Strong Corporate Governance Benefits U.S. Equity REIT Bondholders

By Sean Pattap, Senior Director, U.S. REITs, Fitch Ratings: Numerous U.S. REIT corporate-governance attributes benefit bondholders, though there is one credit negative that investors should consider.
Sean Pattap

Numerous U.S. REIT corporate governance attributes benefit bondholders, though there is one credit negative that investors should consider.

Recent investor activism has spurred investors to ask Fitch Ratings about governance attributes that impact REIT bondholders. Corporate governance analysis is an integral part of evaluating a bond’s risk profile because certain changes in policies may weaken a company’s anti-takeover defenses or raise the influence of activists, thereby increasing implied riskiness of a bond.

Of 64 REITs that Fitch examined, the limited number of staggered boards, high percentage of independent board members, experienced board membership, the widespread incorporation of credit metrics into management compensation and board background diversity are positives for bondholders. One credit negative, however, is the preponderance of REIT CEOs that serve as independent members of other boards.

Only 11 percent of REITs that Fitch analyzed have staggered boards, a low percentage.  Of note when considering cliff risks to bondholders posed by investor activism, U.S. equity REITs have bond indentures that include financial covenants.  Therefore, a risk to REIT bondholders is that activists could replace multiple board members, which could lead to decisions that weaken a REIT’s credit profile within the confines of covenants.

A board that is independent, active, knowledgeable and committed signals a robust governance framework.  Fitch views positively boards that include non-executive members with diverse skills, views and professional experience.   On average, 78 percent of board members are independent, and 39 percent of independent board members do not have a commercial real estate background. These are both credit positives as they are indicative of a broad representation of perspectives and balance of members’ expertise on REIT boards.

Fitch views negatively REIT CEOs that serve as independents on multiple boards (63 percent), as it may be challenging to effectively balance day-to-day CEO responsibilities with overseeing other companies.

Of the 64 companies examined, 39 (61 percent) incorporate at least one credit metric element into management compensation.  The incorporation of credit metrics into management compensation is unequivocally a positive for bondholders and provides tangible evidence that the board considers the interests of bondholders as opposed to shareholders exclusively.