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Fitch Affirms Cathay No.2 at 'A(twn)'; Outlook Stable
October 25, 2017 / 3:54 AM / in 2 months

Fitch Affirms Cathay No.2 at 'A(twn)'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, October 24 (Fitch) Fitch Ratings has affirmed Cathay No.2 Real Estate Investment Trust Fund's (Cathay No.2) National Long-Term Rating at 'A(twn)' and National Short-Term Rating at 'F1(twn)'. The Outlook is Stable. KEY RATING DRIVERS Consistent Asset Performance: Cathay No.2 has maintained stable rental yield (rental income/book value of investment property) of over 5% since 2008. The average occupancy rate has remained above 95% since 2010 and was at 98.7% in 1H17. The occupancy rate remained healthy at 92% in 2008 and 87% in 2009 during the trough of the economic downturn. The resilient occupancy rate and stable rental rates generate sufficient liquidity, as reflected in the stable EBITDA margin of more than 80% in the past decade. Adequate Net Cash Position: Cathay No.2 has no outstanding debt and had available cash of TWD493 million at end-1H17. The REIT has a 35% gearing limit for further investments. To date, however, it has not used it, and it does not have any investment proposal on hand that would require it to activate its gearing. Fitch does not rule out the possibility of acquisitions in the next 18 months as the growth in property values in Taiwan has been mild in the past 12 months. However, the economic uncertainties, restrictions on investments by insurers and a requirement that new assets meet a minimum return on investment (annual rental income/total assets) have made Cathay No.2 cautious towards new investments. Solid Asset Pool: Cathay No.2 has three office buildings with long operating histories (27-37 years) in Taipei. All are located in the city's traditional prime downtown area. The market value of the three buildings increased by 55.3% in 2008-2016 (CAGR of 5.7%). Annual rental income steadily rose to TWD409 million in 2016 from TWD379 million in 2008 (CAGR of 1%). Although we do not expect the pace of increase in market value to continue in the next two years, the central location of the buildings will ensure rental income and market value remain resilient, which provides strong support to the credit profile. Small and Concentrated Property Portfolio: The scale of Cathay No.2 is limited, with assets valued at TWD13.7 billion (USD460 million) compared with the asset sizes of USD1 billion-4 billion for Asian peers in the same rating category. The limited scale and concentration in Taipei significantly constrain the rating. Prospects of Rental Growth Limited: Growth in demand for office space in Taipei is limited by weak economic performance, and muted expansion and investment by foreign enterprises. A high-end office building called Taipei Nanshan Plaza in Xinyi District is due to start operation in 2018, but Fitch expects the impact on Cathay No.2's rental rate to be minimal as the REIT has renewed leases of the majority of its tenants that have contracts expiring in the next 12 months. Furthermore, the new building is classified as Grade A office space while Cathay No.2's three buildings are classified as Grade B/B+, which appeals to a different tenant segment. The mature residential area around the three buildings will also help Cathay No.2's rental income remain resilient. DERIVATION SUMMARY Cathay No.2's ratings are supported by its prudent financial management and resilient rental income from its investment properties, which are in Taipei's mature CBD area and well-served by public transportation. Cathay No.2's ratings are constrained by its small scale as reflected in its investment property EBITDA of USD12 million and property asset value of only USD460 million. Cathay No.2, is rated one notch lower than Advanced Semiconductor Engineering, Inc.'s (ASE, A+(twn)/Rating Watch Negative), which is a leading player in the outsourced semiconductor assembly and testing industry (OSAT) in Taiwan. The one-notch difference reflects Cathay's much smaller EBITDA size. The OSAT industry is likely to face soft market fundamentals, high competition, debt-funded consolidation, and large investment requirements. In contrast the real estate business is more stable. Cathay's financial profile is also much stronger with no debt likely to be incurred in the rating horizon. Cathay No.2's net cash position also compares favourably with Fitch-rated Hong Kong landlords rated in the 'A' categories on the international scale, which have net leverage of 3.0x-4.0x, and 'BBB' rated Singapore REITSs, which have net leverage of 5.0x-7.0x. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Rental growth of 1 % in 2018-2020 - Management fee and other costs remain flat in2018-2020 - Occupancy rate of 99% in 2018-2020 - Growth in investment property value of 3% a year in 2018-2020 RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Negative Rating Action - Sustained decline in rental yield to below 5% (FY16: 5.7%) - Sustained decline in occupancy rate below 85% - Sustained weakening in EBITDA margin below 60% (FY16: 79.9%) - Substantial asset acquisition - Incurrence of any debt Positive rating action is unlikely in the next 12 months due to the small scale of Cathay No.2's portfolio. LIQUIDITY Sufficient Liquidity, No Debt: Cathay No.2 has very sound financial performance. At end-June 2017, the fund has no outstanding debt with available cash of TWD493 million. All cash balances are available cash. The REIT's maximum leverage is generally 35% of total asset value. Leverage may exceed 35% (but capped at 50%) provided the REIT discloses its credit rating from a major rating agency. Contact: Primary Analyst Vicki Shen Director +852 2263 9918 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Chloe He Associate Director +852 2263 9933 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Note to editors: Fitch's National ratings provide a relative measure of creditworthiness for rated entities in countries with relatively low international sovereign ratings and where there is demand for such ratings. The best risk within a country is rated 'AAA' and other credits are rated only relative to this risk. National ratings are designed for use mainly by local investors in local markets and are signified by the addition of an identifier for the country concerned, such as 'AAA(twn)' for National ratings in Taiwan. Specific letter grades are not therefore internationally comparable. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Additional Disclosures Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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