Stock Review

An announcement from this small group may foreshadow bigger things for the real estate investment trust sector.

Galileo Japan Trust – twice rejected as a potential investment opportunity by our own Nathan Bell – made an announcement today headed ‘Capital management update’. The section marked ‘revaluations’ was particularly revealing.

In keeping with prior practice, the board has ‘instructed independent valuers to complete revaluations on a representative cross section of the portfolio as at 31 December 2008’. Such valuations are crucial for highly-geared Real Estate Investment Trusts (REITs) like Galileo. The covenants attached to the group’s foreign currency hedging contracts stipulate that ‘total interest bearing liabilities (including mark to market of derivative contracts) to total assets should not exceed 70% for any period and should not exceed 65% for more than 90 days.’

Nothing new in any of that. What was interesting was a disclosure that the group ‘understands that the Japanese lender holding security over the Japanese property portfolio is instructing an independent valuer to conduct market appraisals to ascertain compliance with loan to value tests in the loan documents’.

Nervous bankers

In other words, the group’s banker is becoming nervous, and perhaps distrustful of the valuations provided to it. Any bets on whether the banker’s valuer will be more conservative than Galileo’s own valuer? It’s not clear whose valuation will prevail if there are material differences – no doubt it will depend on the fine print in the loan documentation – but the lender in this case presumably feels it has something to gain from the exercise.

If these lender’s valuations become a new trend across the sector, then it could have serious implications for any REITs that are close to breaching their banking covenants. Four hundred years ago, Galileo Galilei offered many new theories to the world. Today, we offer one prompted by this announcement from his namesake: Beware of bankers bearing valuers.

Greg Hoffman

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