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India’s First Commercial Mortgage Based Security (CMBS) on Offer by DLF

DLF has launched India’s first Commercial Mortgage Based Security (CMBS) by securitizing the lease rentals on two malls in Vasant Kunj in Delhi, DLF Emporio and DLF Promenade. DLF will receive Rs. 800 cr. for a period of 7.5 years, where interest is paid through rents received from tenants of the property.

How CMBS Works

The idea is that the mall owner (DLF) issues Non Convertible Debentures (NCDs) to investors and gets money immediately.

Then, to pay off the interest each month, it sends the lease rentals of a mall to a single escrow account, which first pays off the interest portion to the CMBS debenture investors.

At the end of the CMBS Period, DLF will pay off the principal. (As a “bullet repayment”)

Crisil has rated the debentures AA, and has the following diagram.


What happens in case of a shortfall or default?

Supposedly, this CMBS has a coverage ratio of 1.7 to 2 – meaning, the lease rentals will by 1.7x to 2x the required monthly interest payment. For example, if the interest rate on the debentures is 15% a year on Rs. 800 cr, then the interest payment per month is Rs. 10 cr. But the rentals will pay between 17 cr. and 20 cr. per month (in the two malls put together), according to Crisil.

If the lease rentals can’t cover interest for any reason (lack  of occupancy or default by renters), there is a “DSRA” (Debt Service Reserve Account) with three months of interest payments that will kick in.

There is a put-option provider who is supposed to pay back the principal+interest in case there is a longer default.

If the put provider doesn’t pay, the debenture holders can enforce the mortgage on the properties (that is, to sell the shops or the malls).

And beyond that, there’s also shares of DLF that are pledged, which can be sold.

Also there can be no further debt taken by using the properties as mortgage.

So it’s a multi level protection against default. Of course, if there is a major crisis, none of these will have value (the property may not be worth much) and DLF shares will be in the toilet.

Who’ll invest?

It will be institutions for the most part. Hedge Funds, Realty funds, PE funds and foreign investors, and possibly HNIs as well. I doubt retail can play a part.

Notes, Risks and Benefits

Malls have three sources of revenue:

  • Parking
  • Lease rentals
  • Revenue share with restaurants/shops

Only the lease rentals and revenue share has been pledged. Not the parking fees, or monthly maintenance fees, from what I can glean. Even the security deposit is not going to be held by the debenture holders. DLF benefits by continuing to have some revenue streams to themselves and get upfront cash of Rs. 800 cr.

We don’t know the costs of the debt yet (interest rate) but if it’s lower than what DLF is paying elsewhere, it can retire higher cost debt.

The lease rentals are pretty big in number, if we assume the CMBS requires Rs. 10 cr. per month as interest, on a presumed 15% interest on Rs. 800 cr. The malls add up to Rs. 800,000 sq. ft of space. With 75% occupancy I estimate that the malls needs to charge Rs. 160 a square foot per month to be able to service the interest. Currently the rates in these malls are upwards of Rs. 500 per sq. foot per month. (Source)

DLF also has to pay back no principal till the very end (7.5 years later) which helps with cash flow. (Bank loans require partial principal repayment too along with interest). Investors will then get interest on their full investment and have no reinvestment risk. Of course, DLF might default after 7.5 years on the principal, which is the major risk with balloon repayments.

The biggest benefit is to the ecosystem. By securitizing receivables, providing a liquidity backstop and providing collateral, the age of the CMBS is here. More real estate owners may go down this route and deepen the market, plus provide higher yield avenues for investments that are secured in multiple ways as above.

Of course we should avoid the problems that have existed elsewhere. Like, ensuring DLF has not taken other loans mortgaging the same property. Or it is not currently funding other loans with these very lease rentals. And that the papers are proper that DLF owns the property (this is a big pain in India, to verify ownership). Most importantly, that the properties don’t violate environmental or zoning laws, in which case the malls can be shut down and/or razed. (There is then very little recourse left for investors)

DLF Benefits but Profits Might Be Hit

DLF benefits from the deal, where they get an upfront Rs. 800 cr. in exchange for this debt.

However, their profits might still take a hit. My reading is that with the new debenture rules in the Companies Act, they will have to invest 15% of the amount to be repaid each year – in this case, 18% of Rs. 120 cr, or Rs. 18 cr. per year – into government securities. And, they will have to set aside Rs. 400 cr. as a debenture redemption reserve. That will hurt their profits!

(DLF reported a net profit of Rs. 729 cr. in 2012-13)

DLF’s share price has been falling in the last three weeks, and is down to Rs. 152 after being at Rs. 180 in early April. The damage is political it seems, with their alleged ties to the Congress party which might be routed in the ongoing elections.

The CMBS, although a good first step to derisk the company from banks and the banks from a large single borrower, might hurt the company’s financials because of the new debenture rules. But this opens the doors for other players to join.

  • DJ says:

    omg, I thought we had the idea that we should not be doing this kind of securitization stuff in India. Wasn’t the financial crisis caused by such instruments? Tauba Tauba. What happened to all the conservatism? Where is Subbarao when you need him. (sarcasm intended)
    On a more serious note, who regulates this stuff? Is it part of shadow financial system that is not regulated?

    • Hey there’s nothing wrong with the concept of securitization at all. The abuse was a marginal one, in the context of requiring ratings, in the context of layering multi-tranched CDOs, in the area of allowing people to write or buy CDS greater than the underlying securities issued. None of that exists in India. In the US, MBS is working well as is – in fact its the best way for banks (and now, the fed) to take exposure to housing.
      Regulation wise it’s all RBI. There is no “shadow” financial system as this is directly regulated…

      • DJ says:

        “On a more serious note…” implies that all that comes above is not serious, a petty jibe, at the luddites in our institutions.
        And, your take isn’t/wasn’t the consensus in RBI/finance ministry. Or else we would have a flourishing credit market in instruments like CDS, and much, much earlier. But, never mind… its probably out-dated criticism.
        It also reminds me of your criticism of exotics desks (as a whole) because they had securitized Madoff exposure when I was pointing out that the vehicles of synthetic securitization and exotics aren’t the problem per se. Now you point out almost something similar. Wah wah…
        Granted that you will say that its not something similar – one can make justified distinctions between marginal abuses, between a CDO and rating mess vs regular CMBS. Agreed.
        But, the point nonetheless was about the change in “common perception” about vehicles like CDOs and recognizing the useful part of these things. For example:
        By the way, a firstpost article says that its not a CMBS but Lease Renewal Discounting. I want to say something sarcastic about that, but I’ll refrain. 😀

        • Heh – gotcha 🙂
          I don’t know if I was ever against MBS (Have always thought spreading the risk is right, but not that ratings should allow a tranche to have a lower risk weight – essentially a rating should be irrelevant). But then much of my views have evolved in the last few years.
          Securitizing the Madoff exposure bit: You refer to this no? I was sarcastic in that entire post 🙂 But even there I wasn’t blaming the exotic instruments – the only thing that mattered was the fiduciary responsibility of JPM.
          And like you said I would say: This CMBS is not really synthetic no? It’s just a simple MBS, versus some of that mad stuff done then. Like a CDO of a pool of lower rated tranches of many MBSes. But then we both agree!
          Also agree that without the luddites we would have had a much better market of this earlier. I’m all for it and am all for standardization as well. Current rules are way too restrictive (only certain entities can write cds, etc).

  • maulik says:

    How exactly it will be different from lease renewal discounting which backs offer?

  • FB says:

    As Deepak says, in LRD (Lease Rental Discounting), both the principal and interest have to be serviced akin to the EMI on your home loan. In a CMBS, there is a bullet payment of principal. As such, for the same rentals, a larger amount can be raised in a CMBS vs a LRD.