Debt Backed By Lease Rental Discounting (LRD) - Rating Methodology

A. Background

Infomerics has been rating the exposure under lease rental discounting (LRD) with rating methodologies for Structured Debt transactions (other than securitization). With increasing prevalence of this product, a need was felt for formulating separate methodology for rating exposure of Lease Rent Discounting.

The following note highlights the key factors considered by Infomerics while assessing the credit risk for lease rental discounting (LRD) loans and details Infomerics’ approach to analyzing quantitative and qualitative risk characteristics that are likely to affect rating outcomes.


B. Rating Methodology

Loan Characteristics

LRD loan is a term loan availed against the existing/expected rentals from a commercial (office space) or a retail (mall / shops) property. The loan is availed by the Issuer/lessor, based on the discounted value of future rentals and the underlying property value. Generally, entities convert the construction loan availed at the time of project development into LRD loans, post the completion of construction, tying up of lease agreements and commencement of rentals. This often helps in reducing the interest cost as lenders view LRD loans as a safer exposure compared to project loans because of the relatively superior predictability of rental cash flows. On most occasions, the lender has the first right over the rentals through an appropriate escrow mechanism with defined cash flow waterfall mechanism. While in some cases the LRD loans are used purely to substitute the high cost construction loans, most often the real estate entities leverage their commercial or retail assets to raise funds in excess of the construction loans to meet their growth capital requirements. These surplus funds are typically used for the repayment of other high cost term loans, to fund construction of other commercial or retail properties and other general corporate purposes.

As the inflows, mainly the rent receivable (parking charges, cafeteria charges, maintenance charges etc. being the other revenue sources), as well as the outflows - mainly debt servicing, taxes and operating and maintenance (O&M) expenses, are fixed in nature, the rating analysis is focused on the adequacy of the inflows to meet the outflows as well as the sustenance of revenue-generating capacity of the said property.

While evaluating entities with multiple LRD loans, each loan is assessed separately along with the cumulative impact of all the LRD loans on the company’s credit risk profile.

Apart from the above, there are instances wherein cash inflows of an issuer are escrowed to the lender. In such instances, if the cash inflow and the cover as proportion of outflows are stable over the medium term, the rating of such issuers can also be governed by the criteria set in this document.

For analytical convenience, the key factors may be grouped under four broad heads – Industry Risk, Business Risk, Financial Risk and Management Risk.


Industry Risk Analysis

  • Demand-Supply Outlook for renting


Business Risk Analysis

  • Property Location, Operating Track Record and Quality
  • Occupancy and Rent Rates
  • Salient Features of the Lease Agreements, including lock in clauses, tenure of lease, rent escalations etc.
  • Tenant Profile and Counter Party Credit Risk
  • Probability of the tenant continuing as lessee even after nearby completion of the lease period.
  • Escrow terms and waterfall structure


Financial Risk Analysis

  • Cash Flow Adequacy and Liquidity Analysis
  • Financial Discipline, Ring Fencing of Cash Flows and Payment Structure
  • Leverage and Financial Flexibility
  • Refinancing Risk
  • Continuation of lease beyond nearest lease period
  • Cash flow stress testing


Management Risk Analysis

  • Track record and experience of promoters in developing/operating similar properties
  • Size of property vis-à-vis other properties under same management vs management bandwidth
  • Group strength
  • Promoter/management’s risk-taking ability and ability to manage refinancing risks


Infomerics’ credit ratings are a symbolic representation of its opinion on the relative credit risk associated with the instrument being rated. This opinion is arrived at following a detailed evaluation of the entity’s business and financial risks, its competitive strengths, the likely cash flows over the life of the instrument being rated, and the adequacy of such cash flows vis-à-vis the debt-servicing obligations. The LRD loans are characterized by relatively superior predictability of underlying rental cash flows, limited operating expenses and ring-fencing of cash flows through maintenance of escrow accounts. The rating analysis is focused on the sustenance of revenue-generating capacity of the underlying property and its adequacy to meet the committed debt-servicing obligations.

Approved in the BM dated 31st May 2022.