Lippo Malls Indonesia Retail Trust bonds are at distressed levels, here is what you should do

• The rating downgrades from both Moody’s and Fitch is likely to impact LMIRT’s ability to refinance its existing borrowings

• LMIRT faces significant currency risk as the REIT earns in IDR while reporting in SGD in its financial statements

• LMIRT intends to cease distributions for the LMRTSP 8.096% Perpetual Corp (SGD) and LMRTSP 6.4751% Perpetual Corp (SGD)

• Low recovery expected for perpetual bonds due to its subordinated ranking

• We recommend ‘sell’ on both LMRTSP 8.096% Perpetual Corp (SGD) and LMRTSP 6.4751% Perpetual Corp (SGD)

Bonds from Lippo Malls Indonesia Retail Trust (“LMIRT”) fell to distressed levels following the release of its full year earnings ending 31 December 2022 (“FY22”). Its USD senior unsecured bonds fell to 70 cents on the dollar while its perpetual bonds fell to below 20 cents on the dollar. 

The REIT, with all of its malls located in Indonesia, struggled to recover from COVID-19. Occupancy rate and shopper traffic remains below pre-pandemic levels. On top of that, a higher interest rate environment and currency depreciation contributed to rising cost for LMIRT. Faced with a mounting debt maturity wall in 2024 and no clear refinancing plans, LMIRT bonds are at risk of a default.

Rating downgrades from Moody’s and Fitch

Last month, LMIRT saw its credit ratings downgraded by rating agencies. Moody’s downgraded the issuer of its senior unsecured bonds from B3 to Caa1 while Fitch downgraded senior unsecured bonds from B- to CCC+.

Moody’s downgraded the issuer as they view that debt restructuring is likely to take place as the trust has no refinancing plans for its bank loans due Nov 23 and Jan 24 as well as its USD bond maturing in Jun 24. The negative outlook reflects Moody’s view that LMIRT has high refinancing risk in a tight funding market. It also reflects the continued uncertainty surrounding the pace of recovery from the pandemic in an environment of inflation and slower growth.

Fitch also had similar concerns. Fitch downgraded LMIRT’s long-term issuer default rating and senior unsecured notes from B- to CCC+. Fitch highlighted LMIRT’s high refinancing risk as the trust would need to refinance almost two-thirds of its debt or SGD 580m within the next 16 months.

The rating downgrades from both Moody’s and Fitch is likely to impact LMIRT’s ability to refinance its existing borrowings. After the downgrades, LMIRT bonds fell to distress levels and this will impact LMIRT’s ability to access debt capital markets. We think LMIRT would need to depend on banks to refinance existing borrowings.

LMIRT faces large currency risk

While revenues and net property income improved in FY22 for LMIRT, the depreciation of Indonesian Rupiah (“IDR”) resulted in SGD 161.8m of losses. LMIRT faces significant currency risk as the REIT earns in IDR while reporting in SGD in its financial statements. Loans are also borrowed in either USD or SGD. The continued depreciation of IDR will result in significant losses for the REIT. Currency fluctuations will also affect the REIT’s aggregate leverage ratio. LMIRT announced on 3 Jan 23 and 1 Feb 23 that the fluctuations of foreign currency resulted in aggregate leverage ratio to rise close to regulatory limits of 45%. Aggregate leverage ratio was 44.6% as of 31 December 2022, an increase of 0.9 percentage points from 43.7% in 30 September 2022.

A breach of 45% in aggregate ratio will result in LMIRT to breach its bank loan covenants. A failure to get waivers on the breach will result in LMIRT to default on its bank loans. With the heightened interest rate environment and inflation likely to remain elevated, we foresee continued strength in the USD and SGD which would cause IDR to remain at current levels.

LMIRT intends to cease perpetual and dividend distribution

LMIRT announced in their latest earnings on 23 Feb 23 that the REIT intends to cease distributions for the LMRTSP 8.096% Perpetual Corp (SGD) and LMRTSP 6.4751% Perpetual Corp (SGD). Currently there were no distributions accrued as at 31 December 2022 as the last distributions declared and were paid on 27 September 2022 and 19 December 2022, respectively. This will trigger the dividend stopper and non-cumulative clause in both perps. LMIRT will therefore not pay any dividend to its shareholders as distributions are not paid to its perpetual bondholders. Interest accrued are non-cumulative and the issuer have no obligation to repay or accrue the distribution. If LMIRT stops its distributions for its perpetual notes and dividends, this would save ~SGD 44m for the REIT. If LMIRT were to cease distributions for both its perps, we see little value in holding the perp as accrued coupons will be non-cumulative.

Recovery amount is adequate but low recovery expected for perpetual bonds

LMIRT has 1.81b of assets that can be liquidated, the following assumptions were given when calculating the recovery rate and recovery amount:

Based on our calculations, the recovery rate for LMIRT when liquidated will be 79%. The recovery amount is adequate and senior bondholders do not lose much of the bond principal if a liquidation occurs.

Based on Fitch’s recovery assumptions, a rating of RR1 was given to the recovery rate for LMRTSP’s senior unsecured bonds. As per Fitch’s methodology, RR1 rated securities have characteristics consistent with securities historically recovering 91%-100% of current principal and related interest. However, the rating was further downgraded to RR4 (recovery rate of 31-50% for the senior bonds) due to their rating cap of RR4 for issuers based in Indonesia. 

LMIRT senior unsecured bonds are currently trading at an ask price of 73.2 and 65.9 for the LMRTSP 7.250% 19Jun2024 Corp (USD) and LMRTSP 7.500% 09Feb2026 Corp (USD) respectively. It is a stark contrast to the SGD perpetual prices of below 20. While there is some recovery prospects for the senior unsecured bondholders, we think there is still room for the senior unsecured bonds to fall. If there is no clear refinancing plans for its 2024 debts, it is likely the senior unsecured bonds will go through restructuring and this will impact the bond prices negatively. 

For perp bondholders, we think the recoverable amount will be low due to the subordinated ranking of the perpetuals. Based on our estimations, the recovery amount would not be sufficient to cover all of LMIRT’s liabilities and perpetuals. Total liabilities will be SGD 1.31b when peperpetual bonds are included. Given that perpetual bondholders will be one of the last creditors to be paid, we think it is unlikely for perpetual bondholders to see significant recovery of their perpetual bonds.

Table 1: Estimated recovery rate for LMIRT

Conclusion

We recommend sell on LMRTSP 8.096% Perpetual Corp (SGD) and LMRTSP 6.4751% Perpetual Corp (SGD). Credit rating downgrades from Moody’s and Fitch makes it difficult for LMIRT to have continued access to capital markets and funding. We expect currency risk to remain elevated due to the high interest rate environment, providing strength to the SGD and USD. LMIRT is at risk of breaching its bank loan covenants if aggregate leverage ratios surpass 45%. In an event of a liquidation, perp bondholders may face low recovery prospects due to the subordinated ranking of perpetual bonds. Perp holders have significant downside risks and we do not see any value in holding the perp if coupon distributions were to cease.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in LMRTSP 8.096% Perpetual Corp (SGD) and the analyst who produced this report holds a NIL position in the abovementioned securities.

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