Securitization is “the issuance of marketable securities backed by the expected cash flows from specific assets (receivables)”
Parties to an issue Originator The initial owner of the loans. Sells them to the SPV Obligors The loan customers. Pay cashflows that are securitised SPV Special purpose Vehicle Set up specifically for transaction. Purchases assets from Originator. Company/Trust/ Mutual Fund Investors Subscribe to securities issued by SPV
Parties to an issue (contd.) Collection Agent Collects money from Obligors, monitors and maintains assets. Usually the originator Credit Enhancement Provider Provides credit enhancement by way of swaps, hedges, guarantees, insurance etc. Merchant Banker As structurer for designing & executing the transaction and as arranger for the securities Credit Rating Agency Provides a rating for the deal based on structure, rating of parties & portfolio, legal and tax opinion etc
Generic deal diagram SPV Investors Originator Obligors Credit Enhancement Providers Rating Agency Structurer Collection Agent 1 2 3 4 5 6 7 9 Issue of securities Collections Credit enhancement Rating 8 Subscription to securities Cash flows 10 11 Servicing of securities Contracts Ongoing cash flows Initial cash flows Original Loan Sale of asset Purchase consideration Arranger
Why securitize assets?
More efficient financing
Improved balance sheet structure
Better risk management
What type of assets can be securitized?
Any type of asset with a reasonably predictable stream of future cash flows can be securitized.
Assets that are easiest to securitize are those: that occur in large pools; for which past experience can be used to predict default rates; for which documentation is standardized; and for which ownership is transferable.
Types of Securitization
MBS (Mortgage based securitization )
ABS (Asset based securitization)
What is required for a successful asset securitization?
Robust financial infrastructure
The Legal Environment
The Accounting Environment
The Regulatory Environment
The Taxation Environment
SECURITISATION -INDIAN CONTEXT
First deal in India between Citibank and GIC Mutual Fund, in 1990 for Rs. 160 million.
Securitisation of cash flow of high value customers of Rajasthan State Industrial and Development Corporation in 1994-95, structured by SBI cap.
Securitisation of overdue payments of UP government to HUDCO by issue of tax-free bonds worth Rs. 500 million
Securitisation of Sales Tax deferrals by Government Of Maharashtra in August 2001 for Rs. 1500 million with a green shoe option of Rs. 75 million.
First deal in power sector by Karnataka Electricity Board for receivables worth Rs. 1940 million and placed them with HUDCO.
Data indicate that ICICI had securitised assets to the tune of Rs. 27500 million in its books at end March 1999.
Some of the companies that have been Involved in this are
Ashok Leyland finance
Cholamandalam investment & finance
MBS - A Win-Win for All
Churn higher returns on lower capital base
Can invest in low-risk rated home loans paper without hassles of origination/ servicing
Financial system as a whole
Expertise of Specialists helps maintain quality of underlying assets and reduces ALM mismatches
Home Loan Customers
Access to cheaper funds
MORTGAGE BACKED SECURITIES IN INDIA
The beginning of Mortgage Backed Securities (MBS) in India was made in August 2000,
when National Housing Board (NHB) issued the first MBS with issue size of INR 59.7 crores, originated by HDFC Ltd.
The US secondary mortgages market
The US secondary mortgages market is considered to be the world’s most developed mortgage securitisation market.
The mortgage originators are commercial banks, thrifts, mortgage banks, and mortgage brokers.
The main secondary market conduits are Fannie Mae, Ginnie Mae and Freddie Mae.
Some private investment banks also act as conduits in the secondary mortgages market, but to a limited extent.
The investors in the secondary mortgages market are the pension funds, the life insurance companies, the commercial banks, the thrifts, and Fannie Mae.
INSTITUTION FRAMEWORK FOR THE SECONDARY MORTGAGES MARKET IN THE US
The housing and mortgages industry in US is overseen by U.S. Department of Housing and Urban Development (HUD).
It also sets goals for government owned Ginnie Mae, and Government Sponsored Enterprises (GSE) like Fannie Mae and Freddie Mac.
The Secretary of HUD is the mission regulator for Fannie Mae and Freddie Mac with oversight authority to ensure that both GSEs comply with the public purposes set forth in their charters.
The secretary is charged with the general regulatory authority over GSEs in all areas other than the GSEs financial safety and soundness.
The financial safety and soundness of GSEs is regulated by an independent office of HUD, the Office of Federal Housing Enterprise Oversight (OFHEO).
It regulates both the GSEs for safety and soundness, by ensuring that they are adequately capitalized and operating their businesses in a financially sound manner.
Institutional Framework in India
Under the present institutional framework National housing Board (NHB) is the apex level financial institution for the housing sector in the country
and performs the role of promotion and development, regulation and supervision, financing, development of secondary mortgages market through securitization of housing loans, and promotion of rural housing.
Most securitisations in India adopt a trust structure – with the underlying assets being transferred by way of a sale to a trustee, who holds it in trust for the investors.
The trustee typically issues PTCs. A PTC is a certificate of proportional beneficial interest.
Beneficial property and legal property is distinct in law – the issuance of the PTCs does not imply transfer of property by the SPV but certification of beneficial interest.
Stamp duty arises from the fact that a transfer of “actionable claims” (which term includes most receivables) will require a written instrument, and such instrument is treated as a “conveyance” in law, meaning a document whereby legal interest is conveyed in property.
A conveyance is a stampable document, and most states impose stamp duties ranging between 3% to 15-16% on the value of the property being transferred in a conveyance.
Since this would completely rule out any securitisation transaction, several states have relaxed their duties applicable on securitisation transactions – mostly to provide for 0.1% duty on the value of receivables being transferred.
The tax laws have no specific provision dealing with securitisation.
Hence, the market practice is entirely based on generic tax principles, and since these were never crafted for securitisations, experts’ opinions differ.
The generic tax rule is that a trustee is liable to tax in a representative capacity on behalf of the beneficiaries
– therefore, there is a prima facie taxation of the SPV as a representative of all end investors.
However, the representative tax is not applicable in case of non-discretionary trusts where the share of the beneficiaries is ascertainable.
The share of the beneficiaries is ascertainable in all securitisations – through the amount of PTCs held by the investors.
The market believes, though with no reliable precedent, that there will be no tax at the SPV level and the investors will be taxed on their share of income.
The scenario is, however, far from clear and the current thinking may be short lived.
Questions for Revision
What is securitization ? What are the advantages of securitization ?
Describe the structure of the securitization process ?