Tuesday 04 November 2014 by Justin McCarthy Company updates

Good news on two FIIG-originated bonds

PAYCE bondholders get the guarantee

PAYCE released a further update on the East Village project to the ASX on 29 October 2014 which confirmed the retail and commercial portion of East Village was opened on 22 October 2014 and that refinance has been completed. A new senior secured term loan, secured by the retail and commercial space, is now in place.

The announcement also confirmed that settlement of 203 out of 206 residential units has been completed and the remaining units are expected to settle shortly.

While not in the announcement, we can also advise that following the refinance of the loan, the guarantee has now been provided from the owner of the East Village retail and commercial space (Joynton North Pty Ltd ATF Joynton North Property Trust) for the benefit of bondholders which significantly improves the security position and de-risks the bond.

The East Village security consists of 33,000 sqm of retail/commercial space which is 100% leased, including 20 year leases to Coles, Virgin Active and Audi and was last valued at $210m in November 2013.

The terms of the bond issue specify that a maximum loan-to-value (LVR) ratio of 70% must be maintained until December 2016 and 60% thereafter, with permitted debt defined as the senior secured bank facility plus the $50m PAYCE bonds on issue.

Assuming a valuation of $210m, the maximum amount of prior ranking secured debt is limited to $97m (i.e. $97m bank debt + $50m bonds / $210m value = 70% LVR) until December 2016 and $76m (i.e. $76m bank debt + $50m bonds / $210m value = 60%) thereafter, providing significant residual value to support the PAYCE bonds.

While we have used a valuation of $210m above, market yields have dropped over the last ten months so it would be reasonable to expect that the valuation has actually increased now that the East Village retail/commercial space is 100% leased (as compared with 75% in November 2013).

Compared to other FIIG-originated deals the PAYCE bond now has one of the lowest risk profiles and exhibits strong value given the security position and general outlook for the PAYCE Group. The bonds are currently indicatively offered at a yield of 7.11% to maturity (or 6.07% to first call date in December 2016).

360 Capital sells its Hurstville property

360 Capital announced to the ASX on 30 October 2014 that an unconditional sale contract for its Hurstville property had been executed, for $47m (before costs). Settlement is expected on 30 September 2015, however, rental payments will be received up to that date.

The gross sale figure of $47m is a 22.1% premium to the current carrying value in the accounts of $38.5m and is viewed as an excellent result and above market expectations.

The sale removes one of the key risks to the business.

This is a significant development for 360 Capital bondholders as the prospect of having the Hurstville property remain on the books untenanted (once the ATO lease expired in February 2015) would have placed a material drag on earnings and cashflow and provided a high degree of uncertainty to the medium term outlook.

Once the sale is completed, 360 Capital will no longer have any direct property exposures and will become a pure fund manager and investment group in line with their stated strategy.

360 Capital has revised its earnings forecasts upwards with FY15 base operating earnings increased by 9.1% to 6.0 cents per share (cps) and operating earnings now expected to be over 10.0cps. This base forecast is at the upper end of guidance that was provided upon the release of the FY14 results (being 8.6cps – 11.0cps).

The company has also announced a formal distribution policy which will reference base operating earnings with 80-100% to be distributed annually. This high payout ratio is in-line with industry norms and as expected. FY15 distribution is now forecast to be 5.75cps representing a payout ratio of 95.8% of base operating earnings.

Note that “active earnings” which would include profits from the sale of directly held properties such as Hurstville (circa $8.5m before adjustments) and any future short term direct property purchases are excluded from distributions and will be reinvested to continue growth. This increases the size of the Group and hence asset backing which is an (indirect) benefit to bondholders.

Finally, the company announced that Group cash reserves prior to the sale were $44m and that there were no bank borrowings against the property. The full net proceeds from the sale of the Hurstville property will be redeployed into the Group’s funds management and co-investment activities.

In summary, this sale materially reduces the uncertainty and hence risk of the 360 Capital bond. Further, the excellent contract price of $47m with no bank debt offsetting the sale provides 360 Capital with scope to reinvest and further grow the business.

With the bonds indicatively offered at 6.63% (a trading margin of circa 350bps) they are considered very good value given the low risk profile of the underlying business and now the removal of one of the key risks.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities. Please note these bonds are only available to wholesale investors.