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Prepared by:- (a)Priyank Misra(75140)
(b)Ujval Chopra(75162)
(c)Shantanu Vashishth(75150)
(d)Puneet Arora(75141)
Subject: Financial Services(Semester IV)
Teacher: Prof. Manoj Sharma
5/5/20131
INTRODUCTION & RELATED CONCEPTS
PROCESS OF SECURITIZATION
INDIAN REGULATORY FRAMEWORK FOR
SECURITIZATION
SECURITIZATION: THE INDIAN SCENARIO
5/5/20132
Securitization refers to the process of pooling and selling existing
assets in the books of a lender/creditor(The ‗Originator‘) to a
Special Purpose Vehicle(SPV) and repackaging them into tradable
,asset-backed securities(ABS).The essential features of
securitization are :-
1) the sale proceeds are available to the Originator of the
transaction(i.e. the seller) immediately;
2) the assets are taken off the Originator‘s books and are not
available to the Originator‘s creditors in the event of his
bankruptcy;
3) can have higher credit ratings than the Originator‘s , depending
on the quality of assets securitized and credit enhancements
made available
5/5/20133
The different entities-:
Originator
• The original lender is called the originator.
• It is the entity on whose books the assets to be securitized exist.
• Typically, the Originator is a bank, a Non-banking finance company(NBFC), a housing finance company
or, occasionally even a manufacturing/service company.
Special Purpose Vehicle
• SPVs are companies with small capital, or sometimes trusts, formed for the specific purpose of issuing
securities in securitization transactions whose ownership and management are independent of the
Originator.
• In order to ensure that the assets actually achieve the bankruptcy remoteness, it is essential to move
them out of the balance sheet of the Originator and park them with another independent entity.
•The SPV is critical in a securitization transaction because it is this entity that delinks the
credit of the entity seeking funding from the creditworthiness of the securities that are
created in a securitization.
 Obligor
• The Obligor(s): The Obligor is the Originator's debtor (borrower of the original
loan).The amount outstanding from the Obligor is the asset that is transferred to
the SPV. The credit standing of the Obligor(s) is of paramount importance in a
securitization transaction 5/5/20134
Servicer
• The servicer collects the moneys due from individual borrowers in the pool, makes payouts
to the investors and follows up on delinquent accounts.
• The servicer also furnishes periodic information to the rating agency and the trustee on pool
performance.
 Trustee
• The trustees have a fiduciary role role to oversee the performance of the transaction until
maturity with a view to protect the interest of the investors.
• The trustee is vested with necessary powers including the, in particular, the power to
changer the Servicer, if necessary
• Trustees tend to be reputed banks, financial institutions or firms of Chartered Accountants or
Solicitors.
 Rating Agency
• Credit rating agencies rate the securities which are issued to provide an external
perspective on the liabilities being created and help the investor make a more informed
decision.
• The rating process would assess the strength of the cash flow and the mechanism designed
to ensure full and timely payment by the process of selection of loans of appropriate credit
quality, the extent of credit and liquidity support provided and the strength of the legal
framework.
5/5/20135
 Structurer
• Normally, an investment banker is responsible as structurer for bringing
together the Originator, credit enhancer/s, the investors and other
partners to a securitization deal. It also works with the Originator and
helps in structuring deals.
5/5/20136

 Credit Enhancement-
• It refers to the various means that attempt to buffer investors
against losses on the asset collateralizing their investment.
• Securities generated in a securitization deal are "credit
enhanced”, meaning their credit quality is increased above that of
the originator's unsecured debt or underlying asset pool.
• This increases the likelihood that the investors will receive cash
flows to which they are entitled, and thus causes the securities to
have a higher credit rating than the originator.
Credit Enhancements are either external(third party) or
internal(structural or cash-flow driven).
5/5/20137
* External Credit Enhancements:-
i. Insurance-
 Full insurance is provided against losses on the assets. This tantamounts to a 100 per
cent guarantee of a transaction‘s principal and interest payments. The issuer of the
insurance looks to an initial premium or other support to cover credit losses.
ii. Third-Party guarantee
 This method involves a limited/full guarantee by a third party to cover losses that
may arise on the non-performance of the collateral.
iii. Letter of credit
 For structures with credit ratings below the level sought for the issue, a third party
provides a letter of credit for a nominal amount. This may provide either full or
partial cover of the issuer‘s obligation.
5/5/20138
*
i. Credit Tranching
The SPV issues two(or more) tranches of securities and establishes a
predetermined priority in their servicing, whereby first losses are
borne by the holders of the subordinate tranches(at times originator
itself).Apart from providing comfort to holders of senior debt, credit
tranching also permits targeting investors with specific risk-return
preferences.
ii. Over Collateralisation
 The originator sets aside assets in excess of the collateral required to
be assigned to the SPV. The cash flows from these assets must first
meet any overdue payments of the main pool, before they can be
routed back to the originator.
iii. Cash Collateral
 This works in the same way as over-collateralisation.However, since
the quality of cash is higher than assets yet to be converted into
cash, the quantum of cash required to meet the desired rating would
be lower than asset over-collateral to that extent.
5/5/20139
iv. Spread Account
 For each period, the difference between the cash flow generated by the pool
of loans and receivables and the interest paid to the holders of the asset-
backed securities and the fees paid (primarily for servicing) is in effect the
monthly profit. In securitization terminology, it is referred to as the excess
spread.
 Only realizations in excess of this specified amount are routed back to the
Originator. This amount is returned to the Originator after the payment of
principal and interest to the investors.
 True Sale-
• The genesis of securitization lies in giving the investors rights over specific
assets of the originator, such that the investors are not affected by the
performance, or bankruptcy of the originator. This would obviously necessitate
that the investors, or the SPV which is a conduit on behalf of the investors, has
legally acquired the assets.
• True sale involves legal separation of the Originator from the assets, with the
purpose of putting them beyond the reach of the Originator or its
creditors, even in the event of bankruptcy of the Originator. This is known as
‘bankruptcy remoteness’ of the transaction
5/5/201310
 Why is True Sale required?
• Bankruptcy Remoteness ensures that the cash flows from the securitized assets are available
solely for the benefit of the SPV and its creditors, namely the holders of the PTCs, or ,in other
words , to allow investors an unqualified right over the assets being securitized.
 What if a transfer is not a true sale?
If the transfer of assets for the benefits of investors is not a true sale, it
might mean:
*the investors are unsecured lenders
*the transfer is regarded as creating security interest in favour of investors; so
the investors are secured lenders (whether such security interest is perfected
or not will depend on the procedure relating to perfection of security
interests)
*worst of all, since the transaction would not have been backed by loan
documentation, the investors may not be regarded as lenders as well -
meaning, they might only have an equitable right to recover their money but
would not stand as unsecured lenders. 5/5/201311
 Pass through Certificates(PTCs) & Pay Through Securities(PTS)
 Pass through Certificates-
• Cash flows are ‗passed through‘ to the holders of the securities in the form of
monthly payment of interest, principal and pre-payments.
• They reflect ownership rights in the assets backing the securities.
• Pre-payment precisely reflects the payment on the underlying mortgage. If it
is a home loan with monthly payments, the payments on securities would also
be monthly but at a slightly less coupon rate than the loan.
 Pay through Securities
• This permits the issuer to restructure receivables flow to offer investment
maturities to the investors associated with varied yields and risks. The issuer
owns the receivables and sells the the debt backed by the assets.
• The cash flows can be remade into various debt tranches with different
maturities.
5/5/201312
ILLUSTRATION OF A SECURITIZATION
* We use a hypothetical securitization to illustrate the key elements of a securitization and the parties to a transaction. Our hypothetical firm is the
Ace Corporation, a manufacturer of specialized equipment for the construction of commercial buildings. Some of its sales are for cash, but the bulk
are from installment sales contracts. For simplicity, we assume that the installment period is typically seven years. The collat- eral for each
installment sales contract (sometimes loosely referred to herein as a loan) is the construction equipment purchased by the bor- rower. The loan
specifies the interest rate the customer pays.
* The decision to extend a loan to a customer is made by the credit department of Ace Corporation based on criteria established by the firm, referred
to as its underwriting standards. In this securitization, Ace Corporation is referred to as the originator because it has origi- nated the loans to its
customers. Moreover, Ace Corporation may have a department that is responsible for collecting payments from customers, notifying customers who
may be delinquent, and, when necessary, recovering and disposing of the collateral (i.e., the con- struction equipment in our illustration) if the
customer fails to make loan repayments by a specified time. These activities are referred to as servicing the loan. While the servicer of the loans
need not be the originator of the loans, in our illustration we are assuming that Ace Corporation is the servicer.
* Suppose that Ace Corporation currently has $400 million in installment sales contracts (i.e., its accounts receivable). The chief financial officer (CFO)
of Ace Corporation wants to use its install- ment sales contracts to raise $320 million rather than issue a tradi- tional corporate bond. To do so, the
CFO will work with its legal staff to set up a legal entity referred to as a special purpose vehicle (SPV), also referred to as a special purpose entity
(SPE). The SPV is critical
* Introduction 9
* in a securitization transaction because it is this entity that delinks the credit of the entity seeking funding (Ace Corporation) from the
creditworthiness of the securities that are created in a securitization. Assume that the SPV set up by Ace Corporate is called Financial Ace Trust
(FACET). Ace Corporation sells $320 million of the loans to FACET and receives from FACET $320 million in cash, the amount the CFO wanted to raise.
Since Ace Corporation is the originator of the loans and has sold these loans to FACET, Ace Corporation is referred to as the originator/seller in this
transaction.
* It is critical that the sale of the loans transferred be a true sale by Ace Corporation to FACET. By a true sale it is meant that the sale of the assets
closely substantively resembles a commercial sale of such assets by Ace Corporation. If it is subsequently determined in a bank- ruptcy proceeding
that the so-called sale by Ace Corporation was merely a nomenclature or a camouflage, then a bankruptcy judge can rule that the assets were never
sold and were merely pledged as col- lateral for a financing. In that case, in the event of a bankruptcy filing by Ace Corporation, the bankruptcy
judge can have the assets of FACET treated as part of the assets of Ace Corporation. This would defeat the purpose of setting up the SPV. Typically, a
true sale opinion letter by a law firm is sought to provide additional comfort to the parties in the transaction.
* Where does FACET obtain the $320 million to buy the assets? It does so by issuing asset-backed securities, called bond classes or tranches. A simple
transaction can involve the sale of just one bond class with a par value of $320 million. The payments to the bond classes are obtained from the
payments made by the obligors (i.e., the buyers of the construction equipment). The payments from the obli- gors include principal repayment and
interest. However, most secu- ritization transactions involve a more complex structure than simply one bond class. For example, there can be rules
for distribution of principal and interest other than on a pro rata basis to different bond classes. The creation of different bond classes allows the
distribution of the collateral‘s risk among different types of investors: investors with different appetite‘s for interest rate risk (i.e., price sensitivity
to changes in interest rates) and credit risk.
* An example of a more complicated transaction is one in which two bond classes are created, bond class A1 and bond class A2. The
* 10 BACKGROUND
* par value for bond class A1 is $120 million and for bond class A2 is $200 million. The priority rule set forth in the structure can simply specify that
bond class A1 receives all the principal generated from the collateral until all the entire $120 million of bond class A1 is paid off and then bond class
A2 begins to receive principal. Bond class A1 is then a shorter-term bond than bond class A2. This type of tranching is used to create securities with
different exposures to interest rate risk.
* Also, as will be explained in later chapters, in most securitizations there is more than one bond class and the various bond classes differ as to how
they share any losses resulting from the obligor defaults. For example, suppose FACET issued $290 million par value of bond class A, the senior bond
class, and $30 million par value of bond class B, a subordinated bond class. As long as there are no defaults by obligors that exceed $30 million, then
bond class A receives full repayment of its $290 million. 5/5/201313
5/5/201314
Typical Securitization Structure
*
5/5/201315
First securitization deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160
mnRs 160 mn
&T raised Rs 4,090 mn through the securitization of future lease rentals to raise capital for its
power plant in 1999.capital for its power plant in 1999.
India‘s first securitization of personal loan by Citibank in 1999 for Rs 2,841 mn
India‘s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in 2001.
securitization of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through off shore
SPV.
India‘s first sales tax deferrals securitization by Govt of Maharashtra in 2001 for Rs1,500
mn.1,500 mn.
India‘s first deal in the power sector by Karnataka Electricity Board for receivables-India‘s first
deal in the power sector by Karnataka Electricity Board for receivables worth Rs 1,940 mn and
placed them with HUDCO. worth Rs 1,940 mn and placed them with HUDCO.
India‘s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002.
India‘s first floating rate securitization issuance by Citigroup of Rs 2,810 mn in 2003 The fixed
rate auto loan receivables of Citibank and Citicorp Finance India included in the securitization
India‘s first securitization of sovereign lease receivables by Indian Railway Finance Corporation
(IRFC) of Rs 1,960 mn in 2005.The receivables consist of lease amounts payable by the ministry
of railways to IRFC.
India‘s largest securitization deal by ICICI bank of Rs 19,299 mn in 2007.Theunderlying asset
pool was auto loan receivables.
 http://www.financialexpress.com/news/Indian-securitization/191022/0http://www.financialexpress.com/news/Indian-securitization/191022/0
*Types of Securitization:
Asset Backed securities (ABS) :
• ABS refers to the securitization of non-mortgage retail loans. Till the late 1990s, assets classes
securitized under ABS in India included only car loans and commercial vehicle loans.
Thereafter, construction equipment loans, two wheeler loans, utility vehicle loans, and personal loan
pools, have also been securitized.
Mortgage Backed Securities (MBS)
• (MBS) are asset-backed securities whose cash flows are backed by the principal and interest payments of a set of
mortgage loans.
• Since the underlying home loans in MBS pool have a floating-rate, the scheduled cash flow on such pools is
uncertain and liable to change, depending on actual interest rate. Moreover, options to convert from fixed to
floating rate and vice-versa, coupled with negotiated re-pricing of loans, added to the uncertainty of the cash
flow in the MBS pool.
• With the underlying loans earning floating rates, Pass Through Certificates (PTCs) in MBS issues are also being
predominantly priced on a floating rate basis. In 2005, 52% of issuance was based on a floating rate.
Collateralized Debt Obligation (CDO) :
• In CDO transactions, the debt securities issued by the SPV are backed by a diversified loan or bond
portfolio. There is thus a basic difference between CDOs and ABS, the latter being homogeneous pools of
assets such as mortgages or credit card receivables, in contrast to the diversified portfolios backing
CDOs.
Collateralized Loan Obligations :
Where the originating bank transfers a pool of loans, the bonds that emerge are called collateralized
loan obligations or CLOs.
Collateralized Bond Obligations :
Where the bank transfers a portfolio of bonds and securitizes the same, the resulting securitized bonds
could be called collateralized bond obligations or CBOs.
5/5/201316
*
17
18
•By the late 1990s, a rising level of bank N.P.As motivated committees like the
Narasimham Committee II and Andhyarujina Committee, which were constituted
for examining banking sector reforms, to seek changes in the legal system to
address the issue of N.P.As.
•The SARFAESI Act empowers Banks / Financial Institutions to recover their Non-
Performing Assets without the intervention of the Court. It was passed in 2002 to
legalize securitisation and reconstruction of financial assets and enforce security
interest. The Act envisaged the formation of Asset Reconstruction Companies
(A.R.Cs) and securitisation Companies (S.Cs).
•The main provisions of this Act include-
registration and regulation of securitisation companies or reconstruction
companies by the R.B.I,
 facilitate securitisation of financial assets of banks,
empower S.Cs/A.R.Cs to raise funds by issuing security receipts to qualified
institutional buyers (QIBs),
empowering banks and FIs to take possession of securities given for financial
assistance and sell or lease the same to take over management in the event of
default.
19
THE SARFAESI ACT, 2002
The Act provides three alternative methods for recovery of N.P.As, namely:
Securitisation: means issuing securities by raising of receipts or funds by
S.Cs/A.R.Cs, from Qualified Institutional Buyers by forming schemes for
acquiring financial assets. The S.C/A.R.C shall maintain separate accounts for
each such scheme for every financial asset acquired, out of investments made
by a QIB and ensure that realizations of such financial assets are applied
towards redemption of investments and payment of returns assured on such
investments under the relevant scheme.
Asset Reconstruction: The S.Cs/A.R.Cs for the purpose of asset
reconstruction should
provide for any one or more of the following measures:
the proper management of the business of the borrower, by change in, or take
over of, the management of the business of the borrower.
the sale or lease of a part or whole of the business of the borrower.
rescheduling of payment of debts payable by the borrower.
enforcement of security interest in accordance with the provisions of this Act
settlement of dues payable by the borrower.
taking possession of secured assets in accordance with the provisions of this
Act.
*
20
Exemption from Registration of Security Receipt: The Act also
provides, notwithstanding anything contained in the Registration Act, 1908, for
enforcement of security without Court intervention:
(a) any security receipt issued by the S.C or A.R.C, as the case may be, under
section 7 of the Act, and not creating, declaring, assigning, limiting or
extinguishing any right, title or interest to or in immovable property except
in so far as it entitles the holder of the security receipt to an undivided
interest afforded by a registered instrument; or
(b) any transfer of security receipts, shall not require compulsory registration.
•The Guidelines for S.Cs/A.R.Cs registered with the R.B.I are:
Act as an agent for any bank or FI for the purpose of recovering their dues
from the borrower on payment of such fees or charges
Act as a manager between the parties, without raising a financial liability for
itself;
Act as receiver if appointed by any court or tribunal.
Apart from above functions any S.C/A.R.C cannot commence or carryout other
business without the prior approval of R.B.I.
*
21
•Right of Title
A securitisation receipt gives its holder a right of title or interest in the financial
assets included in securitisation. This definition holds good for securitisation
structures where the securities issued are referred to as 'Pass Through
Securities'. The same definition is not legally inadequate in case of 'Pay Through
Securities' with different tranches.
•Thin Investor Base
The SARFAESI Act has been structured to enable security receipts to be issued
and held by Qualified Institutional Buyers. It does not include N.B.F.C or other
bodies unless specified by the Central Government as a financial institution. For
expanding the market for SR, there is a need to increase the investor base. In
order to deepen the market for SR there is a need to include more buyer
categories.
•Investor Appetite
Demand for securities is restricted to short tenor papers and highest ratings.
Also, it has remained restricted to senior tranches carrying highest ratings, while
the junior tranches are retained by the originators as unrated pieces. This can
be attributed to the underdeveloped nature of the Indian market and poor
awareness as regards the process of securitisation.
22
THE SECURITISATION COMPANIES AND
RECONSTRUCTION COMPANIES (RESERVE BANK)
GUIDELINES AND DIRECTIONS, 2003
The R.B.I issued guidelines and directions relating to registration, measures of
A.R.Cs, functions of the company, prudential norms, acquisition of financial assets and
related matters under the powers conferred by the SARFAESI Act, 2002.
Defining N.P.As: Non-Performing Asset (N.P.A) means an asset for which:
Interest or principal (or installment) is overdue for a period of 180 days or more from the
date of acquisition or the due date as per contract between the borrower and the
originator, whichever is later;
Interest or principal (or installment) is overdue for a period of 180 days or more from the
date fixed for receipt thereof in the plan formulated for realization of the assets.
Interest or principal (or installment) is overdue on expiry of the planning period, where no
plan is formulated for realization of the any other receivable, if it is overdue for a period of
180 days or more in the books of the S.C or A.R.C.
It is provided that the Board of Directors of a S.C or A.R.C may, on default by the
borrower, classify an asset as a N.P.A even earlier than the period mentioned above.
23
THE RECOMMENDATIONS OF THE HIGH LEVEL
COMMITTEE ON CORPORATE DEBT AND
SECURITISATION, 2005
•The recommendations of the High Level Committee on Corporate Debt and
Securitisation (Chairman: Dr.R.H.Patil) in 2005 proved to be one of the turning
point towards the development of the corporate debt and securitisation market.
Some of the key recommendations included:
Evolve a consensus on the affordable rates and levels of stamp duty on debt
assignment, Pass through Certificates (PTCs) and security receipts (SRs) across
States.
An explicit tax pass-through treatment to securitisation SPVs / Trust SPVs
should be provided. Wholesale investors should be permitted to invest in and
hold units of a close-ended passively managed mutual fund whose sole objective
is to invest its funds in securitised paper.
Large-sized NBFCs and non-NBFCs corporate bodies established in India may be
permitted to invest in SRs as Qualified Institutional Buyers. Private equity funds
registered with SEBI as venture capital funds (VCFs) may also be permitted to
invest in SRs within the limits that are applied for investment by VCFs into
corporate bonds
24
R.B.I GUIDELINES FOR SECURITISATION OF
STANDARD ASSETS (FEB 2006)
•In February 2006, the RBI issued guidelines for securitisation of standard assets
by Banks, FIs and NBFCs. These guidelines provided the regulatory framework for
several critical aspects of securitisation and are expected to establish a more
robust structured credit market. The guidelines were broadly as follows:
Detailed guidelines to ensure ―arms length‖ relationship between the
originator and the SPV, i.e. they are independent of each other.
Credit enhancements provided by the originator for the first as well as second
losses to be deducted from the capital.
Any profit/premium arising on account of sale not allowed to be booked
upfront and is to be amortised over the life of the securities issued or to be
issued by the SPV
Disclosure by the originator, as notes to accounts, a comparative position for
two years of the following items: 1) the total number and book value of loan
assets securitised; 2) sale consideration received for the securitised assets and
gain/loss on sale on account of securitisation; 3) form and quantum (outstanding
value) of services provided by way of credit enhancement, liquidity
support, post securitisation asset servicing, etc.
25
R.B.I GUIDELINES FOR SECURITISATION OF
STANDARD ASSETS (FEB 2006)
•Though some concerns have been raised regarding these guidelines as being
restrictive, RBI is very clearly treading a cautious step adopting an officially
termed ―incentive-compatible prudential approach towards securitisation‖ - an
approach defensible in the aftermath of the recent sub-prime episode in some
developed countries.
•In 2007, the Securities Contracts (Regulation) Amendment Act 2007 amended
the Securities Contract (Regulation) Act to include ―securitised instruments‖ in
the definition of ―securities‖. The amendment has paved way for listing and
trading of securitised debt on stock exchanges.
26
GUIDELINES ON SECURITISATION AND DIRECT
ASSIGNMENT TRANSACTIONS (MAY 2012)
•The RBI, in May 2012, put out the final guidelines on securitisation and direct
assignment of assets by banks.
•This is the first time the RBI has issued separate guidelines for Direct
Assignment transactions. Amongst the important new prescription in the
guidelines is the prohibition of credit enhancement for direct assignment
transactions. The other key stipulations are a Minimum Holding Period (MHP) for
Originators before off-loading the receivables and a Minimum Retention
Requirement (MRR) through the tenure of the transaction.
•The guidelines are expected to have far-reaching implications on the issuance
volumes as well as the nature of the transaction structures adopted.
*
27
*
•Key Originators segment
N.B.F.Cs
Key Investor segment
Banks
Typically AAA ratings targeted, though wider ratings spread over past 2 years.
•Tenure
MBS: door-to-door 12 to 20 years (Average 6 to 8 years)
ABS: door-to-door 40 to 60 months (Average 18 to 24 months)
•Investor Yield
ABS – fixed yield
RMBS – floating yield, linked to pool yield or external benchmark.28
29
30
•Securitisation in India began in the early 1990s, with CRISIL rating the first
securitisation program in 1991-92, of an auto loan. Citibank securitized auto loans and
placed a paper with GIC mutual fund worth about Rs. 16 crores.
•Securitisation began with the sale of consumer loan pools, and originators directly
sold loans to buyers. They acted as servicers and collected installments due on the
loans.
•Creation of transferable securities backed by pool receivables (known as PTCs)
became common in late 1990s. Through most of the 90s, securitisation of auto loans
was the mainstay of the Indian markets.
•Initially it started as a device for bilateral acquisitions of portfolios of finance
companies.
These were forms of quasi-securitisations, with portfolios moving from the balance
sheet
of one originator to that of another.
•But from 2000 till today, Asset-Backed Securities (ABS) and Residential Mortgage-
Backed Securities (RMBS) have fuelled the growth of the Indian securitisation market.
HISTORY OF SECURITISATION IN INDIA
*
31
*
32
*
33
*
34
SECURITISATION IN INDIA (2000-2006)
•The volume of issuances of securitised transactions grew exponentially beginning in
2000 due to rapid growth of consumer finance. There were approximately 75 issuances
each year after 2000 till 2006.
•Securitisation of rated transactions increased from less than Rs.1,000crore in 1998, to
over Rs.30,000 crore in 2004 – 05.
•Number of originators was less than 5 in 2000, and rose to more than 20 in 2005.The
top five originators accounted for 90% of the issuance volume in 2004-05.
•Investors acceptance of securitized instruments also gradually improved, due to
passing of SARFAESI Act in 2002.There was pressure on the resources of large
originators due to continued growth in consumer credit. The growth of debt funds, the
largest investors in securitized paper, also supported the expansion of the
securitisation market .
•ABS accounted for over two-thirds of issuances of all securitised issuances during this
period. From 2004 to 2005, 40% of vehicle finance was funded through ABS backed by
auto loans.
35
Scenario before Feb
2006 Guidelines
Scenario after Feb 2006
Guidelines
•Securitisation transactions
dominant (over 80% in FY06)
•ABS is the key product, and
ABS issuance is dominated by
banks .
•Surge in Direct Assignment
transactions (75% in FY12)
•Securitisation by banks
gradually reduced - no bank-
originated transactions in last
2 years , although they are
the key investor segment.
•Surge in ABS as well as RMBS
transactions, and decline in
LSO (Loan Sell-Off) issuances.
*
36
37
Source: ICRA Rating Feature, May 2012
38
*
•During FY2012, the securitisation market in India grew by 15% over the
previous year, in value terms. The number of transactions was also 32% higher in
FY2012 than in the previous fiscal year.
•LSO issuance has been witnessing a sharp decline since FY2009. LSO, or Loan
Sell-Off transactions were largely short-term in nature and the Originator would
typically disburse the loan with the specific intention of securitising it soon
after the disbursement.
•RBI‘s draft guidelines issued in the first quarter of FY2011, specially the
requirement of Minimum Holding Period (MHP) of 9 to 12 months, created a
potential interest rate risk for the Originator and adversely affected the LSO
issuance volume.
39
40
Source: ICRA Rating Feature, May 2012
*
41
*
•After the issuance of the securitisation guidelines in 2006, there has been a high
preference for ‗direct or bilateral assignment‘ of retail loan pools, i.e., direct sale of a
selected loan pool by the ‗Originator‘ to the ‗Purchaser‘ together with limited credit
support, as against securitisation which involves the sale of receivables to a SPV and
issuance of PTCs by the SPV.
•Over the past four years i.e. since FY2009, about 75-80% of the total number of ABS and
RMBS transactions has been in the nature of direct assignment transactions. This is huge
growth, considering the figures of 25% in FY2006, and 58% in FY2008.
•The preference for par structures continued to be high in FY2012; ―premium‖ structures
accounted for only 10% of the total number of ABS and RMBS issuance during the year as
against 37% and 18% in FY2010 and FY2011, respectively. RBI‘s circular of January 2011
notifying banks to consider only the par value of transactions for obtaining priority sector
benefit on loans, was a huge factor contributing to the preference for ―par‖ structure.
42
*
Source: ICRA Rating Feature, May 2012
•The number of ABS issues increased significantly by 58% in FY2012 to 178
transactions.
•The average deal size was lower at Rs. 146 crore in FY2012 compared to
Rs. 193 crore in FY2011. This was on account of higher number of
Microfinance transactions executed in FY2012 at 65 that was about twice
the issuance in FY2011 at 34.
•The total number of issuers in the ABS space increased from 23 to 33 as
some microfinance entities entered the securitisation (or assignment)
market.
•Shriram Transport Finance Company, SREI Equipment Finance, Indiabulls
Financial Services Ltd., Sundaram Finance and Shriram City Union Finance
were the largest Originators in FY2012, altogether contributing to over 60%
of the total number of ABS issuances.
43
*
44
*
•In FY2012, Commercial Vehicle (CV) and Construction Equipment (CE)
loans continued to be the key asset class accounting for two-thirds of
the total ABS volumes.
•The long and relatively stable track record of CV / CE lending in the
country (also demonstrated through good performance of the past
pools) and the relatively larger size of CV / CE loan portfolios in the
industry have been the key factors for the popularity of this asset
segment in securitisation.
•Microfinance and SME loans, which had a small share in securitisation
in the previous year‘s emerged as the other key loan categories to be
securitised accounting for almost 11% each in FY2012 from about 7% and
2% in FY2011.
• However, there was some securitisation of Two Wheeler and Three
Wheeler loans in FY2012, a segment absent during the previous two
years. 45
*
46
*
Source: ICRA Rating Feature, May 2012
•The number of RMBS issuances increased to 22 in FY2012 along with an
increase of 53% in value terms. However, the average deal size marginally
reduced to Rs. 349 crore in FY2012 from Rs. 359 crore in FY2011.
•RMBS segment continued to be highly concentrated with HDFC and Dewan
Housing Finance, which together contributed to about 85% of all issuances.
•Despite higher issuances seen in the year, the traditional obstacles to RMBS in
India, viz., long tenure of RMBS paper, the lack of secondary market
liquidity, high stamp duty on transfer of security, tenure uncertainty, interest
rate risk and prepayment risk, continued to hinder the growth of this segment.
•Nevertheless, regulatory requirements—certain category of home loans qualify
as priority sector lending—provide the motive for trading in home loans too.
Accordingly, banks were typically the investors in these transactions.47
*
*
48
•Though retail loan securitisation improved in FY2012, the issuance
volume in India continues to remain subdued and concentrated among a
few originators.
•Around 75% of the market in FY2012 was essentially bilateral loan pool
trading, driven by the economics of priority sector lending targets. It
follows that the investor segment is largely banks—mainly private sector
and foreign banks.
•The final guidelines on securitization and bilateral assignments are
expected to result in a significant decline in volume of bilateral
assignments given the prohibition on credit enhancements by
originators in these transactions.
•In addition to regulatory prescriptions, the pace of growth in loan book
size among key players would continue to be a basic determinant of
level of securitisation activity.

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Securitisation

  • 1. Prepared by:- (a)Priyank Misra(75140) (b)Ujval Chopra(75162) (c)Shantanu Vashishth(75150) (d)Puneet Arora(75141) Subject: Financial Services(Semester IV) Teacher: Prof. Manoj Sharma 5/5/20131
  • 2. INTRODUCTION & RELATED CONCEPTS PROCESS OF SECURITIZATION INDIAN REGULATORY FRAMEWORK FOR SECURITIZATION SECURITIZATION: THE INDIAN SCENARIO 5/5/20132
  • 3. Securitization refers to the process of pooling and selling existing assets in the books of a lender/creditor(The ‗Originator‘) to a Special Purpose Vehicle(SPV) and repackaging them into tradable ,asset-backed securities(ABS).The essential features of securitization are :- 1) the sale proceeds are available to the Originator of the transaction(i.e. the seller) immediately; 2) the assets are taken off the Originator‘s books and are not available to the Originator‘s creditors in the event of his bankruptcy; 3) can have higher credit ratings than the Originator‘s , depending on the quality of assets securitized and credit enhancements made available 5/5/20133
  • 4. The different entities-: Originator • The original lender is called the originator. • It is the entity on whose books the assets to be securitized exist. • Typically, the Originator is a bank, a Non-banking finance company(NBFC), a housing finance company or, occasionally even a manufacturing/service company. Special Purpose Vehicle • SPVs are companies with small capital, or sometimes trusts, formed for the specific purpose of issuing securities in securitization transactions whose ownership and management are independent of the Originator. • In order to ensure that the assets actually achieve the bankruptcy remoteness, it is essential to move them out of the balance sheet of the Originator and park them with another independent entity. •The SPV is critical in a securitization transaction because it is this entity that delinks the credit of the entity seeking funding from the creditworthiness of the securities that are created in a securitization.  Obligor • The Obligor(s): The Obligor is the Originator's debtor (borrower of the original loan).The amount outstanding from the Obligor is the asset that is transferred to the SPV. The credit standing of the Obligor(s) is of paramount importance in a securitization transaction 5/5/20134
  • 5. Servicer • The servicer collects the moneys due from individual borrowers in the pool, makes payouts to the investors and follows up on delinquent accounts. • The servicer also furnishes periodic information to the rating agency and the trustee on pool performance.  Trustee • The trustees have a fiduciary role role to oversee the performance of the transaction until maturity with a view to protect the interest of the investors. • The trustee is vested with necessary powers including the, in particular, the power to changer the Servicer, if necessary • Trustees tend to be reputed banks, financial institutions or firms of Chartered Accountants or Solicitors.  Rating Agency • Credit rating agencies rate the securities which are issued to provide an external perspective on the liabilities being created and help the investor make a more informed decision. • The rating process would assess the strength of the cash flow and the mechanism designed to ensure full and timely payment by the process of selection of loans of appropriate credit quality, the extent of credit and liquidity support provided and the strength of the legal framework. 5/5/20135
  • 6.  Structurer • Normally, an investment banker is responsible as structurer for bringing together the Originator, credit enhancer/s, the investors and other partners to a securitization deal. It also works with the Originator and helps in structuring deals. 5/5/20136
  • 7.   Credit Enhancement- • It refers to the various means that attempt to buffer investors against losses on the asset collateralizing their investment. • Securities generated in a securitization deal are "credit enhanced”, meaning their credit quality is increased above that of the originator's unsecured debt or underlying asset pool. • This increases the likelihood that the investors will receive cash flows to which they are entitled, and thus causes the securities to have a higher credit rating than the originator. Credit Enhancements are either external(third party) or internal(structural or cash-flow driven). 5/5/20137
  • 8. * External Credit Enhancements:- i. Insurance-  Full insurance is provided against losses on the assets. This tantamounts to a 100 per cent guarantee of a transaction‘s principal and interest payments. The issuer of the insurance looks to an initial premium or other support to cover credit losses. ii. Third-Party guarantee  This method involves a limited/full guarantee by a third party to cover losses that may arise on the non-performance of the collateral. iii. Letter of credit  For structures with credit ratings below the level sought for the issue, a third party provides a letter of credit for a nominal amount. This may provide either full or partial cover of the issuer‘s obligation. 5/5/20138
  • 9. * i. Credit Tranching The SPV issues two(or more) tranches of securities and establishes a predetermined priority in their servicing, whereby first losses are borne by the holders of the subordinate tranches(at times originator itself).Apart from providing comfort to holders of senior debt, credit tranching also permits targeting investors with specific risk-return preferences. ii. Over Collateralisation  The originator sets aside assets in excess of the collateral required to be assigned to the SPV. The cash flows from these assets must first meet any overdue payments of the main pool, before they can be routed back to the originator. iii. Cash Collateral  This works in the same way as over-collateralisation.However, since the quality of cash is higher than assets yet to be converted into cash, the quantum of cash required to meet the desired rating would be lower than asset over-collateral to that extent. 5/5/20139
  • 10. iv. Spread Account  For each period, the difference between the cash flow generated by the pool of loans and receivables and the interest paid to the holders of the asset- backed securities and the fees paid (primarily for servicing) is in effect the monthly profit. In securitization terminology, it is referred to as the excess spread.  Only realizations in excess of this specified amount are routed back to the Originator. This amount is returned to the Originator after the payment of principal and interest to the investors.  True Sale- • The genesis of securitization lies in giving the investors rights over specific assets of the originator, such that the investors are not affected by the performance, or bankruptcy of the originator. This would obviously necessitate that the investors, or the SPV which is a conduit on behalf of the investors, has legally acquired the assets. • True sale involves legal separation of the Originator from the assets, with the purpose of putting them beyond the reach of the Originator or its creditors, even in the event of bankruptcy of the Originator. This is known as ‘bankruptcy remoteness’ of the transaction 5/5/201310
  • 11.  Why is True Sale required? • Bankruptcy Remoteness ensures that the cash flows from the securitized assets are available solely for the benefit of the SPV and its creditors, namely the holders of the PTCs, or ,in other words , to allow investors an unqualified right over the assets being securitized.  What if a transfer is not a true sale? If the transfer of assets for the benefits of investors is not a true sale, it might mean: *the investors are unsecured lenders *the transfer is regarded as creating security interest in favour of investors; so the investors are secured lenders (whether such security interest is perfected or not will depend on the procedure relating to perfection of security interests) *worst of all, since the transaction would not have been backed by loan documentation, the investors may not be regarded as lenders as well - meaning, they might only have an equitable right to recover their money but would not stand as unsecured lenders. 5/5/201311
  • 12.  Pass through Certificates(PTCs) & Pay Through Securities(PTS)  Pass through Certificates- • Cash flows are ‗passed through‘ to the holders of the securities in the form of monthly payment of interest, principal and pre-payments. • They reflect ownership rights in the assets backing the securities. • Pre-payment precisely reflects the payment on the underlying mortgage. If it is a home loan with monthly payments, the payments on securities would also be monthly but at a slightly less coupon rate than the loan.  Pay through Securities • This permits the issuer to restructure receivables flow to offer investment maturities to the investors associated with varied yields and risks. The issuer owns the receivables and sells the the debt backed by the assets. • The cash flows can be remade into various debt tranches with different maturities. 5/5/201312
  • 13. ILLUSTRATION OF A SECURITIZATION * We use a hypothetical securitization to illustrate the key elements of a securitization and the parties to a transaction. Our hypothetical firm is the Ace Corporation, a manufacturer of specialized equipment for the construction of commercial buildings. Some of its sales are for cash, but the bulk are from installment sales contracts. For simplicity, we assume that the installment period is typically seven years. The collat- eral for each installment sales contract (sometimes loosely referred to herein as a loan) is the construction equipment purchased by the bor- rower. The loan specifies the interest rate the customer pays. * The decision to extend a loan to a customer is made by the credit department of Ace Corporation based on criteria established by the firm, referred to as its underwriting standards. In this securitization, Ace Corporation is referred to as the originator because it has origi- nated the loans to its customers. Moreover, Ace Corporation may have a department that is responsible for collecting payments from customers, notifying customers who may be delinquent, and, when necessary, recovering and disposing of the collateral (i.e., the con- struction equipment in our illustration) if the customer fails to make loan repayments by a specified time. These activities are referred to as servicing the loan. While the servicer of the loans need not be the originator of the loans, in our illustration we are assuming that Ace Corporation is the servicer. * Suppose that Ace Corporation currently has $400 million in installment sales contracts (i.e., its accounts receivable). The chief financial officer (CFO) of Ace Corporation wants to use its install- ment sales contracts to raise $320 million rather than issue a tradi- tional corporate bond. To do so, the CFO will work with its legal staff to set up a legal entity referred to as a special purpose vehicle (SPV), also referred to as a special purpose entity (SPE). The SPV is critical * Introduction 9 * in a securitization transaction because it is this entity that delinks the credit of the entity seeking funding (Ace Corporation) from the creditworthiness of the securities that are created in a securitization. Assume that the SPV set up by Ace Corporate is called Financial Ace Trust (FACET). Ace Corporation sells $320 million of the loans to FACET and receives from FACET $320 million in cash, the amount the CFO wanted to raise. Since Ace Corporation is the originator of the loans and has sold these loans to FACET, Ace Corporation is referred to as the originator/seller in this transaction. * It is critical that the sale of the loans transferred be a true sale by Ace Corporation to FACET. By a true sale it is meant that the sale of the assets closely substantively resembles a commercial sale of such assets by Ace Corporation. If it is subsequently determined in a bank- ruptcy proceeding that the so-called sale by Ace Corporation was merely a nomenclature or a camouflage, then a bankruptcy judge can rule that the assets were never sold and were merely pledged as col- lateral for a financing. In that case, in the event of a bankruptcy filing by Ace Corporation, the bankruptcy judge can have the assets of FACET treated as part of the assets of Ace Corporation. This would defeat the purpose of setting up the SPV. Typically, a true sale opinion letter by a law firm is sought to provide additional comfort to the parties in the transaction. * Where does FACET obtain the $320 million to buy the assets? It does so by issuing asset-backed securities, called bond classes or tranches. A simple transaction can involve the sale of just one bond class with a par value of $320 million. The payments to the bond classes are obtained from the payments made by the obligors (i.e., the buyers of the construction equipment). The payments from the obli- gors include principal repayment and interest. However, most secu- ritization transactions involve a more complex structure than simply one bond class. For example, there can be rules for distribution of principal and interest other than on a pro rata basis to different bond classes. The creation of different bond classes allows the distribution of the collateral‘s risk among different types of investors: investors with different appetite‘s for interest rate risk (i.e., price sensitivity to changes in interest rates) and credit risk. * An example of a more complicated transaction is one in which two bond classes are created, bond class A1 and bond class A2. The * 10 BACKGROUND * par value for bond class A1 is $120 million and for bond class A2 is $200 million. The priority rule set forth in the structure can simply specify that bond class A1 receives all the principal generated from the collateral until all the entire $120 million of bond class A1 is paid off and then bond class A2 begins to receive principal. Bond class A1 is then a shorter-term bond than bond class A2. This type of tranching is used to create securities with different exposures to interest rate risk. * Also, as will be explained in later chapters, in most securitizations there is more than one bond class and the various bond classes differ as to how they share any losses resulting from the obligor defaults. For example, suppose FACET issued $290 million par value of bond class A, the senior bond class, and $30 million par value of bond class B, a subordinated bond class. As long as there are no defaults by obligors that exceed $30 million, then bond class A receives full repayment of its $290 million. 5/5/201313
  • 15. * 5/5/201315 First securitization deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160 mnRs 160 mn &T raised Rs 4,090 mn through the securitization of future lease rentals to raise capital for its power plant in 1999.capital for its power plant in 1999. India‘s first securitization of personal loan by Citibank in 1999 for Rs 2,841 mn India‘s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in 2001. securitization of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through off shore SPV. India‘s first sales tax deferrals securitization by Govt of Maharashtra in 2001 for Rs1,500 mn.1,500 mn. India‘s first deal in the power sector by Karnataka Electricity Board for receivables-India‘s first deal in the power sector by Karnataka Electricity Board for receivables worth Rs 1,940 mn and placed them with HUDCO. worth Rs 1,940 mn and placed them with HUDCO. India‘s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002. India‘s first floating rate securitization issuance by Citigroup of Rs 2,810 mn in 2003 The fixed rate auto loan receivables of Citibank and Citicorp Finance India included in the securitization India‘s first securitization of sovereign lease receivables by Indian Railway Finance Corporation (IRFC) of Rs 1,960 mn in 2005.The receivables consist of lease amounts payable by the ministry of railways to IRFC. India‘s largest securitization deal by ICICI bank of Rs 19,299 mn in 2007.Theunderlying asset pool was auto loan receivables.  http://www.financialexpress.com/news/Indian-securitization/191022/0http://www.financialexpress.com/news/Indian-securitization/191022/0
  • 16. *Types of Securitization: Asset Backed securities (ABS) : • ABS refers to the securitization of non-mortgage retail loans. Till the late 1990s, assets classes securitized under ABS in India included only car loans and commercial vehicle loans. Thereafter, construction equipment loans, two wheeler loans, utility vehicle loans, and personal loan pools, have also been securitized. Mortgage Backed Securities (MBS) • (MBS) are asset-backed securities whose cash flows are backed by the principal and interest payments of a set of mortgage loans. • Since the underlying home loans in MBS pool have a floating-rate, the scheduled cash flow on such pools is uncertain and liable to change, depending on actual interest rate. Moreover, options to convert from fixed to floating rate and vice-versa, coupled with negotiated re-pricing of loans, added to the uncertainty of the cash flow in the MBS pool. • With the underlying loans earning floating rates, Pass Through Certificates (PTCs) in MBS issues are also being predominantly priced on a floating rate basis. In 2005, 52% of issuance was based on a floating rate. Collateralized Debt Obligation (CDO) : • In CDO transactions, the debt securities issued by the SPV are backed by a diversified loan or bond portfolio. There is thus a basic difference between CDOs and ABS, the latter being homogeneous pools of assets such as mortgages or credit card receivables, in contrast to the diversified portfolios backing CDOs. Collateralized Loan Obligations : Where the originating bank transfers a pool of loans, the bonds that emerge are called collateralized loan obligations or CLOs. Collateralized Bond Obligations : Where the bank transfers a portfolio of bonds and securitizes the same, the resulting securitized bonds could be called collateralized bond obligations or CBOs. 5/5/201316
  • 17. * 17
  • 18. 18 •By the late 1990s, a rising level of bank N.P.As motivated committees like the Narasimham Committee II and Andhyarujina Committee, which were constituted for examining banking sector reforms, to seek changes in the legal system to address the issue of N.P.As. •The SARFAESI Act empowers Banks / Financial Institutions to recover their Non- Performing Assets without the intervention of the Court. It was passed in 2002 to legalize securitisation and reconstruction of financial assets and enforce security interest. The Act envisaged the formation of Asset Reconstruction Companies (A.R.Cs) and securitisation Companies (S.Cs). •The main provisions of this Act include- registration and regulation of securitisation companies or reconstruction companies by the R.B.I,  facilitate securitisation of financial assets of banks, empower S.Cs/A.R.Cs to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and FIs to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default.
  • 19. 19 THE SARFAESI ACT, 2002 The Act provides three alternative methods for recovery of N.P.As, namely: Securitisation: means issuing securities by raising of receipts or funds by S.Cs/A.R.Cs, from Qualified Institutional Buyers by forming schemes for acquiring financial assets. The S.C/A.R.C shall maintain separate accounts for each such scheme for every financial asset acquired, out of investments made by a QIB and ensure that realizations of such financial assets are applied towards redemption of investments and payment of returns assured on such investments under the relevant scheme. Asset Reconstruction: The S.Cs/A.R.Cs for the purpose of asset reconstruction should provide for any one or more of the following measures: the proper management of the business of the borrower, by change in, or take over of, the management of the business of the borrower. the sale or lease of a part or whole of the business of the borrower. rescheduling of payment of debts payable by the borrower. enforcement of security interest in accordance with the provisions of this Act settlement of dues payable by the borrower. taking possession of secured assets in accordance with the provisions of this Act.
  • 20. * 20 Exemption from Registration of Security Receipt: The Act also provides, notwithstanding anything contained in the Registration Act, 1908, for enforcement of security without Court intervention: (a) any security receipt issued by the S.C or A.R.C, as the case may be, under section 7 of the Act, and not creating, declaring, assigning, limiting or extinguishing any right, title or interest to or in immovable property except in so far as it entitles the holder of the security receipt to an undivided interest afforded by a registered instrument; or (b) any transfer of security receipts, shall not require compulsory registration. •The Guidelines for S.Cs/A.R.Cs registered with the R.B.I are: Act as an agent for any bank or FI for the purpose of recovering their dues from the borrower on payment of such fees or charges Act as a manager between the parties, without raising a financial liability for itself; Act as receiver if appointed by any court or tribunal. Apart from above functions any S.C/A.R.C cannot commence or carryout other business without the prior approval of R.B.I.
  • 21. * 21 •Right of Title A securitisation receipt gives its holder a right of title or interest in the financial assets included in securitisation. This definition holds good for securitisation structures where the securities issued are referred to as 'Pass Through Securities'. The same definition is not legally inadequate in case of 'Pay Through Securities' with different tranches. •Thin Investor Base The SARFAESI Act has been structured to enable security receipts to be issued and held by Qualified Institutional Buyers. It does not include N.B.F.C or other bodies unless specified by the Central Government as a financial institution. For expanding the market for SR, there is a need to increase the investor base. In order to deepen the market for SR there is a need to include more buyer categories. •Investor Appetite Demand for securities is restricted to short tenor papers and highest ratings. Also, it has remained restricted to senior tranches carrying highest ratings, while the junior tranches are retained by the originators as unrated pieces. This can be attributed to the underdeveloped nature of the Indian market and poor awareness as regards the process of securitisation.
  • 22. 22 THE SECURITISATION COMPANIES AND RECONSTRUCTION COMPANIES (RESERVE BANK) GUIDELINES AND DIRECTIONS, 2003 The R.B.I issued guidelines and directions relating to registration, measures of A.R.Cs, functions of the company, prudential norms, acquisition of financial assets and related matters under the powers conferred by the SARFAESI Act, 2002. Defining N.P.As: Non-Performing Asset (N.P.A) means an asset for which: Interest or principal (or installment) is overdue for a period of 180 days or more from the date of acquisition or the due date as per contract between the borrower and the originator, whichever is later; Interest or principal (or installment) is overdue for a period of 180 days or more from the date fixed for receipt thereof in the plan formulated for realization of the assets. Interest or principal (or installment) is overdue on expiry of the planning period, where no plan is formulated for realization of the any other receivable, if it is overdue for a period of 180 days or more in the books of the S.C or A.R.C. It is provided that the Board of Directors of a S.C or A.R.C may, on default by the borrower, classify an asset as a N.P.A even earlier than the period mentioned above.
  • 23. 23 THE RECOMMENDATIONS OF THE HIGH LEVEL COMMITTEE ON CORPORATE DEBT AND SECURITISATION, 2005 •The recommendations of the High Level Committee on Corporate Debt and Securitisation (Chairman: Dr.R.H.Patil) in 2005 proved to be one of the turning point towards the development of the corporate debt and securitisation market. Some of the key recommendations included: Evolve a consensus on the affordable rates and levels of stamp duty on debt assignment, Pass through Certificates (PTCs) and security receipts (SRs) across States. An explicit tax pass-through treatment to securitisation SPVs / Trust SPVs should be provided. Wholesale investors should be permitted to invest in and hold units of a close-ended passively managed mutual fund whose sole objective is to invest its funds in securitised paper. Large-sized NBFCs and non-NBFCs corporate bodies established in India may be permitted to invest in SRs as Qualified Institutional Buyers. Private equity funds registered with SEBI as venture capital funds (VCFs) may also be permitted to invest in SRs within the limits that are applied for investment by VCFs into corporate bonds
  • 24. 24 R.B.I GUIDELINES FOR SECURITISATION OF STANDARD ASSETS (FEB 2006) •In February 2006, the RBI issued guidelines for securitisation of standard assets by Banks, FIs and NBFCs. These guidelines provided the regulatory framework for several critical aspects of securitisation and are expected to establish a more robust structured credit market. The guidelines were broadly as follows: Detailed guidelines to ensure ―arms length‖ relationship between the originator and the SPV, i.e. they are independent of each other. Credit enhancements provided by the originator for the first as well as second losses to be deducted from the capital. Any profit/premium arising on account of sale not allowed to be booked upfront and is to be amortised over the life of the securities issued or to be issued by the SPV Disclosure by the originator, as notes to accounts, a comparative position for two years of the following items: 1) the total number and book value of loan assets securitised; 2) sale consideration received for the securitised assets and gain/loss on sale on account of securitisation; 3) form and quantum (outstanding value) of services provided by way of credit enhancement, liquidity support, post securitisation asset servicing, etc.
  • 25. 25 R.B.I GUIDELINES FOR SECURITISATION OF STANDARD ASSETS (FEB 2006) •Though some concerns have been raised regarding these guidelines as being restrictive, RBI is very clearly treading a cautious step adopting an officially termed ―incentive-compatible prudential approach towards securitisation‖ - an approach defensible in the aftermath of the recent sub-prime episode in some developed countries. •In 2007, the Securities Contracts (Regulation) Amendment Act 2007 amended the Securities Contract (Regulation) Act to include ―securitised instruments‖ in the definition of ―securities‖. The amendment has paved way for listing and trading of securitised debt on stock exchanges.
  • 26. 26 GUIDELINES ON SECURITISATION AND DIRECT ASSIGNMENT TRANSACTIONS (MAY 2012) •The RBI, in May 2012, put out the final guidelines on securitisation and direct assignment of assets by banks. •This is the first time the RBI has issued separate guidelines for Direct Assignment transactions. Amongst the important new prescription in the guidelines is the prohibition of credit enhancement for direct assignment transactions. The other key stipulations are a Minimum Holding Period (MHP) for Originators before off-loading the receivables and a Minimum Retention Requirement (MRR) through the tenure of the transaction. •The guidelines are expected to have far-reaching implications on the issuance volumes as well as the nature of the transaction structures adopted.
  • 27. * 27
  • 28. * •Key Originators segment N.B.F.Cs Key Investor segment Banks Typically AAA ratings targeted, though wider ratings spread over past 2 years. •Tenure MBS: door-to-door 12 to 20 years (Average 6 to 8 years) ABS: door-to-door 40 to 60 months (Average 18 to 24 months) •Investor Yield ABS – fixed yield RMBS – floating yield, linked to pool yield or external benchmark.28
  • 29. 29
  • 30. 30 •Securitisation in India began in the early 1990s, with CRISIL rating the first securitisation program in 1991-92, of an auto loan. Citibank securitized auto loans and placed a paper with GIC mutual fund worth about Rs. 16 crores. •Securitisation began with the sale of consumer loan pools, and originators directly sold loans to buyers. They acted as servicers and collected installments due on the loans. •Creation of transferable securities backed by pool receivables (known as PTCs) became common in late 1990s. Through most of the 90s, securitisation of auto loans was the mainstay of the Indian markets. •Initially it started as a device for bilateral acquisitions of portfolios of finance companies. These were forms of quasi-securitisations, with portfolios moving from the balance sheet of one originator to that of another. •But from 2000 till today, Asset-Backed Securities (ABS) and Residential Mortgage- Backed Securities (RMBS) have fuelled the growth of the Indian securitisation market. HISTORY OF SECURITISATION IN INDIA
  • 31. * 31
  • 32. * 32
  • 33. * 33
  • 34. * 34 SECURITISATION IN INDIA (2000-2006) •The volume of issuances of securitised transactions grew exponentially beginning in 2000 due to rapid growth of consumer finance. There were approximately 75 issuances each year after 2000 till 2006. •Securitisation of rated transactions increased from less than Rs.1,000crore in 1998, to over Rs.30,000 crore in 2004 – 05. •Number of originators was less than 5 in 2000, and rose to more than 20 in 2005.The top five originators accounted for 90% of the issuance volume in 2004-05. •Investors acceptance of securitized instruments also gradually improved, due to passing of SARFAESI Act in 2002.There was pressure on the resources of large originators due to continued growth in consumer credit. The growth of debt funds, the largest investors in securitized paper, also supported the expansion of the securitisation market . •ABS accounted for over two-thirds of issuances of all securitised issuances during this period. From 2004 to 2005, 40% of vehicle finance was funded through ABS backed by auto loans.
  • 35. 35 Scenario before Feb 2006 Guidelines Scenario after Feb 2006 Guidelines •Securitisation transactions dominant (over 80% in FY06) •ABS is the key product, and ABS issuance is dominated by banks . •Surge in Direct Assignment transactions (75% in FY12) •Securitisation by banks gradually reduced - no bank- originated transactions in last 2 years , although they are the key investor segment. •Surge in ABS as well as RMBS transactions, and decline in LSO (Loan Sell-Off) issuances.
  • 36. * 36
  • 37. 37 Source: ICRA Rating Feature, May 2012
  • 38. 38
  • 39. * •During FY2012, the securitisation market in India grew by 15% over the previous year, in value terms. The number of transactions was also 32% higher in FY2012 than in the previous fiscal year. •LSO issuance has been witnessing a sharp decline since FY2009. LSO, or Loan Sell-Off transactions were largely short-term in nature and the Originator would typically disburse the loan with the specific intention of securitising it soon after the disbursement. •RBI‘s draft guidelines issued in the first quarter of FY2011, specially the requirement of Minimum Holding Period (MHP) of 9 to 12 months, created a potential interest rate risk for the Originator and adversely affected the LSO issuance volume. 39
  • 40. 40 Source: ICRA Rating Feature, May 2012 *
  • 41. 41 * •After the issuance of the securitisation guidelines in 2006, there has been a high preference for ‗direct or bilateral assignment‘ of retail loan pools, i.e., direct sale of a selected loan pool by the ‗Originator‘ to the ‗Purchaser‘ together with limited credit support, as against securitisation which involves the sale of receivables to a SPV and issuance of PTCs by the SPV. •Over the past four years i.e. since FY2009, about 75-80% of the total number of ABS and RMBS transactions has been in the nature of direct assignment transactions. This is huge growth, considering the figures of 25% in FY2006, and 58% in FY2008. •The preference for par structures continued to be high in FY2012; ―premium‖ structures accounted for only 10% of the total number of ABS and RMBS issuance during the year as against 37% and 18% in FY2010 and FY2011, respectively. RBI‘s circular of January 2011 notifying banks to consider only the par value of transactions for obtaining priority sector benefit on loans, was a huge factor contributing to the preference for ―par‖ structure.
  • 42. 42 * Source: ICRA Rating Feature, May 2012
  • 43. •The number of ABS issues increased significantly by 58% in FY2012 to 178 transactions. •The average deal size was lower at Rs. 146 crore in FY2012 compared to Rs. 193 crore in FY2011. This was on account of higher number of Microfinance transactions executed in FY2012 at 65 that was about twice the issuance in FY2011 at 34. •The total number of issuers in the ABS space increased from 23 to 33 as some microfinance entities entered the securitisation (or assignment) market. •Shriram Transport Finance Company, SREI Equipment Finance, Indiabulls Financial Services Ltd., Sundaram Finance and Shriram City Union Finance were the largest Originators in FY2012, altogether contributing to over 60% of the total number of ABS issuances. 43 *
  • 44. 44 *
  • 45. •In FY2012, Commercial Vehicle (CV) and Construction Equipment (CE) loans continued to be the key asset class accounting for two-thirds of the total ABS volumes. •The long and relatively stable track record of CV / CE lending in the country (also demonstrated through good performance of the past pools) and the relatively larger size of CV / CE loan portfolios in the industry have been the key factors for the popularity of this asset segment in securitisation. •Microfinance and SME loans, which had a small share in securitisation in the previous year‘s emerged as the other key loan categories to be securitised accounting for almost 11% each in FY2012 from about 7% and 2% in FY2011. • However, there was some securitisation of Two Wheeler and Three Wheeler loans in FY2012, a segment absent during the previous two years. 45 *
  • 46. 46 * Source: ICRA Rating Feature, May 2012
  • 47. •The number of RMBS issuances increased to 22 in FY2012 along with an increase of 53% in value terms. However, the average deal size marginally reduced to Rs. 349 crore in FY2012 from Rs. 359 crore in FY2011. •RMBS segment continued to be highly concentrated with HDFC and Dewan Housing Finance, which together contributed to about 85% of all issuances. •Despite higher issuances seen in the year, the traditional obstacles to RMBS in India, viz., long tenure of RMBS paper, the lack of secondary market liquidity, high stamp duty on transfer of security, tenure uncertainty, interest rate risk and prepayment risk, continued to hinder the growth of this segment. •Nevertheless, regulatory requirements—certain category of home loans qualify as priority sector lending—provide the motive for trading in home loans too. Accordingly, banks were typically the investors in these transactions.47 *
  • 48. * 48 •Though retail loan securitisation improved in FY2012, the issuance volume in India continues to remain subdued and concentrated among a few originators. •Around 75% of the market in FY2012 was essentially bilateral loan pool trading, driven by the economics of priority sector lending targets. It follows that the investor segment is largely banks—mainly private sector and foreign banks. •The final guidelines on securitization and bilateral assignments are expected to result in a significant decline in volume of bilateral assignments given the prohibition on credit enhancements by originators in these transactions. •In addition to regulatory prescriptions, the pace of growth in loan book size among key players would continue to be a basic determinant of level of securitisation activity.