SECURITISATION

Securitisation Defined

– Converting existing cash flows into tradable

securities
– Liquefying assets comprising loans and
receivables through issuance of negotiable
certificates
– Conversion of long term assets into cash or liquid
assets
What can be securitised ?

 Loan receivables (Asset Backed Securities-ABS)

– Auto loans
– Personal loans
– Education loans
 Housing Loans (Mortgage Backed Securities- MBS)
 Lease receivables
 Portfolio of bonds (Collateralized Debt Obligations-
CDOs)
 Purchase contracts for natural resources such as oil,
gas, timber etc
What can be securitised ?…..

 Non Performing Loans or Assets (NPAs)

– NPAs have emerged as one of the important
asset category which can be securitized in the
recent times by banks.
– Releases capital in the balance sheet of banks
– Can be better managed by specialized agencies
– Investors having higher risk appetite can achieve
significant returns.
What can be securitised ?…..

 Future Flow Securitization

– Credit Card receivables
– Trade credits receivables
– Electricity/ Water bills
– Toll road receivables
How does it help?

 The Originator’s
– Cash flow considerations
– Balance Sheet considerations
 Exposure limitations, asset-liability mismatch, interest rate risk
management, Capital considerations
– Spread considerations
– Cost considerations
 The Investor gets an option for an alternative
investment.
 The risk is spread for the investor and originator
Originators

 Who has securitised assets in the market

– LIC Housing Finance
– HDFC
– Citi Bank
– Ashok Leyland Finance
– GE Capital
– ICICI Bank
– Shriram investments
Who are the parties involved

 Originator : The entity whose assets are to

be securitised
 Obligors : The amount outstanding from
them is the asset. The originator’s debtors.
 Servicer or Receiving and Paying agent
(mostly the Originator itself) :Collects the
payments due from the obligors.
Parties involved….

 Special Purpose Vehicle (SPV) : A low-capitalized

and tax efficient shell company created to hold the
assets in its books and makes upfront payment to
the originator. Ensures ‘bankruptcy remote’ from the
originator. Normally created by the Arranger or Agent
and Trustee. Acts as issuer of the security.

 Credit Rating Agency : Ensures credit quality of the

pool.
Parties involved…..

– Decides on the extent of credit enhancement.

– Examines whether legality of the transaction is
valid.
 Guarantors / Credit protection providers
– On the happening of pre-defined events, affecting
the underlying cash flows or assets or the
payment ability of the obligors, these entities pay
monies that are passed on to the investors.
Parties involved…..

 Trustee or Agent
– Manager of the SPV. Does all acts and deeds that
would protect the interest of the investors
including initiating legal proceedings against
various participants in case of breach of terms
and triggering payment from various credit
enhancement structures.
 Structurer
– The investment banker who designs and
executes the transaction
 Special Purpose Vehicle

 SPV is a legal entity set up for a specific and

limited purpose by another entity, the
sponsoring firm.
 It can be a limited liability company – pvt or
public, partnership firm or trust.
 Can be a subsidiary or orphan
 In most cases SPV is an independent entity in
the form of trust with a trustee taking care of the
admin.
 Special Purpose Vehicle

 Creation of SPV benefits the originator in

reducing cost of capital, leverage,
improvement in liquidity, reduction of interest
rate, currency and maturity risk.
 Enron established 3000 off balance sheet
SPVs.
 SPVs cannot legally go bankrupt
 Special Purpose Vehicle

 Restrictions on objects, powers and

purposes
 Limitations on ability to incur indebtedness
 Incorporation of separateness covenants
restricting dealings with parents and affiliates
 They are structured to be tax neutral, if not it
would result in double taxation
Issues to be evaluated in
securitization deal

 Type of underlying security attached

 Ability to estimate the cash flows from the
asset
 Payment frequency and the propensity to
prepay or make delayed payments
 Nature of obligors on whom the cash flows
are dependent
Asset Pool characteristics

 Age of the asset pool

 Seasoning of the asset pool
 Stress testing of the pool
 Delinquencies
 Historical NPA levels of the originator
 Prepayment history
 Geographical spread of the pool
 Special features of the asset pool
Special features of Securitisation

 How will the prepayment of loans be handled (early

amortisation)
 How was the credit enhancement decided
– Provision of cash collateral
– Over collateralization
– Third Party Guarantee
– Structuring (Water fall mechanism)
– Recourse obligation accepted by the originator.
 Sufficiency of credit enhancement/ Dynamic credit
enhancements
Special features….

 What has been the reputation of the originator/ credit

rating agency and the arranger
 What is loan recovery mechanism.
Pass Through Certificates (PTCs)

 Securities issued by the SPV

 Beneficial Interest Certificates
 Certificates of proportional beneficial interest
in the assets held by the SPV
 SPV can re-configure the cash flows – Pay
Through Certificates
Risks

1. Credit Risk and Bankruptcy Risk : Ability of the entity to pay its
obligations and survive as a viable entity.
2. Performance Risk : Ability to perform and fulfill contractual
obligations.
3. Asset/ Collateral Risk : Variation in the value of the underlying
asset.
4. Payment / Counter party Risk : Ability of other parties to the
transaction, like swap provider, paying bank etc., to meet their
obligations.
5. Interest Rate Risk : Risk arising out of variation in interest rates.
Risks….

6. Exchange Rate Risk : Risk arising out of variation in exchange rates of

various currencies.
7. Liquidity Risk : Ability to liquidate the underlying assets or collateral
and generate liquidity to service the Investors in a timely manner.
8. Commingling Risk : When a Servicer is appointed to collect moneys
from the Obligors, the funds collected may be retained by the
Servicer with itself for a short period of time before remitting to the
SPV. The risk of loss of money due to a credit event or Bankruptcy of
the Servicer is called Commingling Risk.
 Risks….

9. Prepayment risk : The obligors repaying ahead of schedule. This

affects the maturity of the investments made by the investors. The
variation in the maturity due to pre-payment by the obligors is the
pre-payment risk.

10. Reinvestment Risk : Some structures (typically pay-through ones)

may have the SPV reinvesting the funds received from the obligors
and the originator and paying out to investors only on pre-specified
dates. The variability in the returns earned on such investment is
reinvestment risk.
Risks….

11. Legal / regulatory / tax Risk : As structured

finance deals involve interpretation of various
laws (including that of income tax laws) and
regulations as also complex documentation, there
is a significant level of legal and regulatory risk.