CMBS Issuances Provide Issuers Access to Non-traditional Investors

India Ratings and Research (Ind-Ra) says that Indian CMBS transactions are different in structure than those executed globally. Given the unique circumstances in which non-convertible debentures backed by property rental income have arrived in India, market participants have many questions on the key rating considerations and the nature of corporate entities that could take benefit of this product. Ind-Ra has strived to answer these questions in its report.

Ind-Ra believes an entity to issue CMBS debt should ideally be a special purpose vehicle, having no risks and businesses other than maintenance of the rental assets, whose cash flows are being securitised. The entity must be ring-fenced from general balance sheet risks of the promoter group. The low number of such special purpose vehicles and high stamp duty cost of asset transfer/assignment limit the number of future CMBS issuers.

 

The agency says that the key reasons for the higher credit ratings of CMBS issuances than those of lease rental discounting (LRD) loans are better ring-fencing of securitised cash flows and assets and stronger security packages. CMBS issuances also have a legal tail with the option to sell the assets for the redemption of outstanding bonds. These issuances also benefit from lower financial leverage and are generally more resistant to revenue drops or other stresses than corresponding LRDs.

CMBS structures also provide for a dynamic response to revenue deterioration in the form of cash trap mechanisms. The agency however estimates that the cash flow back to the issuer in CMBS issuances is usually 2x to 3x that in LRD loans.

The agency further says that for its analysis of CMBS issuance, it considers the asset quality and the stability of rental income. It also gives importance to the quality of tenants, lease tenors and the lock-in periods of leases covering substantial part of the transaction tenor. The agency however does not consider the rental growth rate, unless rental growth is coming from highly rated tenants having lock-in periods beyond the transaction tenor. The agency takes into the account only stabilised income from a property, and does not consider other income from revenue sharing in retail malls, fit-out income and interest income from inter-company debts due to their unpredictable nature.

Ind-Ra believes that appropriate consideration/provisioning for management fees, leasing costs and maintenance expenses are important for the long-term sustainability of healthy rental income.

The agency believes that amortising CMBS structures are less risky than others, due to the lower bullet amounts to be refinanced on the scheduled maturity dates. The agency puts a lot of emphasis on refinance risk and legal tail period. The legal tail period provides for security enforcement and sale of underlying assets to redeem outstanding bonds, in case an issuer fails to refinance the bullet amount. The length of legal tail period should depend upon the security package and the enforcement mechanism provided in the transaction.

CMBS issuances, though a handful so far, have fulfilled the need of both issuers and investors. They have allowed issuers to access non-traditional investors such as mutual funds and insurance companies while also allowing these investors to access high-quality investments within the real estate sector. However, significant growth of these offerings will be contingent on easier stamp duty provisions and ease of creation of issuing entity within the Indian regulatory and legal framework.

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