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SECURITIZATION IN

INDIA
CONVENTIONAL BOND
STRUCTURE

Earning Bonds
s Power Issuer Investo
Structure of a etc Cash r
normal debt
instrument  A debt instrument is the obligation of the issuer

 Normally, the credit profile of the issuer depends on the aggregated earnings power of
its businesses in the context of its financial risk profile and management capability

 It is these businesses that would need to generate the cash flows for bond redemption
LIMITATIONS OF CONVENTIONAL
DEBT FUNDING
 Limited flexibility to enhance the credit quality of the borrower

 Largely standardized loan products homogenizing credit quality across cross-section of asset side
inflows and liability side outflows

 Firms unable to package out different levels of risk to meet varying needs of investors

Are  Consequently, cost of funds linked to average credit profile of different cash flows

alternatives
available?
SECURITIZATION -
BASICS
 Securitization is the pooling of “homogeneous”, “financial"," cash flow
producing”, “illiquid” assets and issuing claims on those assets in the form of
marketable / tradable securities

 Typically, a lender / originator advances a loan to borrower and over a period


of time, he expects to receive repayment of principal and interest.

 In securitization, the lender / originator sells the right to receive the future
receivables to a third party and receives the present value of the receivables
at the initiation of the transaction

 The higher yield associated with these securities attracts investors who are
willing to bear the associated credit, prepayment and liquidity risk
SECURITIZATION -
BASICS
 The basic principles of direct assignment remain the same - the
only difference being that the investor records the transaction as
‘loans’ in its books and doesn’t invest in a tradable security

 The originator also provides an upfront credit enhancement in the


transaction to cover for the shortfalls in the pool because of
borrower defaults;

 The primary advantage of securitization is the flexibility provided


in terms of unbundling of risks and allocation of the same to
various parties who are able to manage those risks
SECURITIZATION -
BASICS
 Securitization involves sale, transfer, pledge of specified
assets to a Bankruptcy-remote Special Purpose Vehicle (SPV)
 The SPV in turn issues Notes (Pass Through Certificates) to
investors in order to fund the purchase of the assets

 Investors (banks, insurance companies, and specialised funds)


rely on the cash flows (principal, interest and sale proceeds
when sold after foreclosure) generated by the underlying
assets to pay interest and principal on the notes

 The risk associated with the assets is stratified by looking at


historical default and loss information
 Generally, the Originator remains the Servicer of the pool of
the assets it had sold to the SPV
SECURITIZATION VS.
TRADITIONAL DEBT
Securitization Traditional Debt
 Isolation of pool – true sale  The issuer holds the assets – provides
security
 Claim only against the pool – no
impact of issuer bankruptcy  Claim against the issuer company

 Typically both principal and interest  Monthly interest; bullet principal payments
repaid monthly
 Rating cannot be higher than the issuer
debt rating
 Credit enhancement helps in getting
a higher rating than the issuer
Securitization vs Bilateral Assignment
Receivables based financing

Loan/Advance Securitization vide


Debenture Backed Bilateral Assignment of issue of tradable
by charge & Escrow receivables between instruments by an
Originator & Purchaser SPV

Full Recourse
On Balance
Sheet Limited Recourse
Limited Recourse Off Balance Sheet
No capital Relief Off Balance Sheet
No gain on Sale Release of capital
Release of capital Possible gain on
Bilateral or CMI Possible gain on Sale
Sale Banks and capital
No capital market market investors
investors

Securitization through issue of tradable instruments would


attract a wider investor base and thereby result in lower
Bilateral Assignment: Structure Diagram

Originator Lease/Loan/Other Obligors


Agreements
Purchase Payment towards
Assignment Consideration Obligation
Of Purchaser/ Servicer
Receivables Investor

Credit Rating Credit


Agency Enhancement

Credit enhancement and rating may be optional in a


bilateral transaction depending on the comfort of the
PARTIES TO A SECURITISATION
Initial owner of the assets
Originator Sells its asset to the SPV

Contractual debtor to Originator


Obligor
Pays cashflows that are securitised

Set up specifically for transaction


SPV Purchases assets from Originator Company/Trust/ Mutual Fund

Subscribe to securities
Investors issued by SPV
PARTIES TO A SECURITISATION

Servicer Collects monies from Obligors, monitors and maintains assets

Receiving & Banker for the deal. Manages inflows& outflows,


Paying Agent invests interim funds, accesses cash collateral

Credit Provides credit enhancement by way of swaps, hedges,


enhancement
guarantees, insurance etc.
provider

Merchant As structurer for designing& executing the transaction and


banker as arranger for the securities
PARTIES TO A
SECURITISATION (CONTD.)
Credit Rating Provides a rating for the deal based on structure, rating of
Agency parties, legal and tax opinion etc

Legal & Tax


Provide key opinions on the structure & underlying contracts
Counsel

Appointed for conducting due diligence both initial and


Auditor during tenor of deal

Custodian Appointed for safe custody of the underlying documents and


R&T Agents registration/ transfer of securities
EXCHANGE OF FUNDS -
INITIAL

Borrowers Rating Agency


Rating with specified
Loan agreement Servicing Agreement credit enhancement

Proceeds Proceeds
Finance Company Ltd.
(Originator) Trust (SPV) Investors
Sale of assets Asset-Backed
Securities

Trust Agreement

Trustee
EXCHANGE OF FUNDS - ONGOING

Borrowers Rating Agency

Loan Rating
repayments
Monthly loan Monthly investor
Finance Company Ltd. repayments payments
(acting as servicer) Trust (SPV) Investors

Monthly
Collection reports
Trustee Responsibilities reports

Trustee

Form of SPV and role of Trustee are critical in a


Tranching of Liabilities

Cash flows from


6 month PTCs
securitized
Originator assets SPV 1 year PTCs Investors
5 year PTCs

Cash flows from Senior PTCs


securitized
Originator assets SPV AAA(SO) Investors
Retained
Unrated
Tranche
PAR AND PREMIUM STRUCTURES

Par
ParStructures
Structures Premium
PremiumStructures
Structures

Investor
Investor pays
pays aa consideration
consideration equal
equal to
to the
the present
present value
value of
of future
future
Investor
Investor pays
pays aa consideration
consideration equal
equal to
to the
the principal
principal cash
cash flows. The investor pays a premium to receive the excess
flows. The investor pays a premium to receive the excess
outstanding (par value) of the pool
outstanding (par value) of the pool interest
interestspread
spread

In
In return,
return, investor
investor isis entitled
entitled to
to receive
receive scheduled
scheduled principal
principal In
In return,
return, investor
investor receives
receives the
the entire
entire cash
cash flows
flows generated
generated from
from the
the
repayments along with a contracted
repayments along with a contracted yield yield pool
pool

Typically,
Typically, interest
interest generated
generated on on the
the pool
pool isis higher
higher than
than the
the
yield
yield to the investor, the difference is called excess interest
to the investor, the difference is called excess interest No
Noexcess
excessinterest
interestin
inthe
thestructure
structure
spread
spread(EIS)
(EIS)

EIS
EIS provides
provides credit
credit support
support to
to the
the investors.
investors. the
the originator
originator The
The rating
rating takes
takes care
care of
of the
the fact
fact that
that the
the investor
investor payouts
payouts are
are higher
higher
retains a subordinated right to receive the EIS.
retains a subordinated right to receive the EIS. and credit enhancement is calculated accordingly
and credit enhancement is calculated accordingly

Prepayments
Prepayments in
in the
the underlying
underlying pool
pool are
are passed
passed on
on to
to the
the As
As investor
investor principal
principal outstanding
outstanding isis higher
higher than
than the
the pool
pool principal,
principal, the
the
investor
investor credit enhancement is utilized to cover the prepayment shortfall
credit enhancement is utilized to cover the prepayment shortfall
BENEFITS OF
SECURITIZATION
 Efficient use of capital

 Off balance sheet treatment and hence release of a portion of capital tied up by these
assets

 Allows the company to continuously churn assets and expand business volumes even
when capital availability is scarce

 Balance sheet management

 Off-balance sheet treatment and upfront profit generated has a positive impact on
financial results like Return of Assets, Earnings per share, Net spread etc.

 Alternate Source of Funding

 Securitization is an alternative source of funding that does not use up limits set up by
banks / institutions on the company and allows allocation of funds by investors over
and above these limits
BENEFITS OF
SECURITIZATION
 Rating enhancement resulting in lower cost of funds

 Capital markets and other investors demand yields linked to the rating of the
issuers for direct debt investment

 Securitization enables a company to achieve a rating several notches above its


standalone rating and thereby lower its cost of funding

 Converting illiquid assets to liquid assets

 Preserving customer relationships

 Securitization allows transfer of credit risk while preserving existing


relationships with customers

 Typically, the originator acts as servicer for the transaction and hence continues
to be the point of interaction with the obligors.
ORIGINATOR’S
OBJECTIVES
 Each originator should define the objectives desired to be
achieved through the proposed securitization transaction in
Structure of order of priority
securitizatio
n may vary
 Access to an alternate source of funds / investor class
significantly  Optimization of regulatory capital requirement
based on the
priority of  Rating enhancement and reduction in cost of funds
objectives of
the
 Balance sheet management : liquidity, asset-liability
matching, debt-equity ratio
originator
 Limited recourse financing
 Risk management – Sector exposure / company exposure
WHAT CAN BE SECURITIZED

 “Financial Asset” means debt or receivables and includes

 Claim to any debt or receivables, secured or unsecured

 Debt or receivables secured by mortgage or charge on immovable


property

 Mortgage, charge, hypothecation or pledge of movable property


 Right or interest in the security underlying such debt or
receivables

 Beneficial interest, whether existing, future, accruing, conditional


or contingent

 Any financial assistance


Retail Assets
Securitization
1400 120

1200 100
1000
80
 ABS market dipped in 2009
800

600
60
 Absence of banks from this market
40
400

200 20  De-growth in retail originations


0 0
FY
2003
FY
2004
FY
2005
FY
2006
FY
2007
FY
2008
FY
2009
 Tight liquidity
Disbursement Issuance (Rs bil) No. of transactions
 Concerns on asset quality
 Largely becoming a liquidity providing
instrument
5%
13%
 Securitisation is a key resource raising avenue
4%
for NBFCs

4%
 CVs emerged as dominant asset class largely
2% 4% driven by Shriram, Tata Motors finance and
New/ used Cars and UV Two wheeler Magma
Personal loan SME loan
Mixed pool Others  Microfinance loans and gold loans are the
Source: ICRA Research & Industry
emerging asset classes
TOP ABS ORIGINATORS

Source: CRISIL report

 Banks have largely been non-existent in ABS market for last one year as the retail
asset growth has been minimal / negative
 ABS continues to be a viable resource raising avenue for NBFCs focusing on asset
finance
 Top originators for 2009-10 till date are Reliance Capital, Tata Motors Finance and
Shriram Transport Finance Limited
WHAT AN ORIGINATOR LOOKS
FOR
Capital relief

Managing Asset liability


mismatch

Advantages of Off-balance sheet funding


securitization over
traditional funding Reducing concentration risk

Direct access to capital


markets

Improved RoA / RoE


SECURITIZATION’S
ANCILLARY BENEFITS
 Securitization creates incentives for originator for
 Developing transparent credit approval process
 Efficient collection procedures, and for strong
mechanisms to control this process
 Clear and efficient processes invariably lead to lower
credit enhancement
 Public availability of information about pool
performance adds to confidence in securitized paper

But, originators prefer to retain customer


relationship and servicing
BENEFITS TO INVESTORS
 Premium over equivalent rated
plain securities
 Focused risks associated with
securities
 Portfolio diversification
 Tailored cash flow structures
 Flexible range of maturities
 Experienced risk assessment
BENEFITS TO THE FINANCIAL
SECTOR

 New forms of securities – market completion


 Assists development of capital markets
 Attracts conservative buyers
 Draws international capital
 Facilitates efficient allocation of risks
Originators – Incentive,
Impacts

 Secured Assets (100% risk weight and 9%

k
Ban
capital), Unsecured Asset (125% risk weight and
Capital 9% capital)
Relief

C
NBF
 12%, 10% in case of Asset Finance Companies

 Standard Provisioning – Secured Assets (0.4%),


k
Ban

Unsecured Assets (2%). NPA are provided as per


Provisioni the RBI norms
 No standard provisioning requirement. Relaxed
ng Relief
NBFC

provisioning norms compared to Banks. Hence


longer collection cycles, higher delinquencies
compared to Banks
Originators – Incentive,
Impacts

 As per Basel – Rated piece (typically BBB) as per

Bank
rating (typically 100% risk weight & 9% capital).
Capital
Unrated to be fully deducted. No reset.
knock off for
Collateral

C
 To be fully deducted out of capital. No reset
NBF
allowed. Basel applicability??

 Profit (IRR from pool – Sell down rate – expected


Bank

collection cost – Expected credit losses) to be


amortised by the seller
Profit
 Profit (IRR from pool – Sell down rate – expected
NBFC

collection cost – Expected credit losses) to be


amortised by the seller
Originators – Incentive,
Impacts

 Proceeds from securitisation have no CRR/SLR

Bank
requirement
Cost of  Reduces priority sector requirement
funds NBFC  Reduces cost of funds. More important in case of
Non Asset Finance NBFCs where provisioning
requirement by Banks is leading to higher costs
BANKRUPTCY
REMOTENESS
 True sale of assets from the seller to the trustee

 Legal separation of assets from the seller is achieved – investor


is not exposed to credit worthiness of seller

 Credit enhancement and liquidity facility – bankruptcy


remoteness achieved through rating triggers

 An independent legal opinion is taken post the transaction to


cover all such legal issues
PERFORMANCE OF SECURITISATIONS IN
INDIA

 Unlike US, the rise in delinquencies has not led to widespread downgrades
or defaults in securitised papers

 Rating agencies largely pre-empted the deterioration in asset quality


and have increased the credit enhancement requirement suitably

 Safety cover for investors has remained robust

 Till date, approximately 700 pools have been rated in India

 38 pools have been downgraded so far


 Only 3 of which have been downgraded to speculative grade

 Some of these 38 pools have been upgraded back to AAA because of


stable performance at later stages