PROJECT REPORT ON

Financing of Lease Rentals

at Reserve Bank of India, New Delhi

Under the guidance of

Mr. M. Pulla Rao, GM, Department of Banking Supervision (DBS), RBI, Delhi Mr. A.K.Sinha, AGM, Department of Banking Supervision (DBS), RBI, Delhi

Submitted by: Mahendra Kumar Rathi , PGDM (09DM060), BIMTECH (2009-2011)

CERTIFICATE

This is to certify that Mahendra Kumar Rathi of Birla Institute Of Management Technology (BIMTECH), Greater Noida has successfully completed his Summer Internship project titled A report on Financing of Lease Rentals at Reserve Bank of India, New Delhi. It is his original work and fit for evaluation in partial fulfilment for the requirement of PGDM Programme.

Mr. M. Pulla Rao GM, DBS

Mr. A.K.Sinha. AGM, DBS

ACKNOWLEDGEMENT

I take this opportunity to express my deep sense of gratitude to all those who have contributed significantly by sharing their knowledge and experience in the completion of this project work. I convey my sincere thanks to my project guide Mr.A.K.Sinha, (AGM, DBS) for his invaluable suggestions and guidance without which the completion of my project would have been a remote possibility. I would also take this opportunity to especially thank Mr. M. Pulla Rao (GM, DBS) and Mrs.M Vedavali (DGM, DBS) for her invaluable guidance and assistance under the overall supervision Shri G. Sreekumar (GM, DBS). Also, I would like to extend thanks to people from various banks (BANK A, BANK B, BANK C, and BANK D) that spared time to respond to the questionnaire and for sharing with me their knowledge and experience in the field of LRD. I convey my sincere thanks to my faculty guide Prof. Ravi Agarwal, Associate Professor BIMTECH, for guiding me and showing me the right path by his valuable suggestions all throughout my journey of this project. I am highly grateful to him for his support. I owe enormous intellectual debt towards my teacher and mentor Prof. Ashok Malhotra whose suggestions and guidance was invaluable and helped me throughout my project. Finally, I would also like to thank all my dear friends and colleagues for their kind cooperation, advice and encouragement during the long and arduous task of preparing this report and carrying out the project.

Date: 07-06-10 Place: Greater Noida Mahendra Kumar Rathi

Table of Contents
CERTIFICATE ............................................................................................................................................. 2 ACKNOWLEDGEMENT ............................................................................................................................ 3 Executive Summary ...................................................................................................................................... 7 CHAPTER-1Research Design................................................................................................................... 9 Research Design...................................................................................................................................... 10 Statement of problem: ......................................................................................................................... 10 Objectives: .............................................................................................................................................. 10 Scope of the study: .............................................................................................................................. 10 Tools for data collection: .................................................................................................................... 11 Sampling design: ................................................................................................................................. 11 Limitations .............................................................................................................................................. 11 Research Methodology ....................................................................................................................... 11 CHAPTER-2 About DBS ....................................................................................................................... 12 About the Department ................................................................................................................................. 13 Department of Banking Supervision ....................................................................................................... 13 Core Functions .................................................................................................................................... 13 Supervisory Process ............................................................................................................................ 13 Supervisory Strategy ........................................................................................................................... 14 CHAPTER-3Lease Rental Discounting (LRD) .......................................................................................... 15 Lease Rental Discounting (Loan against Future Rent Receivables /Loan against Rental Income) ........ 16 Features: .............................................................................................................................................. 16 ELIGIBILITY ..................................................................................................................................... 17 Security: .............................................................................................................................................. 17 PROPERTY DOCUMENTS: ............................................................................................................. 17 Lease Rent: Process ............................................................................................................................ 18 SANCTION AND DISBURSEMENT: .............................................................................................. 19 Current Situation ................................................................................................................................. 19 CHAPTER-4 Leasing .............................................................................................................................. 21 Background ............................................................................................................................................. 22 Types of Lease Agreements: ............................................................................................................... 22 Lease Financing ...................................................................................................................................... 27 Meaning of Lease Financing ............................................................................................................... 27 Importance of Lease Financing ........................................................................................................... 27

Lease Evaluation Lessees angle.......................................................................................................... 27 Lease evaluation leasers angle ................................................................................................................ 30 CHAPTER-5 Commercial Real Estate (CRE) ........................................................................................ 31 Commercial Real Estate .......................................................................................................................... 32 COMMERCIAL REAL ESTATES PRICE FACTORS ..................................................................... 32 Indian real estate market ..................................................................................................................... 33 Growth in other sectors supporting real estate ........................................................................................ 34 IT/ITES and other businesses ............................................................................................................. 34 Organised retail ................................................................................................................................... 34 Hotels and logistics ............................................................................................................................. 34 Commercial office space ..................................................................................................................... 35 Key risks and concerns ....................................................................................................................... 35 Guidelines on Commercial Real Estate (CRE) Exposure ........................................................................... 37 Definition of CRE Exposure ................................................................................................................... 37 The approach followed by RBI ............................................................................................................... 37 Loans extended against the security of future rent receivables ............................................................... 38 Rate of provisioning................................................................................................................................ 38 Prudential Guidelines on Capital Adequacy and Market Discipline ...................................................... 39 Assessment of lease related risks ................................................................................................................ 39 Credit Risk .............................................................................................................................................. 39 Interest Rate Risk .................................................................................................................................... 44 Liquidity Risk ......................................................................................................................................... 45 Transaction Risk ..................................................................................................................................... 45 Compliance Risk ..................................................................................................................................... 46 Risk Management System....................................................................................................................... 46 CHAPTER-6 Securitisation .................................................................................................................... 48 Securitisation............................................................................................................................................... 49 Meaning of securitisation:....................................................................................................................... 49 Securitisation of receivables: .................................................................................................................. 50 Relevance of securitisation in some infrastructure sectors ..................................................................... 50 Power .................................................................................................................................................. 50 Roads................................................................................................................................................... 51 Ports .................................................................................................................................................... 51 Urban Infrastructure ............................................................................................................................ 51

Future receivables: .................................................................................................................................. 51 Export Receivables: ............................................................................................................................ 52 Credit card receivables: ....................................................................................................................... 52 Airline ticket receivables: ................................................................................................................... 52 Future oil sales: ................................................................................................................................... 52 Lease rentals: ...................................................................................................................................... 53 Securitisable Assets : .............................................................................................................................. 53 Mortgage-backed ................................................................................................................................ 53 Retail Loan Pools ................................................................................................................................ 53 How securitization work: ........................................................................................................................ 54 Current Scenario ..................................................................................................................................... 54 Section II ..................................................................................................................................................... 57 CHAPTER-7 Analytical Hierarchy Process (AHP) ................................................................................ 57 Analytical Hierarchy Process (AHP) .......................................................................................................... 58 LRD Factors for Approval of Loan....................................................................................................... 58 Objective: ................................................................................................................................................ 58 Problem Identification: ........................................................................................................................... 58 Objectives behind Problem Selection: .................................................................................................... 58 Analytical Hierarchy Process (AHP): ..................................................................................................... 58 Using Analytical Hierarchy Process: .................................................................................................. 59 Model the problem as a hierarchy ....................................................................................................... 60 Hierarchies defined ............................................................................................................................. 60 AHP hierarchies explained.................................................................................................................. 61 A simple AHP hierarchy ..................................................................................................................... 62 Establish priorities .............................................................................................................................. 62 Identification and Ranking of Factors:.................................................................................................... 65 Data collection and tabulation: ............................................................................................................... 67 Results ..................................................................................................................................................... 67 Conclusion .............................................................................................................................................. 69 Results Summary: ................................................................................................................................... 70 CHAPTER-8 Findings and Conclusion................................................................................................... 71 Findings and recommendations .................................................................................................................. 72 References ................................................................................................................................................... 75 Annexure:.................................................................................................................................................... 76

Executive Summary
Globalisation has fuelled the need for greater liquidity and granularity of investments in the real estate market. Securitisation transformation of firm specific assets and prospects into marketable securities has become an important part of financial intermediation, giving banks an opportunity to expand their services and boost lending. In recent years, securitisation the transformation of firm-specific assets and earning prospects into marketable securities has become an important part of financial intermediation. On the one hand, this has been perceived as threat to commercial banking, as it allows firms and individuals direct access to the markets for liquidity, instead of going to banks. On the other hand, securitisation is also an opportunity for commercial banks to provide new services thereby increasing lending. Banks have always been the chief financiers of the real estate industry. Today, they have a lot of instruments that make the financing of the real estate industry easy. Securitising real estate is one of the emerging methodologies. Under this is the securitisation of future rent receivables, called Lease Rental Discounting (LRD), Construction of residential and commercial spaces is a largely unorganised market in India and the developer cannot raise the money from the market through equity. He would need to take a loan from the market or banks. The developer repays the loan in installments. The money for these installments comes from the rents the developer receives or from the proceeds from the sale of these properties. In case he leases out the property, he receives rent on a monthly basis for long periods. Once a developer invests in a project, his money stays locked in it and he cannot raise fresh debt from the market. In such situations, it becomes almost impossible for him to pursue other projects, resulting in a major loss of opportunity. This is where LRD comes to the rescue. The developer pledges his future rentals to a bank that disburses a loan. The bank discounts all the future rents depending on the lock-in periods, the profile of the tenant and other factors. The developer becomes the `lessor' and the tenant the `lessee'. The bank takes into consideration growth prospects, road infrastructure, law and order, water and power supply, medical facilities and presence of industries in the city. While evaluating the real estate in question, banks look at accessibility of the building, aesthetics, surroundings and other such characteristics of the building.

This project report commences with the Introduction to LRD (Lease Rental Discounting). The purpose of this report is to first identify about the product. It will be followed by the understanding of Leasing, Securitisation, and Commercial Real Estate. The second phase includes the study of the factors for which approval authority is more concerned while evaluating project. The methodology adopted during this project covered primary data collection and analysis of secondary data also. The primary data was collected by visiting four banks. A questionnaire was prepared, centring towards LRD practices followed in the Indian banking industry in accordance with the RBI issued guidelines. Using the primary and secondary data, as stated above, an exploratory research was undertaken. Finally a model is proposed using the present value.

CHAPTER-1

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6 Research Design

Research Design
Statement of problem:

Lease Rental Discounting has become a preferred route of refinancing for developers with revenue generating assets in commercial and retail segments. Many large developers like DLF and Pheonix Mills have raised debt in the nature of lease rental discounting in recent times. The trend has gathered momentum in the retail segment as the developers now desist from outright sale of quality space, which provides them with better leverage over a period. LRD contribute 2% -3% to banks loan and advance portfolio. Normally LRD comes under real estate sector and real estate sector is cyclical in nature. As stated above, this product becomes a preferred route for financing so there are various risks and uncertainty are attached with this product As this product is introduced recently, so to gain background information this project was assigned by Reserve Bank of India to analyse various facets of LRD in Indian banking context Hence, the study entitled Financing of Lease Rentals has been undertaken.

Objectives: The objectives of this report are: To study the whole concept of Lease Rental Discounting, its methods and needs of LRD. To study the lending process and make a critical review of the loan facilities sanctioned by commercial banking. To study the various risks faced by banks and the risk management process that are pertinent to the commercial banking sector for LRD. To study credit sanction process. To study the guidelines commended by the Reserve Bank of India to commercial banks for management of risks. To study the extent of implementation of these guidelines in these banks.

Scope of the study:

The current study covers 4 banks, viz. Bank A, Bank B, Bank C and Bank D. The identity of the banks cannot be revealed as per directions by RBI.

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Tools for data collection:

The study required both primary and secondary data. Primary data was collected with the help of questionnaires, in depth interview schedules and observation. Secondary data has been collected through Published reports, Circulars and Bulletins.

Sampling design:

The judgement sampling method has been used to collect the data. Four banks have been undertaken in this study.

Limitations This Study is limited to only commercial banks. NBFCs and other financial institutions are not included in this study. In exploratory research, we try to identify background information and clarify problems with the help of questionnaire, in depth interview and observation which are qualitative in nature so answers to questions may differ from person to person. Small sample size.

Research Methodology

The present study is of analyticalal and exploratory nature. Accordingly the use is made of secondary as well as primary data. The secondary data is collected mainly through various newspapers, magazines, Internet and RBI review reports. To supplement the secondary data, some primary data has also been used which is collected through interviews and personal visits to the various companies to know the present situation of the market.

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CHAPTER-2

10 About DBS
11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

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About Department
Department of Banking Supervision
The Reserve Bank of India has been entrusted with the responsibility of supervising the Indian banking system under various provisions of the Banking Regulation Act, 1949 and RBI Act, 1934. As regards commercial banks and FIs, this responsibility is discharged through the Department of Banking Supervision (DBS), which supervises 92 commercial banks and 9 select financial institutions (FIs), through its 16 Regional Offices.
Core Functions

The Department of Banking Supervision at present exercises the supervisory role relating to commercial banks and select FIs in the following forms: a. Undertaking scheduled and special on-site inspections of banks, their off-site surveillance as also post inspection follow-up of compliance. b. Serving as the secretariat for the Board for Financial Supervision (BFS). c. Determining the criteria for the appointment of statutory auditors and special auditors and assessing audit performance and disclosure standards. d. Dealing with financial sector frauds and attending to the complaints received against the banks and FIs from public, banks, Government, etc. e. Exercising supervisory intervention in the implementation of regulations which includes recommendation for removal of managerial and other persons, suspension of business, amalgamation, merger/winding up, issuance of directives and imposition of penalties. In 2004, the work relating to inspection of Authorised Dealers has also been transferred from the Foreign Exchange Department to this Department.
Supervisory Process

A high powered Board for Financial Supervision (BFS), comprising the Governor of RBI as Chairman, one Deputy Governor as Vice Chairman, other Deputy Governors and four Directors of the Central Board of RBI as Members was constituted in November 1994 with the mandate to exercise the powers of supervision and inspection in relation to the banking companies, financial institutions and non-banking financial companies. Presently, BFS exercises supervision not only over banks but also over select Developmental Finance Institutions (DFIs), Non-banking Financial Companies (NBFCs), Primary Dealers (PDs) and Urban Cooperative Banks (UCBs).

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Supervisory Strategy

The Department of Banking Supervision has formulated and put in place a supervisory strategy which, besides retaining the importance of on-site inspections which has been the main plank of banking supervision, also focuses on three other areas:

off-site monitoring through introduction of a set of Returns; strengthening of the internal control systems in banks and Increased use of external auditors in banking supervision.

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26 CHAPTER-3 27

Lease Rental Discounting (LRD)

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Lease Rental Discounting (Loan against Future Rent Receivables /Loan against Rental Income)
Lease Rent Discount is a method to obtain finance from bank or other lending institutions. Lease Rent Discount (LRD) consideration is between the borrower who owns the premises, the tenant who has rented the said premises or taken on lease and the bank or financial institute or Corporate. The rent is considered as fixed income over a stipulated time i.e. Lease or rent period or tenure. These receivables can be clubbed and discounted at attractive rates. The product is aimed at providing Term Loan to owners of commercial or residential properties who have let them out to reputed companies Commercial, Industrial, Software, Multinational Companies), Banks, Financial- Institutions, Insurance Companies etc. on lease basis thus having fixed rent receivables. The agreement is between the borrower and lender and the major term of repayment of rent is directly deposited with the lender and not with the borrower. The borrower is sanctioned a loan based upon the rent to be collected over the period of lease. The property owners/borrower can then utilize these funds for any purpose including meeting business and personal needs for generating further assets, which can yield higher returns for themselves. Further, the funds could also be deployed for expansion of their business activities. This will give a source to accelerate the rotation of their funds. Lease rental discounting offers immediate liquidity, against commercial property, to lessor's/ property owners who have leased out their properties.

Features:

The loan is secured in nature. Only those who own a clear and marketable property can avail this loan. Loan is long term in nature ,usually ranges between 7 to 15 years depending on the use of property.( Commercial or residential) Interest rates are low when compared to unsecured loan. Funds can be used for any personal or business purpose. Best suited for people looking for debt consolidation and business expansion Quantum of loan is high depending on the value of future rent. It increases the future borrowing capacity along with property appreciation. This will give a source to accelerate the rotation of their funds. The underlying tenanted property, which may be commercial property or quasi commercial property will be taken as collateral. Rent receipts are payable by the tenant directly to an escrow account with the lender.

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ELIGIBILITY

Property owners having their properties situated in metro, urban, semi-urban and rural areas who have let out such properties to Public Sector Undertakings/Govt./Semi/State Govt. and reputed corporate, Banks, Financial Institutions, Insurance Companies, Multinational Companies, reputed private schools/colleges (approved by/affiliated to State Board/University/AICTE/any other Govt. body) and reputed private hospitals/nursing homes and franchisee/dealers/distributors of reputed corporates may avail finance against future lease rentals for meeting business/personal needs. Information evaluated in the product offering includes: Due diligence on lessor be ensured while carrying out credit appraisal by verifying the information provided by the prospective borrowers from: The original documents, Spot verification, Personal visits and obtaining market reports about the borrower/co-borrower besides ensuring that the applicants fulfill all the eligibility criteria and that their name does not appear in CIBIL/ECGC/RBI/ other banks/financial companies defaulters list, and Ensuring that the borrowers do not have any outstanding statutory liabilities like income tax, sales tax, wealth tax, service tax, PF, ESI, etc. Lessee details Lessor details Deal structure and Cash flow pattern envisaged in the agreement(s)

Security:

Assignment of Lease Rentals. Assignment of LIP, NSC etc., if found necessary. Equitable mortgage of the leased property or any other immovable property. In case of Company, personal guarantee of promoter Director(s).

PROPERTY DOCUMENTS:

The borrower and/or the guarantors have to provide the following documents to the banks or the lending institutions while submitting the Lease Rent Discount Loan Application. Certain documents may be demanded by the bank or the lending institutions in post sanction phase or on periodical basis.

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Address Proof : Latest Electricity/Telephone Bill or Receipt of Maintenance Charges or Valid Passport or Voters Identity Card or Purchase/Lease Deed/ Leave and License Agreement of Residence or Office Premises. Identity Proof : Valid Passport, PAN Card, Voters Card, a other photo identification issued by Government Agencies. Business Proof : VAT/CST Registration No. or MIDC Agreement or SSI Permanent Registration Certificate or Warehouse Receipts or Shop & Establishment Act Certificate or Copy of Lease Agreement along with the latest Rent paid Receipt. Business Profile on Companys Letterhead. Partnership deed in case of partnership firms. Certificate of incorporation, Date of Commencement of Business and Memorandum of Title Deeds, Form 32, Addition or Deletion of Directors in case of companies. Last three years Trading, Profit & Loss A/c. and Balance Sheets (duly signed by a Chartered Accountant wherever applicable). Last one years Bank statement of the Firm/company. If existing loan, then sanctioning letter and repayment schedule of the same. Firm/Companys PAN Cards. Individual Income Tax Returns of the Individual/Partners/Directors for last three years. Last one years Bank statement of Individuals, Partners, Directors. SEBI formalities in case of listed companies. Share Holding pattern of Directors duly certified by a Chartered Accountant. List of the Existing Directors of the company from the Registrar of the Companies. Written and approved confirmation of having no legal suit filed against any of the directors. If any such legal suit or proceedings are pending then the details of such legal suit or proceeding. Original Lease Agreement / Sub-Lease Agreement. Original Registration Receipt of Lease Agreement /Sub-Lease Agreement, if available. Original Sale Deed in the name of the Owner in respect of the property leased. Original Registration Receipt for Registration of the Sale Deed. Copy of Latest Property Tax / Electricity Bill payment receipt.

Lease Rent: Process

Personal interview /discussions are held with the customers by the banks officials. Bank's Field Investigation team visits the business place/work place of the applicant. All the documents submitted are verified by the bank with the originals so as to ensure the authenticity of the same. Bank verifies the track record of the applicant with the common information sharing bureau (CIBIL).

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In case of fresh projects, the bank analyses the background of the applicant/firm/company and the Technical feasibility/financial viability of the project based on various parameters and also the existing market conditions. Depending on the size of the project, the file is put up for sanction to the appropriate level of authority.

SANCTION AND DISBURSEMENT:

On approval/sanction, the sanction letter is issued specifying the terms and conditions for the disbursement of the loan. The acceptance to the terms of sanction is taken From the applicant. The processing charges as specified by the bank have to be paid to proceed further with the disbursement procedure. The documentation procedure takes place viz. Legal opinion of various property documents and also the valuation reports.(Original Documents to title of the immovable assets are offered) All the necessary documents as specified by the legal dept., according to the terms of sanction of the loan of the bank are executed. Disbursement of the loan takes place after the Legal Dept. Certifies the Correctness of execution documents.

Current Situation Portfolio

Bank A B C D Total Advances LRD 154,702.99 4,176.98 84,332.00 2,276.96 32,780.00 842.45 220.00 2.42

160,000.00

140,000.00 120,000.00 100,000.00 80,000.00

60,000.00 Total Advances

LRD

40,000.00 20,000.00 0.00 A B C D

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Non-individual advances refer to loans like loans against property, builder loans and lease rental discounting etc. Their number has gone up quite high in the books of HFCs since the past three years which has raised a question regarding the asset quality, said CARE Managing Director and CEO D R Dogra. "This is an alarming trend as such loans tend to turn bad compared to those given to individuals. Individuals, who borrow to buy their own houses are less likely to default compared to nonindividuals," Dogra stated. The proportion of non-individual loans increased from 23-24 per cent at the end of FY '07 to around 29 per cent at the end of FY '09. The gross NPA levels of HFCs stood close to one per cent and net NPA level was around 0.5 per cent in the nine months ended December 2009, Dogra said. "Financial year 2009-10 was a double whammy for HFCs with competitive pressures mounting towards reduction in lending rates and at the same time banks with lower borrowing cost enjoying the edge to their benefit," Dogra said. Also, the interest margin of HFCs is likely to improve with the rise in lending rates in the period ahead, he said. There are several businesses which have obtained high cost funds like unsecured business loans and leveraged themselves to a greater extent, thereby putting pressure on higher interest cost and lower profit margins. LAP perfectly fits for such businesses to reduce their borrowing cost and consolidate debt at lower cost. The other advantage is the tenor for LAP loan is generally in the range of 7 to 15 years, thereby giving the borrower to plan business expansion, among other things. This allows the best use of the property that is owned and at the same time will enable the raising of funds required for various purposes. Also, a loan against property comes with a low interest rate compared to that of a personal loan or home loan.

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28 CHAPTER-4 29

30 Leasing

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Background
A lease is an agreement allowing one party to use anothers property, plant, or equipment for a stated period of time in exchange for consideration. Leases have become more prevalent as businesses and consumers look for alternatives to finance the acquisition of fixed assets. A lease agreement involves at least two parties) a lessor , who owns the property, and a lessee, who uses the property. The lessor, essentially a creditor in the transaction, is repaid from a combination of lease or rental payments, tax benefits, and proceeds from the sale or re-lease of the property at the end of the lease term. Although leasing is often thought of as a modern day financing technique, indications are that leasing transactions took place around 2000 B.C., when Sumerian farmers leased tools from temple priests. The basics of leasing have changed little since that time. Over the years, the strength of the leasing industry has been its resiliency and its ability to make the most of the changing business environment. Leasing is the most widely used method of personal property financing in the United States today. For lessors, leasing is another competitive product that can satisfy the needs of bank customers; leases may be safer than other bank products because the transactions are secured; and leases are generally more profitable than commercial loans because of advantages inherent in their structure, such as tax benefits. Leasing is a way for lessees (customers) to conserve capital because, in effect, they obtain 100 percent financing. Depending on the structure of the lease, the risks of ownership (such as the possibility that the product will become obsolete) can be transferred to the lessor. Tax benefits could also be transferred to a lessor, resulting in lower lease payments to the lessee. Operating leases are off-balance-sheet, which may improve certain of the lessees key financial ratios. A special type of transaction, the sale-leaseback, allows the owner of a piece of property (usually real estate) to raise funds while retaining use of the property. In such a transaction (actually two separate transactions) the owner of the property sells the property and immediately leases it back. There is no physical transfer of the property. From a safety and soundness perspective, leases that result from sale-leaseback transactions should be reviewed in essentially the same manner as other leases.
Types of Lease Agreements:

Leases can be classified: a) Finance and Operating lease b) Sale and lease back and Direct lease c) Single investor lease and Leveraged lease d) Domestic lease and International Lease

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Financial Lease

The International Accounting Standard No. 17 has defined a finance lease as: A lease that transfers substantially all the risks and rewards incidental to the ownership of an asset. Title may or may not eventually be transferred This kind of lease is non-cancelable or is cancelable at significant cost so that the contract aims to eventually transfer title to the lessee, if the contract contains a bargain purchase option or if the term of the lease covers 75% of the economic life or if the discounted sum of the minimum lease rental payments add up to at least 90% of the total cost of the asset, one might argue that in substance the lease is basically a financing arrangement by which the user (the lessee) in effect gets the owner (the lessor) to finance the acquisition of an asset. Features: Long-term, non-cancellable lease contracts are known as financial leases The essential point of financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost. Under this lease, the lessor recovers 90% of the fair value of the asset as lease rentals and the lease period is 75% of the economic life of the asset. The lease agreement is irrevocable Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor Financial lease is also known as capital lease In India, financial leases are very popular with high-cost and high technology equipment In such leases, the lessor is only a financier and is usually not interested in the assets It is for this reason that such leases are also called as full payout leases Types of assets included under such lease are ships, aircrafts, railway wagons, lands, buildings, heavy machinery, diesel generating sets and so on.

Operating leases

The International Accounting Standard No. 17 has defined an operating lease as: an operating lease is one which is not a finance lease This kind of lease involves the right to cancel when the lessee desires with no significant economic penalties attached to the cancellation, or if the lease is for a fixed period after which the lessor walks off with the asset, then it makes sense to think of the lease contract as a simple

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rental: the cost of use is charged to the period of use as an expense in the lessees books. The lessor treats the rental payment as lease revenue and offsets the lease revenue with depreciation and other costs (taxes etc.) associated with ownership. Maintenance costs associated with the asset are charged to expense in the books of the person who is contractually responsible for asset maintenance. Features: This lease agreement gives to the lessee only a limited right to use the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period. The lessor provides services attached to the leased asset, such as maintenance, repair and technical advice. For this reason, operating lease is also called service lease. The lease rentals include a cost for the services provided. The lessor does not depend upon a single lessee for recovery of his cost. Normally the lease is for a short period and even otherwise is revocable at a short notice. Mines, Computers hardware, trucks and automobiles are found suitable for operating lease because the rate of obsolescence is very high in this kind of assets.

Sale & Leaseback

In this kind of lease the owner of an asset sells the asset to a party (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals however, under this arrangement, the assets are not physically exchanged but it all happens in records only. Features: This is nothing but a paper transaction. Sale and lease back transaction is suitable for those assets, which are not subjected to depreciation but appreciation, say land. The advantage of this method is that the lessee can satisfy himself completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement. Under this transaction, the seller assumes the role of a lessee and the buyer assumes the role of a lessor. The seller gets the agreed selling price and the buyer gets the lease rentals It is possible to structure the sale at agreed value (below or above the fair market price) and to adjust difference in the lease rentals. The effect of profit/loss on sale of assets can be deferred.

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A classic example of this type of lease is the sale and lease back of safe deposit vaults by banks under which banks sell them in their custody to a leasing company at a market price substantially higher than the book value, the leasing company in turn offers these lockers on a long-term basis to the bank, the bank sub-leases the lockers to its customers.

Leveraged Leases

A leveraged lease is a specialized form of direct financing lease that involves at least three parties: a lessee, a long-term creditor (the debt participant), and a lessor (the equity participant). This type of lease transaction is complex because of its size, the number of parties involved, legal demands, and the unique advantages to all parties. Because of the legal expenses and administrative costs involved, leveraged leasing usually finances only large capital property projects. The structure of leveraged leases allows them to be tailored to best meet the tax needs of the parties involved. In a leveraged lease, the lessor that purchases the property provides only a percentage (usually 20 to 40 percent) of the capital needed. After obtaining this substantial leverage in the transaction, the lessor takes out a nonrecourse loan for the balance of the purchase price from long-term lenders (the debt participants). That borrowing is secured by a first lien on the property, assignment of the lease, and assignment of the lease rental payments. The lessor, as the owner, is able to take accelerated depreciation and to claim any available investment tax credit based on the total cost of the property. The lessor also retains the residual value rights to the property at the end of the lease period. Under this arrangement, the lessee has use of the property at a lower cost in exchange for leaving the tax benefits with the lessor. This tradeoff ideally produces an attractive rate of return for the lessor and financing for the lessee at a cost below the lessees normal borrowing rate. When the purchase price of the property is large, a leveraged lease may involve several lessors and debt participants. In such cases, an owner trustee generally holds title to the property and represents the lessors. Or an indenture trustee may hold the mortgage on the property on behalf of the debt participants. Because of the complexity of leveraged leases, they should be offered only by banks with appropriate expertise. Examiners should determine whether the personnel who structure and administer leases are qualified in that area and have a working knowledge of applicable tax laws and regulations. If collateral entails credit risk, a securitization will often be structured with some sort of credit enhancement. This may include over-collateralization, a third party guarantee, or other enhancements. Also, by their nature, securitizations diversify the default risk of the underlying assets.

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Credit ratings are often obtained for those securitizations that entail credit risk, and most ratings are investment grade. If a securitization has different classes of bonds, each may receive a different credit rating. Credit ratings can be misleading for novices. The fact that a securitization has an AAA rating doesn't mean it is risk free. It only means that the chance of a bond holder incurring a loss attributable to default on the underlying assets is remote. Other risks, which can affect the timing of payments, may be considerable. Also, because valuing the underlying assets is often difficult, there is a risk that an investor will overpay for a securitization the investor is ill-equipped to value on its own. Standard categories of securitizations are Mortgage-backed securities (MBS), which are backed by mortgages; Asset-backed securities (ABS), which are mostly backed by consumer debt; Collateralized debt obligations (CDO), which are mostly backed by corporate bonds or other corporate debt. Each segment of the market offers unique opportunities and risks, reflecting the nature of the underlying assets and market conventions that have evolved over time.
Domestic Lease and International Lease

Domestic Lease: - All the parties to the lease transaction namely equipment supplier, lessor and the lessee are domiciled in the same country International Lease: Import Lease: The lessor and the lessee are domiciled in the same country but the equipment supplier is located in a different country Cross-Border Lease:

The lessor and the lessee are domiciled in different countries. The domicile of the supplier is immaterial
Sub-lease

A transaction in which the lease property is re-leased by the original lessee to a third party and the lease agreement between the two original parties remains the same.
Secondary Lease

A second lease period during which the lessee will pay nominal peppercorn rentals in order to ensure that the lease period is long enough for the lessee to gain maximum benefit from the lease.

26

Lease Financing
Lease financing is based on the observation made by Donald B. Grant: Why own a cow when the milk is so cheap? All you really need is milk and not the cow!
Meaning of Lease Financing

A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer conveys to the equipment user the right to use the equipment in return for a rental. In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals).
Importance of Lease Financing

Leasing industry plays an important role in the economic development of a country by providing money incentives to lessee. The lessee does not have to pay the cost of asset at the time of signing the contract of leases. Leasing contracts are more flexible so lessees can structure the leasing contracts according to their needs for finance. The lessee can also pass on the risk of obsolescence to the lessor by acquiring those appliances, which have high technological obsolescence.

Lease Evaluation Lessees angle

Lease evaluation depends on these factors: Financial Non- Financial Factors Simple documentation Expeditious sanction Post sanction reporting Flexibility Financial Position/Experience of Lessor

27

Weingartners Model

Leasing and buying as two ways of investing in an asset Evaluate lease as an Investment alternative Lease if NPV(L) > NPV(B) > 0 Buy if NPV (B) > NPV (L) > 0 Discount Rate Marginal Cost of Capital K = D/(D+E) x kD(1-T) + E/(D+E) x kE NPV (B) = - Initial Investment + PV of EBDIT x (1-T) + PV (Tax Shield of Depreciation) + PV of Net salvage Value NPV (L) = -PV of Lease Rental + PV of EBDIT x (1-T) + PV (tax Shield on Lease Rentals) Manage The decision to invest has already been made Asset will be debt financed Lease is a substitute to debt Discount rate = Marginal Cost of Debt Net value of lease = Initial Investment - PV (Tax Shield of Depreciation) - PV of Net salvage Value - PV of Lease Rental + PV (tax Shield on Lease Rentals) Management Fee + PV (Tax Shield on Management Fee) PV (Interest tax shield on displaced debt

28

 Amount borrowed = PV of Lease payment management Fee + PV (Tax Shield on Management Fee) NAL = NPL NPV = Initial Investment - PV (Tax Shield of Depreciation) - PV of Net salvage Value - PV of Lease Rental + PV (tax Shield on Lease Rentals) Management Fee + PV (Tax Shield on Management Fee)

Equivalent Loan Model

The decision to invest has already been made Asset will be debt financed Lease is a substitute to debt Discount rate = Marginal Cost of Debt Net value of lease = Initial Investment - PV (Tax Shield of Depreciation) - PV of Net salvage Value - PV of Lease Rental + PV (tax Shield on Lease Rentals) Management Fee + PV (Tax Shield on Management Fee) PV (Interest tax shield on displaced debt Amount borrowed = PV of Lease payment
Bower-Her ringer-Williamson (BHW)

Cash Flow Stream Financing & Operating FAL = PV of Loan Payment P.V. of Lease Payments OAL = PV of Lease Related tax Shield PV of loan related tax shields PV of Residual Value If FAL+OAL > 0 -Lease If FAL + OAL < 0 - Borrow and Buy Discount Rate PV of Lease Payment pre-tax marginal cost of debt OAL post tax marginal cost of capital Amount Borrowed = Cost of Asset

29

Bower Model

COP = Initial Investment - PV (Tax Shield of Depreciation) - PV of Net salvage Value COL = PV of Lease Rental - PV (tax Shield on Lease Rentals) + PV (Tax Shield on Interest) Decision: COL<COP Lease COL > COP Buy Discount Rate Tax Shields - unspecified rates Net salvage value marginal cost of capital Lease Rental pre-tax cost of debt Amount borrowed = Cost of Asset

Lease evaluation leasers angle

Break even rental for the leaser

Its the minimum lease rental which the lessor can accept NAL= 0 Here PV of the leasers cash flow stream is zero and the lease rental is an unknown variable. Discount rate = k1 = ke x E/ D+E + kd (1-T) x D/D+E Where k1 marginal cost of the funds, ke marginal cost of equity, kd marginal cost of debt D:E target debt equity ratio of the lessor.
Negotiating lease rentals

It helps in defining the range in which the rental can be negotiated. The break even rental of the lessor defines the lower limit of this range which is B1. It defines the upper limit if the range which is LB. the difference between the LB and LB1 is defined as the spread between the break even rentals of the lessor and lease. As long as the rentals remain within the range LB and LB1, both will enjoy a positive net advantage of leasing.
Internal rate of return of a lease

It is the lease investment where the rate of interest at which the NAL is zero. The lease investment is accepted if and only if the IRR exceeds the marginal cost of capital. Required IRR is the risk adjusted rate of return required by the leaser. I= If +Ie + Id Here I =risk adjusted rate of return .

30

31 CHAPTER-5 32

Commercial Real Estate (CRE)

31

Commercial Real Estate

Commercial real estate is any dealing with real property in the business context. This could include the leasing of office space, selling real property as part, or all, of the sale of a business or owning an apartment complex. It could even include industrial or agricultural property, or even residential property wherein the property involves rental homes or apartments being held as business investments. India is the 4th largest economy in the world, and has the 2nd highest GDP among the developing countries based on purchasing power parity. IT and IT enabled services sector in India is still in its growing stage due to increasing demand for business processing units in India and is estimated to grow by 107% to $583 million in revenue. Taking this factor into consideration, the total value of real estate created by the IT and ITES sector in the next three years will be Rs.132000.This could lead to a space requirement of 20-25 million sq. ft. per annum, According to a Merrill Lynch report.
COMMERCIAL REAL ESTATES PRICE FACTORS

Regional prosperity, the most important factor that influences the price of the commercial real estate is the prosperity of the region where the property is located. And, the level of prosperity is determined by the grade of the commercial district located, management level, traffic volume, consumption structures and level. Traffic and Transportation condition : During the appraisal for commercial real estate, there are two sides to be considered: 1) customer side, one need to consider if public transportation passes the property being evaluated, the number of routes that does pass through, the time interval of the buses and the population inside the public transportation network. Also, parking spaces needs to be considered. 2) Proprietor side, one needs to consider the conveniences for trucks up and off loads. Proximity to the main street: Generally speaking, the property should be as close to the street as possible. If there are various sides of the property that is exposed to the main street then it is advantageous for the property to increase its price. Internal Layout: Commercial properties internal layout should be designed to favor the arrangement of shelves and counters; also it should encourage customer stay. Usually, large commercial properties need to be divided for lease. Therefore, the layout needs to be flexible enough to be divided. Storey of Building: The unit that is located on the lower floors or ground floor usually is more advantageous; however, if theres escalator then the disadvantage of the higher floors can be diminished. Area: The property should have suitable area and size that operation demands. Height: The room height of a commercial real estate should be suitable and adequate. If the height is too low then it creates discomfort and pressure which is not beneficial for operating the business. But, if the height is too high then the construction cost will increase and not favorable for increasing the real estates price.

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Storage space Interior decoration and construction framework: Interior decoration has a big portion of a commercial real estates value; and, a same house can have a different price with different styles of interior decoration. In addition, the value of the property can also be affected by the material used for the construction frame work. Possibility to Sublease: The agreements between land lord and tenant sometimes do not allow tenants to sublease the unit or property and this regulation affects the flexibility of commercial properties investment, hence affecting the properties value. Inter-changeability of different type of retail format. Ownership distribution: There are cases where there are multiple owners for the property and sometimes it is not possible to unify the atmosphere of the plaza or mall; hence, long vacancies will affect the propertys appraised value. Availability of central air condition and the level of management fee.

Indian real estate market

The Indian Real Estate market has shown remarkable growth in past few years and this sector has become one of the most lucrative sectors to invest in. It has matured and has become more regularised as the policy makers realise the importance of this sector for the development of the country. A brief about the industry The Indian Real Estate Industry is currently estimated to be US$ 48 billion, with a CAGR of 30 % Total economic value estimated to be US$ 40-45 billion accounting for 4 to 5 % of the GDP Growth driven primarily by IT/ITeS, growing presence of foreign businesses in India, the globalization of Indian corporate and, the rapidly increasing consumer class providing a huge market potential The real estate sector is in an early growth stage, can be segmented into residential, commercial, retail and hospitality asset classes Demand-supply gap across all segments for quality real estate The Indian economy has grown at 11% CAGR in the past five years and is expected to deliver 8%+ real growth going forward. India is the tenth largest economy in the world and fourth largest based on purchasing power parity. Also, India is the second fastest growing economy, well poised to become the third largest economy in the world by 50 (source: PwC). This lends strong base for a robust growth in the real estate market.

33

Growth in other sectors supporting real estate

IT/ITES and other businesses

The IT/ITES sector grew at a phenomenal pace in the past decade, significantly impacting office real estate in India. The sector comprises ~75-80% of the current commercial demand. Bangalore is the traditional hub for IT/ITES space in India. In the South, Hyderabad, Pune and Chennai are developing as key centres of commercial development. In the North, Delhi, Noida and Gurgaon are the preferred destinations. As regards the West, Mumbai is grappling with upcoming demand that is pushing up the prices in commercial business districts (CBDs) and peripheral areas.
Organised retail

At present, Indias retail market is ~US$270bn and growing ~7-9% and annuall estimate for the retail market to be US$600bn by FY17E. And, given that retail is globally the largest industry at ~US$7.2trn, we expect significant action in the space as is evident by the fact that many international retailers and brands are entering the Indian retail market.

In next three years, ~220 malls are expected to come up in India, including specialised malls catering to automobiles, jewellery, furniture and electronics. Further, many upcoming malls would offer hotel and amusement facilities.
Hotels and logistics

The growth in tourism and business travel, and the emergence of low cost airlines have led to increased demand for hotel rooms. As a result, there is a shortage of quality hotel rooms across

34

all major cities. Occupancy rates are at an all-time high, with luxury hotels in Mumbai, New Delhi and Bangalore quoting room rates higher than the average room rate (ARR) in the US.
Commercial office space

Growth Drivers Growth in IT/ITES sector at 30 % annually (source: NASSCOM) Significant growth in FDI

Market Structure Dominated by a few large national developers with pan-India presence Regional players are expanding to achieve a Pan-India presence Shift in the type of operations from Sale Model to lease & maintain model

Segmentation Commercial Space can be classified broadly into Grade A and B Business activity shifting from CBD to SBD and from Tier I to Tier II & III

Outlook Commercial market expected to grow at CAGR of 20 % to 22 % over the next five years IT/ITeS sector expected to require in excess of 250 million sq. ft of commercial office space by 2012-13

Key risks and concerns

A. Overheating market On the macroeconomic front, inflation has risen sharply from 3.9 % in April 2006 to 9 % in April 2010. On the real estate front, persistent demand-supply gap has led to spiralling property prices Capital values have risen by more than 100 % in all key markets Oversupply expected in few product classes IT SEZs, Luxury end residential

B. Absence of REITs REITs are a significant source of capital and liquidity for real estate industry globally Absence of REITs in India has restricted retail investor participation and limited capital flows C. Regulatory issues ULCRA is yet to be repealed in some key states, such as Maharashtra, Karnataka and West Bengal

35

 Stamp duty rates are still high in many states resulting in high transaction costs The real estate rental trends in commercial sector are momentous as the key tendency among the investors is to rent a commercial space instead of buying. It will facilitate low risk and less worry on maintenance. Commercial rentals including corporate office space, BPO spaces, mall space, shops and showrooms are an integral part of the commercial rentals in India. Buying good space in high quality development and leasing it to a good brand is a wise investment decision. Usually, commercial lease agreements specify a 15% escalation in the real estate rental in every three years which is a good enough yield. For those considering regular rental returns rather than capital appreciation, mall space has the distinction to be an excellent option. It gives returns higher than that received with office space and much higher than the rental returns from residential space. Deployment of Gross Bank Credit by Major Sectors

In the above table, total loans for real estate sector as on 26 February, 2010 was Rs. 91607 cr.

36

Guidelines on Commercial Real Estate (CRE) Exposure

Definition of CRE Exposure
Real Estate is generally defined as an immovable asset- land (earth space) and the permanently attached improvements to it. Income-producing real estate (IPRE) has been defined in para 226 of the Basel-II Framework, which is reproduced below: "Income-producing real estate (IPRE) refers to a method of providing funding to real estate (such as, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, and hotels) where the prospects for repayment and recovery on the exposure depend primarily on the cash flows generated by the asset. The primary source of these cash flows would generally be lease or rental payments or the sale of the asset. The borrower may be, but is not required to be, an SPE (Special Purpose Entity), an operating company focused on real estate construction or holdings, or an operating company with sources of revenue other than real estate. The distinguishing characteristic of IPRE versus other corporate exposures that are collateralised by real estate is the strong positive correlation between the prospects for repayment of the exposure and the prospects for recovery in the event of default, with both depending primarily on the cash flows generated by a property". From the definition of IPRE given above it may be seen that for an exposure to be classified as IPRE/CRE, the essential feature would be that the funding will result in the creation / acquisition of real estate (such as, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, and hotels) where the prospects for repayment would depend primarily on the cash flows generated by the asset. Additionally, the prospect of recovery in the event of default would also depend primarily on the cash flows generated from such funded asset which is taken as security, as would generally be the case. The primary source of cash flow (i.e. more than 50% of cash flows) for both repayment and recovery would generally be lease or rental payments or the sale of the assets.

The approach followed by RBI

The approach followed is closely aligned to Basel II definition and Commercial Real Estate exposure would accordingly be defined as at above. It follows that if the repayment primarily depends on other factors such as operating profit from business operations, quality of goods and services, tourist arrivals etc., the exposure would not be counted as Commercial Real Estate. CRE exposures to the extent secured by Commercial Real Estate would attract a risk weight of 100 percent. In cases where a part of the CRE exposure is not covered by the security of commercial real estate, that part would attract a risk weight for CRE exposure or as warranted by the external rating of the borrower, whichever is higher.

37

Loans extended against the security of future rent receivables

A few banks have formulated schemes where the owners of existing real estate such as shopping malls, office premises, etc. have been offered finance to be repaid out of the rentals generated by these properties. Even though such exposures do not result in funding/acquisition of commercial real estate, the repayment might be sensitive to fall in real estate rentals and as such generally such exposures should be classified as CRE. However, if there are certain in built safety conditions which have the effect of delinking the repayments from real estate price volatility like, the lease rental agreement between the lessor and lessee has a lock in period which is not shorter than the tenor of loan and there is no clause which allows a downward revision in the rentals during the period covered by the loan banks can classify such exposures as non CRE. Banks may, however, record a reasoned note in all such cases. The RBI is of the view that the banks should be able to determine whether an exposure is CRE or not. Accordingly, banks should record a reasoned note justifying the classification, it further says. According to the apex bank, it is possible that an exposure could have multiple classifications, such as CRE, infrastructure lending and capital market exposure. In such cases, the exposure should be reported under all relevant classifications, with a footnote to avoid double counting. Such cases would attract all regulatory concessions and limits, if any, as applicable to the classifications, the RBI further clarifies. The RBI has clarified that if repayment depends primarily on factors such as operating profit from business operations, quality of goods and services, tourist arrivals et al, then they would not be classified as commercial real estate exposure.

Rate of provisioning

38

Prudential Guidelines on Capital Adequacy and Market Discipline

Banks are required to maintain a minimum Capital to Risk-weighted Assets ratio (CRAR) of 9 percent on an ongoing basis. Claims secured by commercial real estate is defined as above will attract a risk weight of 100 per cent

Assessment of lease related risks

Management should have a system that identifies, measures, monitors, and controls the banks risk exposure. For LRD loan there are various risks which are mentioned below but pricing , cost escalation , adverse and geological condition are more prominent. The examiner seeks to understand and evaluate the banks credit policies or practices and portfolio administration.

Credit Risk
Credit risk is the risk to earnings or capital arising from an obligors failure to meet the terms of any contract with the bank or otherwise to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance. It arises any time bank funds are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether reflected on or off the balance sheet. In assessing credit risk, the examiner must realize that the rental payments on a lease carry substantially the same risk as payments on a secured loan. Leases should be reviewed. Ownership of the underlying property is an additional consideration in evaluating a lease transaction. If the lessee defaults, the bank, as owner, usually can recover the property expeditiously. Before entering into a lease, a bank must reasonably expect to realize the return on its full investment in the leased property, and the estimated cost of financing the property over the lease term, from a combination of rental payments, estimated tax benefits, and estimated residual value of the property when the lease term expires. For each lease, the examiner should review the risks affecting collectability from each of these three sources by ensuring that the bank has established the creditworthiness of the lessee, has considered potential changes in tax benefits, and has periodically assessed the value of the leased property. For assessing credit risk and credit worthiness banks are using financial statement, net worth and credit rating.

39

Column1 CREDIT RISK RATING MODEL INDUSTRY/ SECTOR PARAMETERS A. HISTORICAL RISK

Column2

Column3

Column4

LOW
1. CONCENTRATION 2. THREATS OF OBSOLESCENCE 3. SUNRISE/ OLD ECONOMY/ SUNSET INDUSTRY 4. INFRASTRUCTURAL CONSTRAINTS 5. OWNERSHIP PATTERN (MORE THAN 50% UNITS) 6. MANAGEMENT (> 50% UNITS) 7. INDUSTRIAL RELATIONS 4 4 4 4 Widely held 3 Professional 3 Good 3

MEDIUM
3 3 3 4 Closely held 2 Entrepreneur 2 Fairly Good 2

HEAVY
-1 -1 -1 0 Family held 2 Family run 2 Poor 0

SUB-TOTAL (MAX SCORE) B. POITICAL/ REGULATORY RISK

25

favorable 1. SECTOR-SPECIFIC MACRO ECONOMIC FACTORS 2. ENVIRONMENT PROTECTION COMPLIANCES 3. TARIFF/NON-TARIFF/EXCISE/TAXES/DUTY BARRIERS 4. PUBLIC SECTOR/ SMALL SECTOR/ POLICY BIAS 5. ACCESS TO CAPITAL MARKETS (PREFERENCE FOR LISTED COMPANIES, NON-LSITED TO HAVE LOWER OR ZERO SCORE) 5 fully compliant 5 low regulation 5 Low bias 5 easy access 5

partially favorable 3 partially compliant 3 medium regulation 3 medium bias 3 somewhat difficult 3

unfavorable 0 non-compliant -5 heavy regulation 0 heavy bias 0 cannot access 0

SUB-TOTAL (MAX SCORE) C. FINANCIAL RISK

25

HIGH 1. CONTRIBUTION TO ECONOMY/GDP 2. STABILITY (PRODUCTION/ DISTRIBUTION/ RECOVERY CYCLE) 3. CYCLICITY 1

MEDIUM 0.5

LOW 0

2 0

1 1

0 2

40

4. VOLATILITY 5. FINANCIAL RATIOS

> 15% I) RETURN ON EQUITY II) DEBT SERVICE COVERAGE RATIO III) TOTAL DEBT TO TANGIBLE NETWORTH RATIO IV) OPERATING PROFIT TO NET SALES V) RETURN ON ASSETS VI) DIVIDENDS PAY OUT RATIO 6. CAPACITY UTILIZATION ETC. >90% I) TOTAL CAPACITY UTILIZATION II) EXCESS CAPACITY (VIS--VIS DEMAND) III) CAPACITY SHORTFALL (VIS--VIS DEMAND) IV) NO. OF UNITS WHOSE ACCOUNTS ARE NPAs V) NO. OF LOSS MAKING UNITS 1 < 10% 1 > 25% 1 < 10% 1 < 10% 1 < 10% VI) NO. OF CLOSED UNITS 1 2 >2 2 < 1.5 2 > 20% 2 > 15% 2 > 50% 2

10 TO15% 1 1 TO 2 1 1.5 TO 2 1 15 TO 20% 1 10% TO 15% 1 40 TO 50% 0.5

< 10% 0 <1 0 >2 0 < 15% 0 < 10% 0 < 40% -1

75 TO 90% 0.5 10 TO25% 0.5 1- TO 25% 0.5 10 TO 20% 0.75 10 TO 20% 0.75 10 TO 20% 0.75

< 75% 0 > 25% -1 < 10% 0 > 20% -1 > 20% -1 > 20% -1

SUB-TOTAL (MAX SCORE) D. STRATEGIC RISK

25

> 10% 1. INVESTMENT IN TECHNOLOGICAL UPGRADATION & R&D AS PERCENTAGE TO TOTAL INVESTMENT 2. COMPETITIVE THREATS I) GLOBAL THREATS II) INDUSTRY COMPETITORS III) NEW ENTRANTS/ ENTRY BARRIERS IV) BARGAINING POWER OF SUPPLIERS V) THREAT OF SUBSTITUTES vi) FUTURE POTENTIAL 5 LOW 3 3 3 3 3 GOOD 5

5 TO 10% 3 MEDIUM 2 2 2 2 2 FAIRLY GOOD 3

< 5% 0 HIGH 0 0 0 0 0 POOR 0

SUB-TOTAL (MAX SCORE) TOTAL SCORE

25 100

41

WEIGHT

40%

BORROWER SPECIFIC PARAMETERS A. OWNERSHIP AND MANAGEMENT RISK

WIDELY HELD 1. OWNERSHIP 2. MANAGEMENT 3. TURNOVER OF KEY TECHNICAL/ MANAGERIAL PERSONNEL 4. IF PART OF BUSINESS GROUP, OVERALL DEALINGS OF GROUP WITH BANK IN EVENT ITEM 4 DOESNOT APPLY TO A BORROWER, ONLY FIRST 3 PARAMETERS SHOULD BE CONSIDERED WITH SCORES OF 4/4/2, 3/2/1 AND 1/1/0 REPECTIVELY FOR A1, A2, A3 3 PROFESSIONAL 3 LOW 2 GOOD 2 CLOSELY HELD 2 ENTREPRENEURIAL 2 MEDIUM 1 SATISFACTORY 1 FAMILY HELD 1 FAMILY RUN 1 HIGH 0 POOR 0

SUB-TOTAL (MAX SCORE) B. OPERATIONAL RISK

10

LOW 1. INPUT/ RAW MATERIALS SOURCING RISK 3

FAIRLY HIGH 2

VERY HIGH 0

2. PRODUCTION RISK (LABOUR/IR, POWER & FUEL, ISO CERTIFICATION, OTHER QUALITY CONTROL NORMS, ENVIRONMENT PROTECTION NORMS, LOCATION ETC.) 3. DISTRIBUTION RISK (MARKETING CHANNELS(DIRECT/DEALERSHIP) MARKET SEGMENTATION (LOCAL/NATIONAL/GLOBAL) MARKET DEMAND, MARKET RESEARCH ETC.) 4. SALES/ COLLECTIONS RISK (MARKET SEGMENT, BILLING/INVOICING SYSTEM/ CREDIT PERIOD, RECEIVABLES MANAGEMENT, PRICING/ TRACK RECORD OF CUSTOMERS) 5. TECHNOLOGY RISK (THREAT OF OBSOLESCENCE, TECHNOLOGICAL UPGRADATION, TECHNICAL SKILLS/ QUALIFIED MANPOWER, TRAINING AND DEVELOPMENT) 6. STRATEGIC RISK ( WHETHER MAJOR INDUSTRY/ SECTOR PLAYER (MARKET SHARE), INDUSTRY/SECTOR COMPETITION, THREAT OF SUBSTITUTES, PRICING ADVANTAGE ETC.)

SUB-TOTAL (MAX SCORE) C. FINANCIAL RISK

18

42

> 1.33 1. CURRENT RATIO 2. NWC/ CURRENT ASSETS 3. TOTAL DEBT/ TNE RATIO 4. OPERATING PROFIT TO SALES 5. RETURN ON TOTAL ASSETS 6. RETURN ON EQUITY 3 > 25% 3 1.5 OR LOWER 3 > 20% 3 > 10% 3 > 15% 3

1.17 TO 1.33 2 20-25% 2 1.5 TO 2 2 15% TO 20% 2 5 TO 10% 2 10 TO 15% 2

< 1.17 1 < 20% 1 ABOVE 2 1 BELOW 15% 1 < 5% 1 < 10% 1

SUB-TOTAL (MAX SCORE) D. TRANSACTION/ COMPLIANCES RISK

18

IN ORDER 1. DOCUMENTATION AND ENFORCEABILITY OF SECURITY 4 FULLY COMPLICANT 2. COMPLIANCES WITH TERMS OF SANCTION 4 WITHIN 30 DAYS OF DUE DATE 3. REVIEWS AND RENEWALS 4. REPAYMENT RECORD (EXAMINE ACCOUNT WISE POSITION) 5. RELATIONSHIP AND VALUE OF ACCOUNT (SHARE OF BANKING BUSINESS, ACCOUNT WISE POSITION FOR LAST FINANCIAL YEAR AND LAST 6 MONTHS) 3 REGULAR 4 GOOD 3

NOT IN ORDER BUT CAN BE RECTIFIED 2

OUT OF ORDER -4 NON COMPLICANT -4

PARTLY COMPLIANT 2 WITHIN 30 TO 45 DAYS OF DUE DATE 2 PARTLY REGULAR 2 FAIRLY GOOD 2

AFTER 45 DAYS 0 IRREGULAR -4 POOR 0

SUB-TOTAL (MAX SCORE) E. SECURITY COVER

18

> 150% 18 (VALUE DECLARED IN LATEST STOCK STATEMENT/ DEBTORS VIS--VIS OUTSTANDINGS ON DATES OF SUCH STATEMENTS) (IN RESPECT OF IMMOVABLE PROPERTY/ COLLATERAL SECURITY, VALUE AS LAST ACCEPTED BY BANK)

100 TO 150% 10

< 100% 0

SUB-TOTAL (MAX SCORE) F. DEFAULT RISK

18

43

(CHECK WHETHER BORROWER IS IN RBI'S DEFAULTER'S LIST OR WHETHER NPA WITH ANY OTHER BANK UPWARD 1. MIGRATION IN CREDIT RATING SINCE LAST REVIEW STANDARD 2. WHETHER NPA NOT NPA 3. WHETHER UPGRADED/ DOWNGRADED IN NPA IN LAST ONE YEAR REGULAR 4. CONDUCT OF ACCOUNTS (SINCE LAST RENEWAL) 4 4 PARTLY REGULAR 2 5 UPGRADED 3 IRREGULAR -5 5 SUB-STANDARD/ DOUBTFUL 0 NO CHANGE 3 LOSS 0 DOWNGRADED -5 DOWNWARD 0

SUB-TOTAL (MAX SCORE) TOTAL SCORE WEIGHT

18 100 60%

Interest Rate Risk

Interest rate risk is the risk to earnings or capital arising from movements in interest rates. From an economic perspective, a bank focuses on the sensitivity of the value of its assets, liabilities and revenues to changes in interest rates. Interest rate risk arises from differences between the timing of rate changes and the timing of cash flows (reprising risk); from changing rate relationships among different yield curves affecting bank activities (basis risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest-related options embedded in bank products (options risk). Like loans, leases are subject to interest rate risk. Loans have an explicit interest rate, whereas a lease transaction is negotiated and underwritten based on an implicit interest rate. This implicit rate is derived from a fixed rate of interest for most leases in the banking industry. Typically, the interest rate risk to the bank is the same as if the bank were making a loan with an explicit fixed interest rate. Fixed interest rates expose the bank to interest rate risk when interest rates change (which they do because of competitive or economic forces). Prepayment or early termination of leases exposes the bank to additional interest rate interest. When the bank funds a lease, management should consider the potential impact on earnings arising from interest rate risk and, through asset-liability management, should attempt to mitigate the risks associated with fixed rate lease financing. Banks can use a variety of techniques to manage interest rate risk, such as adjusting the maturity and payment frequency of the lease, basing the implicit interest rate on a floating rate, and hedging the fixed rate exposure but as a general, these banks are not concerned about this kind of risk.

44

Liquidity Risk
Liquidity risk is the risk to earnings or capital arising from a banks inability to meet its obligations when they come due, without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the banks failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value. Examiners normally assess an assets liquidity risk in terms of its expected life and the ease with which it can be converted into cash. A leases liquidity risk is no different. Examiners must evaluate the terms of the leases and determine whether anything could affect the banks expected yield on the leasing portfolio. To the extent that such factors are present, the examiner would assess any expected needs to liquidate portions of the portfolio to meet other funding requirements or take advantage of other opportunities. Concentrations by obligor, industry, or property type must be carefully reviewed to evaluate the liquidity risk. For LRD there is high risk of liquidity.

Transaction Risk
Transaction risk is the risk to earnings or capital arising from problems with service or product delivery. This risk is a function of internal controls, information systems, employee integrity, and operating processes. Transaction risk exists in all products and services. One important component of transaction risk that is unique to leasing is residual, or property, risk. Residual value is an estimate of future value that is, an estimate of the amount that will be realized upon disposal or release of the property at the end of the lease term. A bank that does not properly control residual risk may be unable to recover its investment. One way of exerting such control is periodically to evaluate leased property for misuse, obsolescence, or market decline, any of which can rapidly depreciate the value of the property. Collateral may be valued by appraisal, engineering estimates, broker/dealers prices for similar used assets, and past recoveries on similar assets. Examiners must carefully review how the property is valued initially and periodically throughout the lease to determine whether the residual value is reasonable. If a bank uses a model to derive residual values, the examiner must determine whether assumptions used in the model are reasonable. A bank can manipulate income by projecting unreasonably high residuals, and thereby expose itself to unwarranted risk during the lease term. Examiners should evaluate residuals on individual leases as part of the overall assessment of transaction risk in the banks portfolio.

The policies, procedures, practices, systems, and controls that allow management and the board of directors to monitor exposure under this product. Incorrect assumptions or changes in market conditions affecting the property could make it difficult for a bank to recover its investment. Managers require accurate and complete MIS in order to monitor payment status, collections, lease run-offs, residual position, and concentrations within the leasing portfolio. Reviews by

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either the internal or external auditors can help the bank assess the effectiveness of its controls on transaction risk.

Compliance Risk
Compliance risk is the risk to earnings or capital arising from violations of, or non-conformance with laws, rules, regulations, prescribed practices, or ethical standards. Compliance risk also arises in situations where the laws or rules governing certain bank products or activities of the banks clients may be ambiguous or untested. Compliance risk exposes the institution to fines, civil money penalties, payment of damages, and the voiding of contracts. Compliance risk can lead to a diminished reputation, reduced franchise value, limited business opportunities, lessened expansion potential, and lack of contract enforceability. Compliance risk in the form of litigation, settlements, or judgments affects leasing. If there are problems with documentation, the bank could lose its contractual rights under a lease. It could lose its ability to realize tax benefits or take advantage of the rights of property ownership, including repossession and sale.

Risk Management System

In view of the growing need for putting in place proper risk management system for identification, assessment and containing risks involved in the banking business, and also with a view to sensitizing the banks in this regard, Reserve Bank of India has been issuing instructions / Guidance notes on various risks for the benefit of the banks. These instructions are indicative in nature and banks may adopt a system depending upon their portfolio size, business complexities, risk appetite, etc. i. ii. Banks should have a Board mandated policy in respect of their real estate exposure. The policy may include exposure limits, collaterals to be considered, margins to be kept, sanctioning authority / level, sector to be financed, etc., though the actual limits / margins may vary from bank to bank depending upon the individual banks portfolio size, risk appetite and risk containing abilities, etc. Banks should have risk management system in place for containing risks involved in this sector, including price risk, etc. Banks should have a monitoring mechanism to ensure that the policy stipulations are being followed by field level functionaries and that their exposure to this sensitive sector is within the stipulated limits.

iii. iv.

Commercial Real Estate Lendings secured by mortgages on commercial real estates (office buildings, retail space, multi-purpose commercial premises, multi-family residential buildings, multi-tenanted commercial premises, industrial or warehouse space, hotels, land acquisition, development and construction, etc.). Exposure would also include non-fund based (NFB) limits; In terms of Basel -II Framework, CRE Exposures are of two types,

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(i) (ii)

Income producing real estates (IPRE) High volatility commercial real estate (HVCRE).

These terms have been elaborated in the Framework in the context of advanced approaches for credit risk. It would be appropriate to follow the same approach for classification of exposures as CRE Exposures by banks which follow the Standardized Approach. While finalising the guidelines on classification of CRE exposure, the RBI has relied on the definition given by the Basel-II framework for income-producing real estate (IPRE). For an exposure to be classified as IPRE/CRE, the funding will have to result in creation/acquisition of real estate (such as office buildings to let, retail space, multi-family residential buildings, industrial or warehouse space and hotels), where the prospects for loan repayment would depend primarily on the cash flows generated by the asset. To put it simply, the primary source of cash flow for repayment of such funded assets would generally have to be lease or rental payments or sale of assets. Any exposure taken against an existing commercial real estate would also come under this category if the prospects for repayments primarily depend on rental/sale proceeds of the real estate. Similarly, extension of guarantees on behalf of companies engaged in commercial real estate activities, exposures on account of derivative transactions undertaken with real estate companies, corporate loans extended to real estate companies and investment made in the equity and debt instruments of real estate companies also qualify to be classified as commercial real estate exposure.

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CHAPTER-6 33

Securitisation

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Securitisation
Just as the electronics industry was formed when the vacuum tubes were replaced by transistors, and transistors were then replaced by integrated circuits, the financial services industry is being transformed now that securitised credit is beginning to replace traditional lending. Like other technological transformations, this one will take place over the years, not overnight. We estimate it will take 10 to 15 years for structured securitised credit to replace to displace completely the classical lending system -not a long time, considering that the fundamentals of banking have remained essentially unchanged since the middle Ages. Lowell L Bryan

Meaning of securitisation:
Securitisation is the process of pooling and repackaging of homogenous illiquid financial assets on the originator's balance sheet into marketable securities that can be sold in the capital markets to the ultimate investors via the special purpose vehicle (SPV).These securities could take the shape of asset backed securities (ABS), Mortgage backed securities (MBS) and infrastructure financing securities. In India, auto loan securitisation, residential housing loan securtisation, future flow and infrastructure receivables securitisation are slowly gaining momentum though the first two taking the main share and infrastructure receivables securitisation being a boon for the Indian Economy. Securitization began in India in the early nineties. CRISIL rated the first securitization programme in 1991-92 when Citibank securitized a pool from its auto-loan portfolio and placed the paper with GIC Mutual Fund. The market for ABS has been stagnant largely for want of a suitable enabling regulatory framework. The simplest way to understand the concept of securitisation is to take an example. Let us say, I want to own a car to run it for hire. I could take a loan with which I could buy the car. The loan is my obligation and the car is my asset, and both are affected by my other assets and other obligations. This is the case of simple financing. On the other hand, if I were to analyticalally envisage the car, my asset in the instant case, as claim to value over a period of time, that is, ability to generate a series of hire rentals over a period of time, I might sell a part of the cash flow by way of hire rentals for a stipulated time and thereby raise enough money to buy the car. The investor is happier now, because he has a claim for a cash flow which is not affected by my other obligations; I am happier because I have the cake and eat it also, and also because the obligation to repay the financier is taken care of by the cash flows from the car itself.

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Securitisation of receivables:
One of the applications of the securitisation technique has been in creation of marketable securities out of or based on receivables. The intention of this application is to afford marketability to financial claims in the form of receivables. Obviously, this application has been applied to those entities where receivables form a large part of the total assets of the entity. Besides, to be packaged as a security, the ideal receivable is one which is repayable over or after a certain period of time, and there is contractual certainty as to its payment. Hence, the application was traditionally principally directed towards housing/ mortgage finance companies, car rental companies, leasing and hire-purchase companies, credit cards companies, hotels, etc. Soon, electricity companies, telephone companies, real estate hiring companies, aviation companies etc. joined as users of securitisation. Insurance companies are the latest of the lot to make an innovative use of securitisation of risk and receivables, though the pace at which securitisation markets are growing, the word "latest" is not without the risk of being stale soon. In developed countries there have been successful attempts to issue securitized gadgets based on future income streams - also known as future flow securitization - that take place from the use of physical assets income arising due to regulations, income from sale of natural resources. Furthermore a wide variety of receivables have been securitized like, Residential mortgages, Credit card receivables, Auto Loans, Swap contracts, Trade receivables, Unsecured term loans, Collateralized bond/loan obligation, Export receivables, Finance leases, Aircraft leases, Insurance premia, Firm and music album receivables, etc.

Relevance of securitisation in some infrastructure sectors

Power

Various public sector units (PSUs) have a high financial exposure to state electricity boards (SEBs), some of which are sub-standard loans since several SEBs have inadequate solvency for meeting obligations on the due date. Securitisation in the power sector can be divided into the following segments: Receivables of PSUs such as National Thermal Power Corporation, Coal India Ltd., Power Finance Corporation, Rural Electrification Corporation, National Hydel Power Corporation, etc.

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from various SEBs can be securitised to reduce/rebalance financial exposure of these PSUs. Securitisation of SEB revenues for resource raising.
Roads

Private sector road projects are expected to earn revenues from toll collections and concessions. However, these projects carry multiple level of risks which could be summarized as under: Construction risk In the event of inordinate delays in procuring land and completing implementation. Traffic Estimation risk Accuracy of estimating traffic in various segments i.e. commercial vehicles, buses, passenger cars, two wheelers and achieving desired traffic estimates. Toll collection risk Intent and willingness of users to pay requisite tolls for usage. Considering the multiple levels of risk, securitisation could be used to slice various levels of risks and thereby facilitate financial closure at an optimal cost of capital.
Ports

The revenues of typical port projects would be in the nature of stowage and loading revenues levied on ships, which stop at the port of call. In addition, ports tend to provide storage facilities for chemicals, cargo, petroleum products, etc. to several large companies. The port authority/operator contract such storage facilities for a long tenure. The port revenues of this nature are suitable for securitisation.
Urban Infrastructure

Primarily, the opportunity in urban infrastructure is in the areas of housing loans (the same has been covered under the section pertaining to mortgage securitisation). The other areas under urban infrastructure are water supply, sewage facilities, garbage disposal, etc Further, the above list is illustrative and not exhaustive. Wherever a reasonably certain sum of money will be received over a certain time, not very short, securitisation possibility exists. In short, the scope of securitisation is vast; ultimately being limited only by the consideration that assets proposed to be securitised must fundamentally be income bearing.

Future receivables:
Providers of utilities such as electricity and telephone services have an excellent opportunity of securitising electricity meter rentals and telephone rentals. The receivables in these cases are

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very widely spread, and delinquency record very favourable. A specific case can be that of VSNL. Being the sole gateway for inward traffic of international calls, the company gets a large and steady inflow of foreign exchange, that is ideal for securitisation.
Export Receivables:

Securitisation of export receivables can be considered by (i) the financing FIs or (ii) exporters themselves. The basic requirement for securitisation would be that the receivables have a reasonable span of life so that they can be segregated and covered by a market instrument.The securitisation of export receivables over a medium to long term period could thus be securitised by any of the above entities. Among the Institutional lenders, EXIM Bank may be able to undertake securitisation since they are involved in financing exporters on deferred terms. Among the exporters, those engaged in export of capital goods may be able to do securitisation if the relevant mechanism is in place.The export receivables are offshore dollar cash flow transactions as secured financing backed by future dollar receivables that can be isolated outside of India. In these transactions, the rights to receive future dollar cash flows can be transferred to an SPV outside India. The offshore vehicle issues the securities.
Credit card receivables:

Securitisation of credit card receivables is an innovation that has found wide acceptance.Although the average tenure of credit available to a credit card holder is generally very short (less than two months), it is revolving in nature. The lacuna of short tenor of the receivables is hence overcome by substitution, whereby collections are used for fresh purchases of receivables. Thus a securitisable asset of marketable tenure comes into being. The structure in this case is generally pay-through, since it is impossible to match the payment made by the cardholder with the payment to the investor. Originators are credit card divisions/subsidiaries of commercial banks, including a number of foreign banks.
Airline ticket receivables:

Future sales of airline tickets can be securitised considering the predictability of the cashflows from the same.
Future oil sales:

Oil sales from confirmed oilfields can form a large pool of assets that are suitable for securitisation, especially considering that the Obligors would normally be high quality corporate.

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Lease rentals:

Equipment and real estate leases exhibit characteristics that are amenable to securitisation, particularly in respect of a fixed payment schedule for the lease rentals. In the Indian context, there is ample scope for securitisation of these future flows in this asset class in view of the impressive growth of hire purchase and leasing finance companies, especially after the issue of guidelines by the RBI regulating their functioning. While portfolios of lease/hire purchase individual commercial properties, provided they are sufficiently big and backed by an agreement. Structuring securitisation transactions in this asset class would have to take into consideration the payment schedule of the underlying receivables, i.e. balloon, bullet, and so on.

Securitisable Assets :
Typically, any asset that produces a predictable stream of cash flows can be securitised. The types of assets that are securitised today include:
Mortgage-backed

Residential mortgage-backed securities (RMBS) Commercial mortgage-backed securities (CMBS)

Retail Loan Pools

Equipment lease / loan receivables Student loan receivables Credit card receivables Auto loan receivables Trade receivables Toll receipts

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How securitization work:

Current Scenario
Issuance volume in the Indian structured finance (SF) market fell 18% in FY2009 over the previous fiscal to Rs. 520 billion. Single corporate loan securitisations [also known as Single Loan Collateralised Loan Obligations (CLOs) or Loan Sell-Offs (LSOs)] accounted for around 68% of the total volume; Asset Backed Securitisation (ABS), traditionally the dominant product class, for around 26%; and Residential Mortgage Backed Securitisation (RMBS) for the balance 6% or so, with its relatively long tenure continuing to hinder investor appetite. Securitisation of retail assets (both ABS and RMBS) cumulatively reported a 47% drop in volume during FY2009 over the previous fiscal.

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During FY2009, the market for SF transactions in India reported a decline of 18% in value terms and 30% in terms of number of transactions over the previous fiscal.

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Traditionally, while ABS had been the dominant product class, in FY2009, as in the previous fiscal, LSO was the largest product class, accounting for an even larger share of 68% of the total issuance volume (as compared to 50% in FY2008). The share of ABS, which includes cars and utility vehicles (UVs), commercial vehicles (CVs), construction equipment (CE), two-wheelers (2W), and personal loans (PL), fell from 49% in FY2008 to 26% in FY2009. The share of RMBS rose from a negligible level of less than 1% in FY2008 to about 6% in FY2009, on the strength of a few year-end deals.

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Section II 34 CHAPTER-7 35

Analytical Hierarchy Process (AHP)

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Analytical Hierarchy Process (AHP)

LRD Factors for Approval of Loan
LRD (Lease Rental Discounting) is a product for the financial institutions, banks. LRD loan consist of 2%-3% of banks portfolio. This project aims at ranking various factors which are more important for bankers or authority for loan approval.

Objective:
Ranking different attributes and factors for which institution is more concerned for finalizing or evaluating this kind of loan using Analytical Hierarchy Process (AHP) technique.

Problem Identification:
Although there is not one factor which contributes to LRD loan approval, there is an ardent need to classify all factors which contribute to the loan approval and rank them on a relative basis.

Objectives behind Problem Selection:

There are various factors which contribute to LRD loan approval. It is important to determine these factors and rank them on which banks are more concerned about those factors as this kind of loan falls in CRE category normally and real estate is cyclical in nature so that the banks can identify various risks which are involved in this product.

Analytical Hierarchy Process (AHP):

Analytical Hierarchy Process (AHP) is one of Multi Criteria decision making method that was originally developed by Prof. Thomas L. Saaty. In short, it is a method to derive ratio scales from paired comparisons. The input can be obtained from actual measurement such as price, weight etc., or from subjective opinion such as satisfaction, feelings and preference. AHP allow some small inconsistency in judgment because human being is not always consistent. The ratio scales are derived from the principal Eigen vectors and the consistency index is derived from the principal Eigen value.

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Users of the AHP first decompose their decision problem into a hierarchy of more easily comprehensible sub-problems, each of which can be analyzed independently. The elements of the hierarchy can relate to any aspect of the decision problemtangible or intangible, carefully measured or roughly estimated, well- or poorly-understoodanything at all that applies to the decision at hand. Once the hierarchy is built, the decision makers systematically evaluate its various elements by comparing them to one another at a time. In making the comparisons, the decision makers can use concrete data about the elements, or they can use their judgments about the elements' relative meaning and importance. It is the essence of the AHP that human judgments, and not just the underlying information, can be used in performing the evaluations. The AHP converts these evaluations to numerical values that can be processed and compared over the entire range of the problem. A numerical weight or priority is derived for each element of the hierarchy, allowing diverse and often incommensurable elements to be compared to one another in a rational and consistent way. This capability distinguishes the AHP from other decision making techniques. In the final step of the process, numerical priorities are calculated for each of the decision alternatives. These numbers represent the alternatives' relative ability to achieve the decision goal, so they allow a straightforward consideration of the various courses of action.

Using Analytical Hierarchy Process:

As can be seen in the material that follows, using the AHP involves the mathematical synthesis of numerous judgments about the problem at hand. It is not uncommon for these judgments to number in the dozens or even the hundreds. While the math can be done by hand or with a calculator, it is far more common to use one of several computerized methods for entering and synthesizing the judgments. The simplest of these involve standard spreadsheet software, while the most complex use custom software, often augmented by special devices for acquiring the judgments of decision makers gathered in a meeting room. The procedure for using the AHP can be summarized as: 1. Model the problem as a hierarchy containing the decision goal, the alternatives for reaching it, and the criteria for evaluating the alternatives. 2. Establish priorities among the elements of the hierarchy by making a series of judgments based on pair wise comparisons of the elements. For example, when comparing potential real-estate purchases, the investors might say they prefer location over price and price over timing. 3. Synthesize these judgments to yield a set of overall priorities for the hierarchy. This would combine the investors' judgments about location, price and timing for properties A, B, C, and D into overall priorities for each property.

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4. Check the consistency of the judgments. 5. Come to a final decision based on the results of this process. These steps are more fully described below.
Model the problem as a hierarchy

The first step in the Analytical Hierarchy Process is to model the problem as a hierarchy. In doing this, participants explore the aspects of the problem at levels from general to detailed, then express it in the multileveled way that the AHP requires. As they work to build the hierarchy, they increase their understanding of the problem, of its context, and of each other's thoughts and feelings about both.
Hierarchies defined

A hierarchy is a system of ranking and organizing people, things, ideas, etc., where each element of the system, except for the top one, is subordinate to one or more other elements. Diagrams of hierarchies are often shaped roughly like pyramids, but other than having a single element at the top, there is nothing necessarily pyramid-shaped about a hierarchy. Human organizations are often structured as hierarchies, where the hierarchical system is used for assigning responsibilities, exercising leadership, and facilitating communication. Familiar hierarchies of "things" include a desktop computer's tower unit at the "top," with its subordinate monitor, keyboard, and mouse "below." In the world of ideas, we use hierarchies to help us acquire detailed knowledge of complex reality: we structure the reality into its constituent parts, and these in turn into their own constituent parts, proceeding down the hierarchy as many levels as we care to. At each step, we focus on understanding a single component of the whole, temporarily disregarding the other components at this and all other levels. As we go through this process, we increase our global understanding of whatever complex reality we are studying. Think of the hierarchy that medical students use while learning anatomythey separately consider the musculoskeletal system (including parts and subparts like the hand and its constituent muscles and bones), the circulatory system (and its many levels and branches), the nervous system (and its numerous components and subsystems), etc., until they've covered all the systems and the important subdivisions of each. Advanced students continue the subdivision all the way to the level of the cell or molecule. In the end, the students understand the "big picture" and a considerable number of its details. Not only that, but they understand the relation of the individual parts to the whole. By working hierarchically, they've gained a comprehensive understanding of anatomy.

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Similarly, when we approach a complex decision problem, we can use a hierarchy to integrate large amounts of information into our understanding of the situation. As we build this information structure, we form a better and better picture of the problem as a whole.
AHP hierarchies explained

An AHP hierarchy is a structured means of modeling the problem at hand. It consists of an overall goal, a group of options or alternatives for reaching the goal, and a group of factors orcriteria that relate the alternatives to the goal. The criteria can be further broken down into subcriteria, sub-subcriteria, and so on, in as many levels as the problem requires. The hierarchy can be visualized as a diagram like the one below, with the goal at the top, the alternatives at the bottom, and the criteria in the middle. There are useful terms for describing the parts of such diagrams: Each box is called a node. The boxes descending from any node are called its children. The node from which a child node descends is called its parent. Groups of related children are called comparison groups. The parents of an Alternative, which are often from different comparison groups, are called its covering criteria. Applying these definitions to the diagram, the four Criteria are children of the Goal, and the Goal is the parent of each of the four Criteria. Each Alternative is a child of its four covering criteria. There are two comparison groups: a group of four Criteria and a group of three Alternatives.

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A simple AHP hierarchy

To avoid clutter in AHP diagrams, the lines connecting alternatives and their covering criteria are often omitted or reduced in number. Regardless of any such simplifications in the diagram, in the actual hierarchy each alternative is connected to every one of its covering criteria. The design of any AHP hierarchy will depend not only on the nature of the problem at hand, but also on the knowledge, judgments, values, opinions, needs, wants, etc. of the participants in the process. Published descriptions of AHP applications often include diagrams and descriptions of their hierarchies. These have been collected and reprinted in at least one book. You can see some more complex AHP hierarchies here. As the AHP proceeds through its other steps, the hierarchy can be changed to accommodate newly-thought-of criteria or criteria not originally considered to be important; alternatives can also be added, deleted, or changed. Establish priorities Once the hierarchy has been constructed, the participants use AHP to establish priorities for all its nodes. In doing so, information is elicited from the participants and processed mathematically. This section explains priorities, shows how they are established, and provides a simple example. Priorities defined and explained Priorities are numbers associated with the nodes of an AHP hierarchy. They represent the relative weights of the nodes in any group. Like probabilities, priorities are absolute numbers between zero and one, without units or dimensions. A node with priority .200 has twice the weight in reaching the goal as one with priority .100, ten times the weight of one with priority .020, and so forth. Depending on the problem at hand, "weight" can refer to importance, or preference, or likelihood, or whatever factor is being considered by the decision makers. Priorities are distributed over a hierarchy according to its architecture, and their values depend on the information entered by users of the process. Priorities of the Goal, the Criteria, and the Alternatives are intimately related, but need to be considered separately. By definition, the priority of the Goal is 1.000. The priorities of the Alternatives always add up to 1.000. Things can become complicated with multiple levels of Criteria, but if there is only one level, their priorities also add to 1.000. All this is illustrated by the priorities in the example below.

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Simple AHP hierarchy with associated default priorities Observe that the priorities on each level of the examplethe Goal, the Criteria, and the Alternativesall add up to 1.000. The priorities shown are those that exist before any information has been entered about weights of the criteria or alternatives, so the priorities within each level are all equal. They are called the hierarchys default priorities. If you understand what has been said so far, you will see that if a fifth Criterion were added to this hierarchy, the default priority for each Criterion would be .200. If there were only two Alternatives, each would have a default priority of .500. Two additional concepts apply when a hierarchy has more than one level of criteria: local priorities and global priorities. Consider the hierarchy shown below, which has several Sub criteria under each Criterion.

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A more complex AHP hierarchy, with local and global default priorities In the interest of clarity, the decision alternatives do not appear in the diagram. The local priorities, shown in gray, represent the relative weights of the nodes within a group of siblings with respect to their parent. You can easily see that the local priorities of each group of Criteria and their sibling Sub criteria add up to 1.000. The global priorities, shown in black, are obtained by multiplying the local priorities of the siblings by their parents global priority. The global priorities for all the sub criteria in the level add up to 1.000.

The rule is this: Within a hierarchy, the global priorities of child nodes always add up to the global priority of their parent. Within a group of children, the local priorities add up to 1.000. So far, we have looked only at default priorities. As the Analyticalal Hierarchy Process moves forward, the priorities will change from their default values as the decision makers input information about the importance of the various nodes. They do this by making a series of pairwise comparisons.

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Identification and Ranking of Factors:

The various factors (criteria) which have been identified for LRD (Lease Rental Discounting) approval are:

1. Risk : This has three alternatives i.e. a. Credit b. Interest c. Liquidity 2. Due diligence : This has three alternatives i.e. a. From the point of view of lessor/borrower b. From the point of view of lessee c. From the point of view of security/collateral documents 3. Return : This has three alternatives i.e. a. ROI b. PV of Rent c. Margin 4. Loan :This has three alternatives i.e. a. Amount of loan b. Tenure of Loan c. Exposure to Sector

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Goal (Ranking factors for approval of Loan Risk Credit Interest Liquidity Due Diligence Lessor Lessee Documents Return ROI PV of Rent Margin Loan Amount Tenure Exposure

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Data collection and tabulation:

The data has been collected using a questionnaire which is filled by four banks and each response has been subjected to AHP analysis. The questionnaire is so designed that the respondents have to choose between two factors at time on the designated scale. On this basis the matrix is obtained which is further processed to obtain the normalised matrix. Using this matrix, the preference matrix is obtained by further normalisation. Based on this, the ranks are obtained for individual samples and these ranks have been summed up for various criteria for overall ranking. This is depicted in the subsequent results section.

Results
Level 1 There were four factors: A: Risk B: Due diligence C: Return D: Loan Among these factors, respondents were more concerned for Loan approval is with the due diligence followed by Loan, Risk and Return respectively. The details about the results are as follows:

Level 2: Within each of the above factors three more factors were studied:

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Under factor A: A1: Credit Risk A2: Interest rate Risk A3: Liquidity Risk Among these factors, respondents were most concerned for A1 followed by A2 and A3 respectively. The details about the results are as follows: Percentage of respondents who gave the corresponding ranks Factor A1 Factor A2 Factor A3 Rank 75 25 25 1 25 50 25 2 0 25 50 3 Under factor B: B1: From the point of view of lessor/borrower B2: From the point of view of lessee B3: From the point of view of security/collateral documents Among these factors, respondents were more concerned for B3 followed by B2 and B1 respectively. The details about the results are as follows: Percentage of respondents who gave the corresponding ranks Factor B1 Factor B2 Factor B3 Rank 25 0 75 1 0 75 25 2 75 25 0 3 Under factor C: C1: ROI C2: PV of Rent C3: Margin

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Among these factors, respondents were more concerned for C3 followed by C1 and C2 respectively. The details about the results are as follows: Percentage of respondents who gave the corresponding ranks Factor C1 Factor C2 Factor C3 Rank 25 25 50 1 50 0 0 2 25 75 50 3 Under factor D: D1: Amount of loan D2: Tenure of Loan D3: Exposure to Sector Among these factors, respondents were more concerned for D1 followed by D3 and D2 respectively. The details about the results are as follows: Percentage of respondents who gave the corresponding ranks Factor D1 Factor D2 Factor D3 Rank 75 0 25 1 25 25 50 2 0 75 25 3

Conclusion
The results obtained showed that the approval authority is more concerned about the Due diligence. Approval authority was found to be least concernd for the return.

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Results Summary:
The results thus obtained are as follows: 1) Risk Rank 3 Within Risk the various rankings are: a. Credit - Rank 1 b. Interest - Rank 2 c. Liquidity -Rank 3 2) Due Diligence - Rank 1 Within due diligence the various rankings are: a. From the point of view of lessor/borrower Rank 3 b. From the point of view of lessee - Rank 2 c. From the point of view of security/collateral documents - Rank 1 3) Return Rank 4 Within Return the various rankings are: a. b. c. ROI - Rank 2 PV of Rent - Rank 3 Margin - Rank 1

4) Loan Rank 2 Within Loan the various rankings are: a. b. c. Amount of loan - Rank 1 Tenure of Loan - Rank 3 Exposure to Sector - Rank 2

36 37 38 39

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40 41 42 43 44 CHAPTER-8 45

Findings and Conclusion

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Findings and recommendations

Bank loans, the key source of funding for developers, have become difficult to get due to banks reluctance to sanction fresh loans. Other investors like private equity (PE) funds are now demanding higher assured returns. Fitch also notes that developers are looking at other refinancing options such as receivable securitisation and lease rental discounting. LRD has become a preferred route of refinancing for developers with revenue generating assets in commercial and retail segments. Many large developers like DLF and Pheonix Mills have raised debt in the nature of lease rental discounting in recent times. The trend has gathered momentum in the retail segment as the developers now desist from outright sale of quality space, which provides them with better leverage over a period. Office and retail space is among the most preferred investment option available for bigger investors. Here, an investor buys a property and lets it out to a company or a retailer. It earns regular rental income and carries the benefits of price appreciation too. Rental income can range between 11 per cent and 12 per cent on investment, and there is room for capital gains. Again, investors are able to leverage much more efficiently by using Lease Rental Discounting (LRD). Let us assume that a property costs Rs 100. This represents a loan component of Rs 85 and a net investment of Rs 15. The basic appreciation of property in most cases is 15 per cent. Assuming that the loan was availed of at an interest rate of 12 per cent and the holding period is two years, the net profit would be Rs 7.9, representing a return on investment (ROI) of 26 per cent. Add to that the additional tax benefits on deduction of interest paid and repayment of loans from gross income. This increases net returns commensurately. In general, developers get loan for construction and development; after completion of construction they lease out that property and on the basis of those future cash flow they get approval of LRD and repay the construction loan so in this way we can notice developer is doing all these things only on the loan and his/her share for this is very low. Banks can classify LRD loan as CRE as well as Non CRE. As rent is dependent on real estate market as what rate is going on that area so this product is indirectly is related to CRE sector.CRE is cyclical in nature with increased buoyancy, the real-estate market now falls in the same league as stocks, bonds, mutual funds, gold and commodities, and insurance policies as a viable investment option for investors in all categories individuals, corporate, and funds. Clarity is required for non CRE exposure. The owners of commercial real estates often rent the property for others to manage or do business; and, some tenants will rent a property then reconfigure it and rent to a third party. Therefore, when conducting an appraisal it is imperative to clearly investigate the ownership of the real estate, and clarify whether the appraisal is at land lords interest or tenants interest. Lease type real estates can calculate its pure income according to the lease contract within the lease period, however, in order to attract popular retail stores, the rent offered may be lower than the market rental rate. Because there is guarantee from the lease contract, hence the risk of

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leasing is relatively lower but as we have seen in last two year More, Subhiksha etc. retail stores closed their operations due to high cost. Proper risk management is required for mitigating this kind of risk. For finalising loan amount banks are using only Margin system so banks should calculate Present Value of future receivables. For calculating PV we have developed one model so this model should be used while calculating loan amount. Maximum care is taken in choosing the right lessor and lessee before entering into an LRD. The credit profile and assets of the lessor are studied carefully. The rent-paying capacity of the lessee, perhaps the most important factor of an LRD, is checked thoroughly, as the whole concept of LRD is based on the regular cash flows from the lessee. Also, banks need to ensure that they are not converting any black money to white in the process. Since its introduction to India in 2000, LRD disbursements stand at a cumulative total of $2-2.5 billion. Of these, approximately $700 million has been floated in the secondary market. The booming Indian real estate market registered the highest yield rates in the world in 2003 with three key markets National Capital Region, Mumbai and Bangalore ahead of London, Frankfurt, Hong Kong, Kuala Lumpur, Singapore, Bangkok, Sydney and Copenhagen. According to one estimate, LRD business worth $1 billion is assumed to take place every year. But the total market size pales in comparison with the US-based Commercial Mortgage Based Securities (CMBS) market, which totalled to a whopping $68 billion in 1999. Clearly, there is an enormous demand for a secondary market for commercial mortgage-backed securities in emerging countries so that the risk in the real estate market can be distributed among various marginal investors. The policy for LRD (Lease Rental Discounting) was comprehensive. Certain observations on policy prescriptions vis--vis prudential norms were as under: 1. The process of monitoring of end use of funds was not incorporated in the loan policy although in policy they specified that funds can be utilized for these purpose but for monitoring of end use of funds banks, are not so concerned. 2. While approval of loan all the banks are more concerned for margin they are not calculating Present Value of future rent. 3. Credit Rating for the borrower is done by on annually based audited financial results and projected balance sheet but there is no uniform or reliable assumptions for projections. 4. There are chances for accepting of unrealistic projections of the sales and profits made by the borrowers in certain cases.

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5. Banks usually do SWOT analysis and real estate sector analysis before approval of loan but in my view SWOT analysis and real estate sector analysis are not comprehensive as bank A gives reference of 2002 paper which is on real estate for growth in real estate sector but after 8 years, situation as well as conditions are changed so accordingly they should consider those things. 6. Normally no consideration is given to market rent for that area, they evaluate rent only on the basis of lease agreements. 7. Rate of Interest is normally is decided on the basis of client. 8. If repayment of loan is not done by lessee, then borrower is liable to pay but in policy there is no clarity like after how many installment which is not paid by lessee borrower have to start payment. 9. Developers have more leverage for this product. 10. Incorrect assumptions or changes in market conditions affecting the property could make it difficult for a bank to recover its investment.

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References
BOOKS AND ARTICLES

Hillier and Hillier (2007): Management Science, Tata McGraw-Hill Publishers, New Delhi, 3rd Edition Comptroller of the Currency Administrator of National Banks (January 1998) :Lease Financing Comptrollers Handbook Malhotra Naresh : Marketing Research, Prentice hall of india, 5th Edition Update On Indian Structured Finance Market by ICRA rating

RBI PUBLICATIONS

DBOD.BP.No. 502 / 08.12.015/ 2008-09 DBOD. No. BP.11021/ 08.12.015/ 2008-09 DBS.CO.PP.BC 21 /11.01.005/2004-05 RBI/2009-10/245 UBD.No.BPD.PCB.26/ DBOD.No.BP.BC. 21 /21.06.001/2009 - 10 DBS.CO.PP.BC 21 /11.01.005/2004-05 DBOD.BP.BC.No. 42 / 08.12.015/ 2009-10

WEBSITES www.ijsimm.com/Full_Papers/Fulltext2009/text8-1_16-26.pdf www.people.revoledu.com/kardi/tutorial/AHP/index.html http://www.vinodkothari.com

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Annexure:
Questionnaire for AHP First choose the factor/element with which you are most satisfied and then rate it on the scale in comparison to the other alternative given: 1: equally concerned from both elements 2: more moderately concerned with one element over other 3: more strongly concerned with one element over other 4: very strongly concerned with one element over other 5: absolutely more concerned with one element over other

(1) With which element you are more concerned for LRD approval...

Risk

Due diligence Rate your above choice on the scale

2) With which element you are more concerned for LRD approval...

Risk

Return Rate your above choice on the scale

(3) With which element you are more concerned for LRD approval...

Risk

Loan Rate your above choice on the scale

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(4) With which element you are more satisfied concerned for LRD approval...

Due diligence

Return Rate your above choice on the scale

(5) With which element you are more concerned for LRD approval...

Due diligence

Loan Rate your above choice on the scale

(6) With which element you are more satisfied concerned for LRD approval...

Return

Loan Rate your above choice on the scale

(7) With which element you are more concerned for LRD approval...

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Credit Risk

Interest Risk Rate your above choice on the scale

(8) With which element you are more concerned for LRD approval...

Interest Risk

Liquidity Risk Rate your above choice on the scale

(9) With which element you are more concerned for LRD approval...

Credit Risk

Liquidity Risk Rate your above choice on the scale

(10) With which element you are more concerned for LRD approval...

From the point of view Lessor/borrower

From the point of view Lessee Rate your above choice on the scale

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(11) With which element you are more concerned for LRD approval...

From the point of view Lessee

From the point of view security/collateral documents Rate your above choice on the scale

(12) With which element you are more concerned for LRD approval...

From the point of view Lessor/borrower

From the point of view security/collateral documents Rate your above choice on the scale

(13) With which element you are more concerned for LRD approval...

ROI

PV of Rent Rate your above choice on the scale

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(14) With which element you are more concerned for LRD approval...

PV of Rent

Margin Rate your above choice on the scale

(15) With which element you are more concerned for LRD approval...

ROI

Margin Rate your above choice on the scale

(16) With which element you are more concerned for LRD approval...

Amount of Loan

Tenure of Loan Rate your above choice on the scale

(17) With which element you are more concerned for LRD approval...

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Tenure of Loan

Exposure to this sector Rate your above choice on the scale

(18) With which element you are more concerned for LRD approval...

Amount of Loan

Exposure to this sector Rate your above choice on the scale

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Annexure:

Confidential

Questionnaire

Name of the organisation Address

: :

Name of Concerned Person : Contact No. Date of Visit : :

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Portfolio: A. How much is your organizations Total Loan amount and advances?

B. How much of the above mentioned amount is used / utilized for Lease Rental Financing?

C. Growth in lease rental financing volumes of last 5 years (Kindly provide data )

D. What is the Collection Procedure adopted in your organisation? ( Kindly provide finer details)

E. Are there any past dues and default on the account of lease rental financing (NPA) existing in your organization?

If yes, then how much F. Please identify the sectors/ activities/areas in which your organisation provides lease rental finance at present and rate them on the basis of priority? Real Estates-Commercial centers Real Estates-Entertainments Real Estates-Residential Real Estates-Office Buildings Hotels / Resorts G. Approximately, how much would you be willing to allocate in each contract?

FromTo:

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Basis of selection

A. How do you select lease rentals for lease rental financing? ( Kindly explain policies for these kind of financing)

B. How do you identify and evaluate future cash flow for lease rental financing? a. Procedure:

b. Do you use any model for evaluation? If yes, then which model?

C. What documents are solicited by your organisation for financing lease rental applications?

D. Calculation of PV (Present Value) -brief Procedure

-How do you choose discount factor for calculating present value of cash flow?

- Time frame

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E. While finalizing installment you are more concerned with: -PV of Rent -Management fee -Any Other....... F. Do you use any Analyticalal Model for calculation? If yes, then which?

Decision: A. Any Internal or External factors which can affect the lease rental financing? If yes, kindly specify.

B. Approval of financing of lease rentals is a centralized or decentralized process?

C. How do you check the credit worthiness of a prospective customer for financing lease rentals? ( Kindly explain credit policy)

D. Is there any requirement of security/collateral for financing of lease? If yes, then please provide greater details?

E. How do you evaluate the projects? What mechanism is in place for evaluation of its security?(Please specify)

F. How much should be the Cost of Capital which you consider for this kind of deal and how do you calculate the cost of capital?

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G. From the financing point of view, for lease rental financing which type of capital do you consider more appropriate (tier I, tier II,)?

H. What is the minimum required rate of return that you would expect from each investment?

I.

Time frame for lease rental finance :

J. Which method do you use for Repayment Structure? -Equated /Level/Constant -Stepped -Ballooned -deferred -Bell Shaped -Zig-zag -Any other......

K. Repayment of loan installments: A. Monthly B. Quarterly C. half-Yearly D. Yearly L. Do you consider lease rentals installments while finalizing these kind of deals from the point of view of lessor and lessee? if yes then which is more suitable: A. Monthly B. Quarterly C. Half-Yearly D. Yearly

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M. How long does your financial institution take in remitting payments?

General: A. Amongst several evaluation methods available, which method does your organisation employ for the purpose of evaluating rent (e.g. Market, assessor) for lease rental financing?

B. What is the correlation between projected and achieved operational results?

# if no correlation exists, then how does your organisation account for this mismatch?

C. How satisfied are you with your employees as far as domain knowledge and technical skills related to lease rental financing are concerned?

D. How does your organization establish the credit worthiness of the parties in question while evaluating the loan applications? Is emphasis laid on the financials of guarantors?

E. Are there any "Exit Mechanism conditions" in place with respect to the lease financing contract? Kindly elaborate. Yes No

F. Suppose there is one company XYZ developers ltd. you have finance lease rentals to this company.ABC ltd. whose operations are so huge and that company is the lessee for XYZ developers ltd. if ABC ltd. requires working capital (working capitals major chunk is rent which is used to pay XVZ developers) then is it possible from your side to finance this type of loan?

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G. Suppose there is one company a XYZ developer you have financed lease rentals with projection of 7 years 500 cr. and you have security worth 200 cr. XYZ developers will going to use 500 cr. Where XYZ developers will use this fund? ( for buying property or use those fund as working capital do you check or identify these things if yes then how)

H. Assignment of Rents to Banks is done by lessor, lessee or any third party (Collection agency) what are the legal aspect on this issue?

I. Suppose there is commercial property of around 20000 sq.ft and you have financed on the basis that in future, the property owner will get lessee for that area but due to some reasons there is unoccupied space then how you manage such risk?

J. Suppose lessor is not receiving rent from lessee due to some reasons and lessor is not able to pay Installment due to this reason then how you manage?

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Risk: A. Kindly prioritise the following risks in this sort of transaction? a. b. c. d. e. f. g. h. i. j. Credit risk Liquidity risk Operational risk Interest rate risk Price risk Legal and compliance risk Reputational risk Strategic risk Solvency risk Possible environmental risks

Other perceived risks: k. What other risk(s) do you perceive your organisation faces apart from the risks mentioned above?

l.

Have you categorized these risks?

m.

What efforts are being made to cover these risks-measurement and their management?

Risk management tools: K. Which risk management model(s) do you use to manage all the risks faced by your bank(s)? To what extent qualitative and quantitative risk management models are used and how are they chosen? Please mention the underlying assumptions if any.

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L. Do you have in house developed risk management tools? What risk management tools do you use (e.g. VaR)?

Credit Risk A. How do you identify Credit worthiness of your customer?

B. Are you using any rating, score method or appraisers for checking credit worthiness of prospective customer? if yes then kindly provide some details.

C. Do you assess the value of leased property periodically? If yes then if there are changes then how you account for them?

Interest Rate Risk A. Are you hedging for interest rate risk? If yes, then how?

B. Economic perspective: - how do you manage the sensitivity of the value of the assets under consideration? -Adjusting the maturing and payment frequency of lease -Basing the implicit interest rate on a floating rate -Hedging the fixed rate exposure -Any other method

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Liquidity Risk How does your organization manage its liquidity risk?

Compliance Risk What is the stance of your organization on this kind of risk?

Rules & Regulations A. Are there any rules & regulation provided by any authority? If yes then kindly mention:

B. Are you aware of the terms & condition of contract between lessor & lessee? If there are many lessee lets say for a Mall there are 100 lessee then how do you monitor all the contracts?

Residual Value A. Is residual value considered? If yes, then how do you calculate the residual value of NPV or IRR (kindly mention assumptions /Model, if any?)

Supervision A. Does management supervise these kinds of deals? If yes, then How?

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Comments and considerations State any comments that you have on financing of lease rentals.

Exhibit: Cash Flow -100 230 -132 PV @ PV @ 10% Amount 20% 1 -100 1 0.909 209.09 0.833 0.826 -109.09 0.6944 0

Year 0 1 2

Amount -100 191.67 -91.67 0

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Annexure: PV model

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Annexure: Process Mapping

Executive Summary for RBI,New Delhi
Highlights
Reduction in Power Consumption considering all measures ( KW ) Total Power Savings considering all measures Total Monetary benefits considering all measures
Total Investments Simple Payback Period

137.65 KW 266864.40 Kwh 1467754.20 Rs

3828000 32 Rs Months

Energy Cost
Variable Unit Charges Fixed Charges Total Average Cost 5.5 Nil 5.5 Rs. Rs. Rs.

Total Operating Hours / Annum

Ceiling Fan CRT AC 1386 2376 1386 Hrs Hrs Hrs

Formulas used
Payback period = (Total Investment / Total Benefit x 12 )
Energy Saving Potential = ( P0-P1)/P1 x 100 Where P0 = Power consumption of inefficient old appliance P1 = Power consumption of energy efficient new appliance

Summary of all Energy Conservation Measures

S.No. Energy Conservation Measures Annual Savings Monetar Energy ( ) y Saving (Rs ) 156340.8 859874.4 26254.8 144401.4 84268.8 463478.4 266864.4 1467754 Payback Investme Period nt ( Rs ) (Months)

1 2 3

Change old ceiling fan with new energy efficient fans of 50W Replace CRT monitors with TFT monitors Replace 1.5 T Non Rated AC with Energy Efficient 5 star rated AC Total

1034000 754000 2040000 3828000

15 63 53 32

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Energy Conservation Measures

Cost based analysis of various conservation measures.

Change old ceiling fan with new energy efficient fans of 50W
Total installed ceiling fans Cost of Energy Efficient fan Power consumed by single old fan Power consumed by new energy efficient single fan Total Power consumed by old fans Total expected power consumed by new fans Reduction in power consumed Reduction in Energy consumption per annum Total Benefits per annum Total Investment Payback period Energy Saving Potential 940 1100 120 50 112800 47000 65800 156340.8 859874.4 1034000 15 58.3 Nos. Rs Watts Watts Watts Watts Watts Kwh Rs Rs Months %

Replace CRT monitors with TFT monitors

Total no. of CRT Effective cost of single TFT Monitor Consumption of single CRT monitor Total consumption of CRT monitors Consumption of single TFT monitor Total expected consumption of TFT monitors Reduction in power consumption Total power saving per annum Total benefits per annum Total investment Payback period Energy Savings Potential
130 5800 125 16250 40 5200 11050 26254.8 144401.4 754000 63 68 Nos. Rs Watts Watts Watts Watts Watts Kwh Rs Rs Months %

Replace 1.5 T Non Rated AC with Energy Efficient 5 star rated AC

Total no. of 1.5 T ACs Effective Cost of 1.5 T 5 star rated ACs Power Consumption of 1 Non rated AC Power Consumption of 1 Star rated AC Present power consumption of non rated Acs Expected power consumption of star rated Acs Reduction in power consumption Total power saving per annum Total monetory benefits per annum Total investment Payback period Energy Saving potential
80 25500 2060 1300 164800 104000 60800 84268.8 463478.4 2040000 53 36.9 Nos. Rs Watts Watts Watts Watts Watts Kwh Rs Rs Months %

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