Shin Kong Life Insurance Song Jiang, Cheng Der, and Panchiao Buildings Real Estate Asset Trust

This report does not constitute a recommendation to buy, hold, or sell securities.

Rating Details

Profile

Trust: Mega International Commercial Bank Co. Ltd. (Mega Bank) as Trustee for Shin Kong Life Insurance Song Jiang, Cheng Der, and Panchiao Buildings Real Estate Asset Trust (the SPT).

Entrusted Properties : The three Song Jiang, Cheng Der, and Panchiao buildings.

Closing Date: Feb.8, 2007.

Final Legal Maturity Date: August 2013.

Originator: Shin Kong Life Insurance Co. Ltd. (SKL, Global Scale Ratings BBB+/Stable/--, National Scale Ratings twAA/Stable/--).

Trustee: Mega Bank.

Property Manager: New Light International Co. Ltd. (New Light International).

Guarantor to Class C certificates: Industrial Bank of Taiwan (IBT, National Scale Ratings twA/stable/twA-2).

Arrangers: IBT and New Light International.

Appraisers: Honda Assets Valuation Co. Ltd. (Honda) and Debenham Tie Leung (DTZ).

Rationale

Taiwan ratings assigned its ratings to Series A beneficiary certificates, Series B beneficiary certificates, and Series C beneficiary certificates to be issued by the SPT. The certificates are backed by three office buildings: Shin Kong Song Jiang and Shinkong Cheng Der--both located in Taipei City; and Shinkong Panchiao--located in Panchiao City, Taipei County.

The ratings address the full and timely payment of interest and full repayment of principal on or before the final legal maturity in August 2013.

The ratings on the Class A and Class B certificates are based on:

• The quality of the properties that secure the certificates;
• Adequate loan-to-value (LTV) ratios and debt-service coverage (DSC) ratios; and
• The value of the properties underwritten assuming stabilized cash flow (as defined under Credit Evaluation).The preliminary rating on the Class C certificates is based on an unconditional guarantee provided by IBT.

Strengths

• The three buildings exhibit excellent occupancy levels;
• Even though our stressed DSC applied to cash flow has taken into account possible expenses during the life of the transaction, the structure has established several reserves for liquidity purposes and to cover expenses;
• Shin Kong Song Jiang building is located in an important business district where small- and medium-size enterprises (SMEs) such as travel agencies and trading companies cluster. The building has convenient public transportation links;
• Shin Kong Panchiao office building is well maintained and located on the edge of a well developed commercial zone near Panchiao City's old railway station and a new zone under development. The new Panchiao Station is about 500 meters away; and
• Certificate amortization in the event of excess proceeds reduces repayment risk compared to a bullet payment structure.

Concerns And Mitigants

• SKL is the largest tenant in the three buildings and is expected to contribute 67% of total rental income. A cash reserve equivalent to six months of the rental contribution of SKL and its affiliates was sized for liquidity purposes to mitigate the concentration risk.
• SKL sold the buildings to the trust and leased back the office space that it occupies. The tenor of the lease contracts with the trust ranges from two and a half to three and a half years. Concerns that the cash flow of the transaction would be significantly affected by SKL's decision not to roll-over the leases are somewhat mitigated by the requirement to provide six months' advance notification.
• Shin Kong Song Jiang building is relatively old at 34 years. The building has, however, been properly maintained. The value of the building was underwritten assuming a stabilized cash flow and taking into account the quality and competitiveness of the building;
• Shin Kong Cheng Der building is located in a non-commercial zone. Demand for office space in this area is primarily derived from local SMEs. We gave a larger haircut on the value of this property (as appraised by DTZ and Honda) than on the other two properties to reflect the building's less favorable location for commercial use;
• The certificates will be redeemed by liquidating the three buildings. It will be possible to redeem the certificates only if the buildings are successfully disposed of by the final legal maturity date. This risk is mitigated by an appropriate level of stress on the value of the buildings.

Transaction Overview

Before the closing date, the Originator transferred the ownership of Song Jiang building, Panchiao building, and Cheng Der building to the trust. On the closing date, Mega Bank, the trustee on behalf of the trust issued NT dollar denominated class A trust certificates [twAAA], class B trust certificates [twA], class C trust certificates [twA] (collectively "Senior Trust Certificates") and unrated subordinated trust certificates. Proceeds from the issuance of the class A, class B, and class C certificates and the unrated subordinated trust certificates were paid to SKL in exchange for the transfer of the properties. Four reserve funds totaling NT$55,994,088 were set aside at closing for liquidity purposes and to cover certain expenses.

The senior trust certificates will pay fixed interest semi-annually. Interest payment and principal repayment on the certificates will be funded by rental collections, proceeds from the disposal of the three properties, and other income from trust assets. Payment on the certificates is on a sequential basis. Excess funds after paying interest and topping up reserves will be used to pay down the principal of the senior trust certificates up to NT$11,500,000 with any shortfall carried forward to the next payment date. Class A and class B certificates are entirely backed by trust assets. Class C certificates will be additionally backed by a bank guarantee from IBT to cover any shortfall on scheduled interest payments and principal when due.

Office Rental Trends

Taipei City

Average office rents in Taipei started to trend down at the end of 2000 when economic conditions in Taiwan deteriorated. A glut of new premium grade office space in subsequent years exacerbated the situation. Average office rents dropped 20%-25% between the end of 2000 and 2Q2004. The average vacancy rate exceeded 12% in 2004..

Average office rents gradually stabilized in 3Q2004. As several companies took advantage of the low rent landscape to upgrade to higher grade office space, rents commanded by some newer and/or better managed buildings registered moderate growth from 4Q2005. Older, poorly maintained office buildings encountered higher pressure, which catalyzed the renovation of several buildings.

The average vacancy rate dropped to about 10% in the third quarter of 2006, as new office space gradually filled up. Taiwan Ratings does not expect average office rents in Taipei City to come under significant downward pressure over the medium term given that there are no major new office construction projects underway. Pressure is likely to be mainly focused on older, poorly managed office buildings.

Panchiao City

The amount of office space in Panchiao City is much less than in Taipei City. Most buildings provide both office and retail space. The main attraction of offices in this area is their low average rent in comparison with Taipei City. Several major office buildings serve as the back offices of large corporations.

The new supply of office buildings in Panchiao is limited. In recent years, the majority of new buildings were commissioned by the government and consequently did not put pressure on average office rents. Despite the anticipation of some additional new supply, Taiwan Ratings does not expect average office rents in Panchiao to come under strong pressure over the medium term. Panchiao's growing status as an important transportation hub is expected to provide additional support to the city's office rents.

Description of Entrusted Properities

Details of the three office buildings supporting the notes are listed below:

Data as of June 30, 2006 

Shin Kong Song Jiang Building

The building is located in the busy Nangjing-Songjiang commercial district. This commercial zone started to develop in the late 1960s and most buildings were constructed before 1985. Demand for office space in this area is mainly derived from SMEs involved in trading, travel, or transportation.

Taipei City exhibits significant industry segmentation, with similar companies tending to locate in specific business districts. Demand for office space in the more modern Tunhua-Mingsheng commercial district to the east is derived mainly from financial institutions. The established industry segmentation mitigates concerns that businesses will move away from the Nanjing-Songjiang district.

Song Jiang building is situated at the intersection of Songjiang Road and Changan East Road. Built in 1972, the 11-story building has a land area of 207 pings, office space of 1,940 pings, and one basement level with space for nine cars. The building has good bus links and is located within walking distance of a new subway line scheduled for completion in 2009.

In terms of floor space, 95% of the building is currently occupied. SKL occupies 68% of the total floor space and is expected to contribute 56% of the total rental income. The remaining floor space is occupied by travel agencies and securities trading companies with lease terms ranging from two to five years. SKL signed a three and a half year tenancy agreement with the trust upon transfer of the building. SKL is not allowed to terminate the tenancy agreement during the first year of the securitization transaction. If SKL terminates the tenancy agreement after the first year, it is required to give six months' notice so as not to forfeit its security deposit.

SKL set aside adequate reserves (sized in the engineering report by Jones Lang LaSalle) at closing to fully cover capital expenditure for the 12 months after closing.

Shin Kong Panchiao Building

The building is located in Panchiao City on the edge of a well developed commercial zone near the city's old railway station and about 500 meters away from the new Panchiao Station--the second largest railway station in Taiwan. Panchiao, with a population of 543,000, is the largest city and biggest transportation hub in Taipei County, and is home to Taipei's county government. Major government offices located in Panchiao include the Financial Supervisory Commission.

Built in 1990, the 12-story building has a land area of 291 pings, office space of 2,029 pings, and two basement levels with space for 24 cars. The building is currently fully occupied. SKL occupies 85% of the total floor space and is expected to contribute 83% of the total rental income. The remaining floor space is occupied by Shin Kong Securities Co. Ltd. and Taiwan Shin Kong Security Co., which are both affiliates of the Shin Kong group. SKL signed a two and a half year tenancy agreement with the trust upon transfer of the building, and is not allowed to move out during the first year of the agreement. If SKL terminates the tenancy agreement after the first year, it is required to give six months' notice so as not to forfeit its security deposit. The building is older than several other office buildings in the area, but is well maintained. Concerns over the expectation of some new supply of office buildings nearby are somewhat offset by Panchiao buildings' combination of convenience and value.

SKL set aside adequate reserves to fully cover capital expenditure for the 12 months after closing.

Shin Kong Cheng Der Building

Built in 1991, this building is located on Cheng Der Road in the mainly residential Shilin district of Taipei City. Office buildings in this district are spread out and supply is limited with total office space of about 10,000 pings, of which the Shihlin Electronic building accounts for 70% of total supply. The office space of most other buildings is less than 1,000 pings per building. Tenants located in the district include a scattering of listed electronics companies, as well as a diverse range of SMEs.

The well-maintained 10-story building has total office space of about 1,000 pings and two basement levels with space for 11 cars. The first floor has office space of about 66 pings and is a good location for retail activities. Other floors have office space of about 100 pings each, and generally attract local SMEs. The building has good access to bus links and the nearest subway station is about one kilometer away. SKL occupies 73% of the total floor space and is expected to contribute 68% of the total rental income. The vacancy rate is currently about 10%. In addition to SKL, Blockbuster Inc. runs a video retail outlet on the first floor and Yuanta Core Pacific Securities Co. Ltd. (National Scale Ratings twAA-/Stable/twA-1) occupies space on the fourth floor. SKL signed a three year tenancy agreement with the trust upon transfer of the building, and is not allowed to move out during the first year of the agreement. If SKL terminates the tenancy agreement after the first year, it is required to give six months' notice so as not to forfeit its security deposit.

SKL set aside adequate reserves to fully cover capital expenditure for the 12 months after closing.

Credit Evaluation

TRC's approach on class A and class B certificates is to assess the ability of the entrusted properties to generate sufficient cash flow (including proceeds from the liquidation of the properties) to meet the interest payments of the certificates and to repay the principal by the final legal maturity date.

A stabilized net cash flow is derived from the net operating income of the properties net of capital expenditures and Taiwan Ratings' estimated tenant turnover costs. Net operating income is produced based on a stabilized level of revenues and expenses of the properties, and considers the properties' performance relative to overall market performance, historical performance, and anticipated performance over the life of the transaction.

The property value underwritten by TRC is derived by applying an appropriate capitalization rate to the stabilized net cash flow. Several considerations are incorporated to determine the capitalization of the property, such as market competition and economic projections.

The repayment of the debt obligation on the class C certificates relies on the credit of IBT, which provides an unconditional guarantee to cover any shortfalls in interest payments on each distribution date and principal by the final legal maturity date of the notes.

Debt Sizing

The amount of debt rated at a particular rating level is determined by the appropriate LTV ratio and DSC threshold of the rating sought. Threshold rates for various rating categories reflect the characteristics of the properties and the REAT structure.

The DSC threshold in the debt-sizing process incorporates an assumed interest rate. The assumed interest rate takes into consideration the market interest rate trend in the local market along with a risk premium based on the characteristics of the property.

According to Taiwan Ratings' property evaluation approach, Shin Kong Song Jiang building is underwritten at NT$560.6 million, a 16% haircut on the average property value from the two appraisers; Shin Kong Cheng Der building is underwritten at $203.5 million, a 28% haircut; and Shin Kong Panchiao building is underwritten at $352 million, a 21% haircut.

The table below details the total debt issuance amount of class A and class B certificates and their respective LTV and DSC:

Structural Review

Property Manager

According to the transaction documents, the property manager, New Light International, entered into an agreement with the trust to maintain and repair the entrusted properties, and prepare a projection of annual capital expenditures on each anniversary of the transaction. The Shin Kong group set up the property manager in 2005 to handle real estate securitizations. The company was established by former employees of SKL and Shinkong Life Real Estate Service Co. (SKRE). New Light International currently manages five properties (including properties under SKL's second REAT and first REIT). The company is outsourcing the repair and maintenance of the Shin Kong Song Jiang, Cheng Der, and Panchiao buildings to SKRE, which was established in 1988 and currently has 105 buildings under management.

Insurance

Shinkong Insurance Co. Ltd. (Global Scale Ratings BBB+/Positive/--, National Scale Ratings twAA-/Positive) provided insurance covering fire, earthquake, typhoon, flood, explosion, loss of rental during reinstatement period, and third party liabilities. The insurance company's credit rating is adequate to support the transaction.

Disposal Of Property

The certificates have a scheduled maturity of five years and a legal final maturity of six and a half years. The property disposal process will commence one year before the expected maturity of the certificates or when a disposal event is triggered. The ask price for disposal will start at 90% of the average market value of the properties obtained from more than two appraisers. A maximum three rounds of bidding is permitted. If the properties fail to be disposed of after the third bid, a certificate holder meeting will be called to determine appropriate action.

In addition to the disposal of property before the expected maturity date, other events that would trigger the disposal of the properties include non-payment of interest due on class B certificates (even given that Class A certificates are still outstanding), the DSC ratio falling below 1.15x, and other events causing a material adverse impact on the most senior class of certificate holders. After making up the shortfall on payments to senior fees and expenses from other reserves, proceeds from the disposal of the properties will be used to redeem the most senior certificates in a sequential order.

When the SPT fails to pay interest due on the most senior certificates or fails to fully redeem the senior certificates by the final legal maturity date, the liquidation procedure will also adopt the bidding process as outlined above. Proceeds from liquidation will apply post-enforcement waterfall where the more senior certificates will be redeemed before the more junior certificates.

Reserves

The transaction set up 10 reserves. The interest, debt repayment, termination penalty, and liquidity reserves can be used to support waterfall payments, while the other reserves are for specific use only.

Capital expenditure: Capital expenditure is sized according to the engineering report prepared by Jones Lang LaSalle. An initial reserve of NT$15,500,000 was deposited at closing to cover expected capital expenditure for the first year of the transaction. The reserve will be replenished by an amount estimated by the property manager sufficient to cover capital expenditure for the subsequent 12 months, subject to a minimum amount of NT$2,350,000 yearly.

Expense retention: An amount of NT$5,600,000 was sized at closing to cover insurance premiums, land value tax, and property tax to be incurred during the first year of the transaction. The reserve will be replenished by an amount estimated by the property manager sufficient to cover the relevant expenses for the subsequent 12 months. Any amount in excess of the used up portion will be retained in the reserve and will not be netted against the amount to be replenished.

Insurance proceeds: The three buildings are covered by third party liability insurance and fire insurance, which indemnifies restoration costs and losses due to the interruption of rental receipts. Any proceeds from insurance claims will be deposited into this reserve and will be applied toward the restoration of the buildings. Notwithstanding, insurance proceeds will be distributed to the waterfall payments when: (1) the proceeds exceed 3% of the total issuance amount of NT$1.392 billion (excluding proceeds covering interruption of rental receipts); and (2) if the building cannot be restored within six months of the expected maturity of the certificates.

Interest reserve: A reserve of NT$9,394,088 was sized at closing and will be replenished to cover six months of interest payments on the outstanding senior certificates.

Security deposit: The security deposit from the tenants will be transferred to the trust upon completion of registration. The security deposit will be returned to the tenants in full or in part according to the tenancy agreement.

Debt repayment: Proceeds from the liquidation of the properties will be deposited into the debt repayment reserve and be applied to the payment of third party fees and expenses, and the principal and interest of the certificates.

Termination penalty:Penalty payments from tenants will be deposited into this termination penalty account and be applied to the payment of third party fees and expenses, and the principal and interest of the certificates.

Management fee: Management fees collected from the tenants will be credited to the management fee reserve. The reserve will be withdrawn to make payments for utilities and miscellaneous expenses of the building. The reserve will be replenished on each payment date to the total amount of management fees collected during the related collection period. If the reserve fails to cover the above expenses, the shortfall will be made up from the general account.

Liquidity reserve: A reserve of NT$25,500,000 was funded at closing and will be replenished up to the amount of either six months of rental payments of the largest tenant or six times the average monthly rental payment, whichever is larger. This reserve provides a buffer in the event that SKL and its affiliates (collectively the largest tenant) terminate the tenancy agreement.

Guaranty deposit: If the trustee fails to pay interest and principal on the class C certificates as scheduled, the guarantee bank, IBT, will deposit the shortfall into the guaranty deposit reserve to apply to the payment of the class C certificates.

The Originator

The originator is the largest tenant in the transaction and is expected to contribute 67% of total rental income. Founded in 1963, SKL is the third largest of 29 life insurance companies in Taiwan. The company has a strong business franchise and market position, with an 11% market share in terms of total premiums written in 2005. It is wholly owned by Shin Kong Financial Holding Co. Ltd. (Global Scale Ratings BBB/Stable/A-3, National Scale Ratings twAA-/Stable/twA-1) and accounted for 73% of the group's consolidated assets in 2005.

Guarantor On Class C Certificates

IBT provided a guarantee on the class C certificates to cover shortfall in interest and principal due. IBT is one of two industrial banks in Taiwan that are permitted to offer medium- and long-term corporate loans, as well as direct investment. It is a small financial institution with total assets of NT$107.7 billion at the end of 2005, or less than 0.5% of system-wide bank assets. Taiwan Ratings is of the opinion that the long-term "twA" rating on IBT is adequate to support the class C certificates.