June CRISIL Insight. NCDs are a win-win for realtors and investors
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1 June 214 CRISIL Insight NCDs are a win-win for realtors and investors
2 Analytical Contacts: Sudip Sural Senior Director CRISIL Ratings Manoj Damle Director CRISIL Ratings Amit Bhave Director CRISIL Ratings Swati Agarwal Team Leader CRISIL Ratings
3 Summary NCDs are a win-win for realtors and investors They have become a supplementary source to fulfil increasing funding needs Our report, In realty, debt will stay high yet funding won t stop, released this April, highlighted how the real estate sector continues to attract funding from banks, non-banks, private equity and real estate funds Driven by private equity and high net worth investors (HNI), issuances of non-convertible debentures have been on an upswing. CRISIL believes the need for higher yields and defined exit timelines for investors will drive NCD issuances, and is providing realtors a supplementary funding avenue in times of booking slowdown Also, structural features, which support repayment, are driving NCD issuances in the lower rating categories. And the presence of specialised investors indicates better ability to gauge risks Issuances have rocketed in the last two years NCD issuances from the real estate sector has increased from Rs. 1 billion in CY27 (refers to calendar year, January 1 to December 31) to Rs.66 billion in CY213 (Chart 1), and have surged specifically in the last two years. Chart 1: Real estate NCDs have taken off in the last two calendar years Rs. Bn CY27 CY28 CY29 CY21 CY211 CY212 CY213 Source: NSE /CRISIL estimates There are two reasons for this: ever-growing funding needs of developers, and high investor interest. Traditionally, developers have depended on banks to finance projects. But as fresh bookings slowed in the last two years, unsold inventories bloated, increasing the funding requirement of developers. CRISIL s analysis of the top 25 developers suggests almost the entire funding requirement for new construction has been met through fresh borrowings during To be sure, bank credit to the real estate sector has grown steadily to Rs.1428 billion in CY213 from Rs. 876 billion in CY29, but bankers have been increasingly selective when lending. Moreover, the Reserve Bank of India s advisory against some of the innovative funding structures like 8:2 has forced developers to look at alternatives. 3
4 Despite higher yields (Table 1), NCDs are becoming increasingly popular with developers because of the following reasons: The money can be utilised for purchase of land and general corporate purposes Repayments can be structured according to developer s cash flows Put & call options offer flexibility to both issuers and investors, the facility of early redemption makes refinancing easier when customer advances rise Table 1: Comparison between bank lending and NCDs in the lower rating category Bank lending NCD Rate of interest 13-17% (floating) 18-24%(fixed) Repayment Fixed repayment schedule Flexible repayment in line with cash flows Early Redemption Prepayment penalty Call/put option End use Cannot be used for land purchase Can be used for purchase of land and general corporate purposes NCD issuances in the AA and A categories also surged in the recent past because interest rates were lower compared with bank loans, and they diversify the funding source of developers. Drawing in private equity and the loaded gentry The main investors in NCDs are non-banking financial institutions, HNIs and real estate funds. Moreover, private equity investors are also shifting from preference shares/pure equity capital to NCDs given certain advantages. Investors have been chasing realty projects through the NCD route for 5 reasons: Yields at per cent are healthy, and in line with sector risk Real -- or inflation-adjusted -- returns elsewhere have been far lower NCDs offer predefined exit timelines compared with equity investment Typical tenures of 3-5 years align well with investment horizon Listed NCD s hence tradability of instruments affords flexibility CRISIL believes there are additional advantages such as the appreciating nature of real estate assets in India, the possibility of project-specific lending, and the ability to ring-fence cash flows of projects. 4
5 Increasing issuances in lower rating category players Issuances by developers with lower credit rating have been rising, driven by healthy returns offered by the sector. Total issuances in BB and below category increased to 2 in CY213 compared with negligible before CY212 (Table 2). Table 2: Number of NCD issuances in the real estate sector Rating category CY27 CY28 CY29 CY21 CY211 CY212 CY213 AA A BBB BB B and below Total issuances Increasing number of issuances Money raised through NCDs by lower-rated companies has been lower than those by investmentgrade firms due to smaller size issuances, (Chart 2), but issuances by them are rising. Real estate is the only sector where there is investor interest for companies with lower credit rating -- as reflected in issuances of Rs.43 billion in CY212 and Rs.12 billion in CY213 (Chart 3). Apart from real estate, microfinance lending is the other sector which raised funds in lower category, but the amount is very low. Chart 2: NCD issuances in real estate sector Rs. Bn CY27 CY28 CY29 CY21 CY211 CY212 CY213 Chart 3: NCD issuances rated BB and below Rs. Bn CY29 CY21 CY211 CY212 CY Rated BBB and above Rated BB and below Real Estate Across all sectors Source: NSE /CRISIL estimates Note: Chart 2: Emaar MGF Land Ltd raised Rs billion CY212; Chart 3: Sistema Shyam Teleservices Ltd raised Rs billion in CY211 CRISIL believes issuances will continue to be high over the near- to medium-term because of the slowdown in bookings and rising inventory levels of developers. 5
6 Key features of real-estate NCDs Investors are private equities, real estate funds, or NBFCs all of which have the expertise to assess projects and structure investments. The transactions are backed by a trustee-monitored framework that defines inflows and outflows and prioritises payments. A detailed business plan is finalised before disbursement, adherence to which remains a key monitorable for the investor. CRISIL believes such a high level of scrutiny allows the investor to have virtual control of the project, which helps in protecting his interest. Also, investors look for secured transactions in projects with good saleability, which typically lead to strong customer advances. The key considerations while evaluating a project are its location and amenities provided, existing sales record, expected customer advances, promoter experience and supply situation in the area. Some features of real-estate NCDs are: Cash flows are ring-fenced because lending is project-specific There was a surge in project-specific funding, which surpassed developer specific lending in CY212 and CY213 (Chart 4) because ring-fencing was easier. Under this, instead of identifying a developer, investors zero in on projects with a good location and saleability. More than 95 per cent of such transactions have been in metros and Tier I cities where saleability is strong in the long run, ensuring cash flows. Chart 4: Increasing project-specific NCD issuances Non project specific (No.) Project specific (No.) Source: NSE /CRISIL estimates Collateralised transactions NCD issuances in the real estate sector are secured through a charge on the asset being funded. They usually carry a security cover of 1.5 to 2.5 times depending on the developer s credit rating and negotiations with investors. Additional comfort is provided through personal and corporate guarantees from promoters. Moreover, the term sheets carry negative covenants such as disallowing any sale without the approval of the lender, barring promoter access to project cash flows sans lender consent, and ensuring the promoter has majority shareholding at all times. Structuring of the transactions Structuring the transaction helps in efficient monitoring of the project. The summary of the various features are given below: 6
7 Escrow accounts for routing all receivables for existing and new sales Priority of payments defined Debt service reserve account for principal and interest payment Any outflow to the promoters only after meeting the obligations of the project/investor Plan to be submitted for receivables, sales expectation and expenses Construction milestones and plans to be adhered to Minimum sales price restriction Trustee appointed to manage the accounts Project management consultant to oversee the progress of the project and coordination between issuer and debenture trustee CRISIL believes the role of the trustee and project management consultant will remain crucial to healthy functioning of the structure. The trustee appointed by the investor is responsible for all projectrelated collections and disbursements through a designated escrow account. It s also the consultant s remit to ensure progress of construction, sales and approvals as per the plans submitted by the NCD issuer, with deviations escalated to investors on an ongoing basis. Structured Obligation ( SO ) Rating CRISIL may provide Structured Obligation ( SO ) ratings based on a structured payment mechanism. Trustee monitored structure with well-defined waterfall mechanism is essential for providing a credit enhancement to the standalone rating of the company. This is because the structure enables ring fencing of project cash flows and prioritises debt servicing and construction. Further, additional features like shortfall undertaking from the parent in the form of guarantees or letter of comfort provide support to the structure. CRISIL s outlook on such transactions CRISIL believes such NCD issuances will remain high in the near- to medium-term because of the realtors requirement for funds. On the other hand, private equity investors and real estate funds will support such transactions driven by expectations of higher returns. Typically, the credit quality of real estate projects is on the weaker side due to the risks of implementation and demand. But CRISIL believes structuring can mitigate this, and provide an opportunity for credit enhancement. Generally, this helps in timely execution of projects because cash flows are separated and leakages thwarted. Needless to mention, it s the trustee s and the consultant s job to keep their eyes on the ball always. The operating profitability of real estate developers has been impacted by slowing demand, rising construction costs and higher rate of interest paid to investors, which is constraining their ability to service debt obligations. CRISIL therefore believes judicious use of NCDs is necessary to keep the funding cost under control. Prudent structuring of the instruments will allow early redemption or refinancing at lower cost should there be any improvement in flow of customer advances. 7
8 Some of the structures rated by CRISIL Project A: Residential real estate project Key terms Purpose: Land acquisition for township project Subordination: Existing bank debt for funding construction activities in the project. NCD to be subordinated to existing bank debt Tenor: No prepayment penalty after 4 years of tenor. Flexible repayment for principal within 1 year period Security: Charge by way of registered mortgage on the entire project and unsold stock and receivables of the project under issuer. Banks have charge on specific projects within the township, which they have funded. Prepayment: Put/call options at specific intervals Structural features Trustee-monitored structure: All the project receivables will be maintained in an escrow account monitored by the trustee. Tri-partied agreement with the company, bank, and investor for transfer of funds from existing accounts of the project to the escrow account. Any distributable surplus requires investor s approval for distribution. Sharing of business plan: Detailed quarter-on-quarter business plan to be submitted by the company. Minimum sales price and quantum of sales defined. Monitoring mechanism: Project Management Consultant to monitor the progress of the project. Also, project management agency to be involved in monitoring the disbursement of construction expenses based on checks for actual development in the project. Project B: Commercial real estate project (under-construction mall/office complex) Key terms Purpose: Construction finance and general corporate purpose Subordination: Existing financial institution debt for funding construction of an office complex Tenor: 12 years Security: Second mortgage on the assets Prepayment: Option to prepay at any time after 15 months of issuance Structural features Comfort from promoters: Overall credit quality of the issuance enhanced by high credit quality promoters. Shortfall undertaking signed for any deficit in the project Personal and corporate guarantee from promoters Sale of assets: Any sale of the project requires investor approval Monitoring of lease deals: Project leasing and timely completion of the project closely monitored by the investor 8
9 Project C: Commercial real estate project (operational mall/commercial complex) Key terms Purpose: General corporate purpose and refinancing of part LRD Interest repayment: Interest-only payment structure for the first 3 years with no cash trapping. Step-up in the interest rate ~.25 per cent in case call option is not exercised Principal repayment: 4 th year onwards principal amortisation will start happening with refinancing at the end of the 9 th year Tenor : 9 years Call option: At the end of 3 years Structural features Plans to lease vacant area: Plans for raising occupancy levels Capex plans: Prior approval from the investor before additional development or refurbishment plans Escrow monitoring: Inflows and outflows to be monitored by the project management consultant 9
10 About CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. About CRISIL Ratings CRISIL Ratings is India's leading rating agency. We pioneered the concept of credit rating in India in With a tradition of independence, analytical rigour and innovation, we have a leadership position. We have rated over 75, entities, by far the largest number in India. We are a full-service rating agency. We rate the entire range of debt instruments: bank loans, certificates of deposit, commercial paper, non-convertible debentures, bank hybrid capital instruments, asset-backed securities, mortgage-backed securities, perpetual bonds, and partial guarantees. CRISIL sets the standards in every aspect of the credit rating business. We have instituted several innovations in India including rating municipal bonds, partially guaranteed instruments and microfinance institutions. We pioneered a globally unique and affordable rating service for Small and Medium Enterprises (SMEs).This has significantly expanded the market for ratings and is improving SMEs' access to affordable finance. We have an active outreach programme with issuers, investors and regulators to maintain a high level of transparency regarding our rating criteria and to disseminate our analytical insights and knowledge. CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of McGraw Hill Financial you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit You can view McGraw Hill Financial s Customer Privacy Policy at Last updated: May, 213 Stay Connected Twitter LinkedIn YouTube Facebook CRISIL Limited CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai 476. India Phone: Fax:
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