When a property fund decides to list on an exchange it called an initial public offering (IPO). List three reasons a fund would want to list?

Answer 7

Reasons to IPO include:
• To buy new or refurbish existing properties
• To expand into a new markets
• To repay debts and change their capital structure
• As an “exit strategy” for the owner or original investors

Question 8

With any IPO a prospectus needs to be prepared. What must the prospectus contain and what is the aim of the prospectus?

Answer 8

Prospectuses must contain:
• information on the features of the securities being offered,
• how many are for sale and subscription price,
• how you can apply to buy them,
• information on the fund, its operations & financial position,
• What they propose to do with the funds,
• the risks associated with the offer.

The aim of a prospectus is so a retail investor can make an informed decision about whether or not to invest.

Question 9

DLX is a property fund that has just listed on the ASX. If the IPO subscription price was $1.15 and the units closed on the ASX after their first day of trade at $1.25, what is the level of under or overpricing?

Answer 9

Fist day return= ((First day price-Subscription Price))/(Subscription Price)

First day return= ((1.25-1.15))/1.15=0.087=8.7%
Given the first day return is positive means the IPO was underpriced by 8.7%

Question 10

Define and discuss the two types of costs in an initial public offering.

Answer 10

The costs of an IPO can be classified as direct and indirect costs.
Direct costs:
• Underwriting
• Printing, distribution, advertising & listing fees
• Lawyer and accounting fees
Indirect costs refers to the underpricing of the IPO.

Question 11

What is a SEO? Describe three different types of SEOs

Answer 11

SEO = seasoned equity offering.
SEO refers to subsequent equity raisings after a trust or company has listed on an exchange. Different types of SEOs include
:
Rights Issue: Equity is offered to existing shareholders to purchase more units/shares in the firm as a proportion of their current holding.

Shape Purchase Plans (SPPs): Offer to existing investors to purchase small parcels of additional equity, without the need for a prospectus. SPPs are open to retail (smaller) investors to give them the same opportunities as institutional investors to participate in capital raisings. SPPs are capped at $15,000.

Private Placements: Sales of equity to institutional investor(s) by direct placement. No prospectus is required because they are sold to wholesale investors. They can be done quicker and cheaper than other SEOs.

Dividend Reinvestment Plans (DRPs): Investors forgo their dividends or distributions for additional units/shares in the firm. DRPs are popular for REITs due to their limit to retain earnings due to the 100% payout requirement of trusts.

Warrants: These are options for an investor to purchase additional units at some point in the future or by installments.

Question 12

DLX has been listed on the ASX for 2 years. REIT management have decided to raise additional equity via a 1 for 5 renounceable rights issue with a subscription price of $1.34. The raising will be used to help finance the acquisition of a new property in Melbourne’s CBD.
i) Given recent research on REIT SEOs, what would you expect to happen to the risk adjusted returns of DLX following the issue?

Answer 12

i) Research has shown, on average, equity raisings used for a REITs core business (property acquisitions, refurbishments etc.) have improved risk adjusted returns following the raisings.

Question 13

DLX has been listed on the ASX for 2 years. REIT management have decided to raise additional equity via a 1 for 5 renounceable rights issue with a subscription price of $1.34. The raising will be used to help finance the acquisition of a new property in Melbourne’s CBD.

Answer 13

ii) A 1 for 5 rights issue means for every 5 units the investor holds they can purchase one additional unit at the subscription price, in this case $1.34.

Question 14

What is a SPP? What are the advantages of a SPP for investors and management?
SOLUTION:

Answer 14

SPP = share purchase plan
SPPs are offered to existing investors to purchase small parcels of additional equity, without the trust having to prepare a prospectus.
Retail (smaller) investors are given the same opportunity as institutional to participate in equity raisings.
The issues are offered at a discount to the market price.
Maximum a REIT can offer is $15,000 without the need for a prospectus.

Question 15

Who do REIT managers prefer to raise funds via a private placement? Why do existing shareholders dislike private placements?

Answer 15

A private placement is the sale of equity to institutional investor(s). Management prefer to raise equity this way because:
• The discount offered compared to other issues is less.
• Because the investors are wholesale, there is no requirement for a prospectus and therefore cheaper.
• Private placements can be organized faster than other equity raisings.
Existing unit holders (who do not participate in the placement) do not like them because they dilute their ownership base.

Question 16

Describe how a dividend reinvestment plan (DRP) works? Why are DRPs attractive to REITs and investors?

Answer 16

DRPs are a process were the investor ‘forgoes’ their distribution in return for additional units in the trust. The number of new units is determined by the value of the dividend. Often the investors receives the units a small discount to the current unit price and does not have to pay any brokerage fees. If the dividend contains any franking credits, those credits are still passed on to the investor.
DRPs are attractive to REITs because they are required to payout 100% of their taxable income (due to the trust structure) they have limited ability to retain earnings. By having a DRP in place the REIT can still meet their legal payout requirement and retain earnings

Question 17

Why do capital raisings have signaling effect? What is the impact on the unit price of a REIT following an equity raising?

Answer 17

There is an information asymmetry between investors and managers. The announcement of a new raising requires the REIT to release information to the market place. This new information is used by investors to assess the strength of the trust. Often equity raisings can signal to the market that managers of the trust believe their units are overvalued.
The consequence of a new equity raising is that it dilutes the value of the units by the discount on the price of the new units. In theory, the value of the units after an issue should reflect the market capitalization before the issue plus the amount of cash raised by the issue.

Question 18

Describe the characteristics of a hybrid security? Provide an example of a hybrid security.

Answer 18

Hybrid securities have the characteristics of both equity and debt. Preference shares (or reset preference shares) are an example. They pay dividends just like shares, some contain voting rights and generally do not have a maturity date. However, similar to debt the dividends are fixed and contractual (similar to interest payments on a loan).

Question 19

Why would a REIT repay capital to unit holders?

Answer 19

Managers may repay capital to unit holders if the trust has sold a property or properties and wants to distribute the proceeds to their unit holders.
A repayment may also signal that management believe that their unit price is undervalued and it is better for the fund to spend cash buying units cheaply rather than buying more properties.

Question 20

explain a CMBS’

Answer 20

CMBS are securitised instruments backed by mortgages over a number of commercial properties owned by a PF
They provide institutional investors with returns based on loan repayments & repayment of capital at maturity
Issues rated by credit agencies – ratings based underlying properties not the actual PF (rated to attract properties)
Rating is actually based on properties not the fund
Very popular 2000 to prior GFC with most rated AAA = lower cost than bank loans
GFC saw margins increase substantially, resulting in decrease demand

Question 21

what are babs

Answer 21

The most common – Bank Accepted Bills (BABs)
BABs issued at discount to face value, the difference represents the interest cost
Typically 90 or 180 day maturities ( most with rollover opportunities)
Interest costs lower due to Banks acting as guarantors
E.G. Trust issues BABs for 90 days at face value of $100,000
They are sold in the money market for $95,000. The $5,000 is the interest cost

Question 22

what is convertiable debt

Answer 22

Convertibles are a hybrid security, start out as debt then can be converted to equity
Commonly pay a fixed rate of interest (i.e. a corporate bond) for set period (≈ 5 years)
After which, PF has right to either redeem (payout) or convert the debt instrument into equity (ie. Convert to units/shares) at a price set by a formula in the deed of the bond.
Advantage: allows PFs to sell deferred equity and not repay the debt

Question 23

explain equity financing for unlisted fund

Answer 23

Unlisted PFs can raise equity by issuing new units
How the units are sold is a decision for management
Public offering (New units to retail investors)
Private placement units to institutional investors (wholesale investors)
Combination of both
Different disclosure regulations for retail v wholesale investors
However, all unit in the fund have the same entitlements to distributions and voting

Question 24

Equity risings for REITs can categorised into:

Answer 24

Initial public offering (IPO)

Seasoned equity offerings (SEO)

Question 25

explain IPO

Answer 25

Initial Public Offerings (IPOs)
An IPO is when a privately owned company/REIT sells shares/units to the general public and subsequently lists on an exchange (ASX)
These transactions occur in what is termed “primary market”
Reasons for IPOs vary:
To buy new or refurbish existing properties
To expand into a new markets
To repay debts and change their capital structure
As an “exit strategy” for the owner or original investors (Most popular reason

Question 26

list differenet type of seo’s

Answer 26

Rights issues – offered to existing holders pro-rata basis.
Securities purchase plans – offered to existing to purchase small additional equity
Private placements - sales of equity to institutional investor(s) by direct offer
dividend reinvestment plans - Investors forego distributions for additional units/shares
Options (warrants) - Give investor the option to purchase additional units
Hybrid Capital - have characteristics of both equity and debt. Preference shares are most common example

Question 27

explain right issues

Answer 27

are offered to existing holders to purchase more units/shares as a proportion of their current holding
Still require a prospectus, but overall costs are lower than IPO
E.G. A 1 for 4 rights issue means that holder can buy 1 additional unit for every 4 they own
Advantage of a rights issues do not dilute the ownership base

Rights issues can be renounceable or non-renounceable
Renounceable means investor can on sell their right
Non-renounceable means the investor can not sell their right
The ‘right’ has value

SEE EXAMPLE IN POWER POINT - GRACIE BOFF

Question 28

explain security share purchase plans

Answer 28

SPPs are offers to existing investors to purchase small additional equity without having to issue a prospectus
Generally offered at a discount to market price
Max offered $15,000 (increased from $5k in 2010)
Open to smaller retail investors to give them same opportunity as institutional to participate in capital raisings

Question 29

explain private placements

Answer 29

PPs are sales of equity to institutional investor(s) by direct offer
Generally offered at a small discount
PPs often organised by investment banks who have relationships with institutional investors
Because offered to institutions no prospectus is needed
Thus can be done quickly and cheapest form of equity raising
Disadvantage for existing investors is that it dilutes ownership of investors not invited to participate

Question 30

explain dividned reinvestment plans

Answer 30

DRPs are a way for funds to retain earnings (same process as unlisted trusts)
Investors forego distributions for additional units/shares
Offered at a discount to market price and no brokerage
Popular for REITs (and unlisted trusts) to retain earnings given the 100% payout requirement

Question 31

explain options to buy units

Answer 31

Give investor the option to purchase additional units at some point in the future or by instalments at different points in the future
The capital raised is the premium paid by the investor to have the option

Question 32

When there is announcements regarding capital raisings there is a signalling effect…

Answer 32

There is an information asymmetry between investors and managers
New raisings sends a signal to investors about the strength of the REIT which in turn may influence unit prices
Generally raisings are only seen as positive if the REIT has attractive opportunities to earn a higher return
Often equity raisings signal that the managers of the trust believes the trust is overvalued

Research on equity raisings by A-REITs shown:
On average investors earn negative risk adjusted returns around the private placements, but insignificant for rights issues
Raisings used for core business (refurbishments, acquisitions etc) investors experience better/increased risk adjusted returns
Raisings used to ‘sure-up’ balance sheets (i.e. pay off debt or reduce leverage) have negative risk adjusted returns