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Securitization of assets
Contents

• Introduction………………………………………………………………………………….1

• Definition……………………………………………………………………………………..1

• Explanation…………………………………………………….…………………………1

• Securitization act 2002……………………………………………………………..1

• Types of securitization……………………………………………………………………2

• Process of securitization……………………………………………………………...3-9

• Motives of securitization……………………………………………………….10-14

• Disadvantages of securitization…………………………………………………….15

• The development of securitization in India………………………………15-19

• Securitization trends in India…………………………………………………..19-20

• Conclusion……………………………………………………………………………..20-21
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SECURITIZATION OF ASSETS.
Introduction .
Securitization is the financial practice of pooling various types of contractual debt such a
residential mortgages, commercial mortgages, auto loan and credit debt obligations and selling
their related cash flows to third party investors as securities, which described as bonds, paws
through securities and collateralized debt obligation(CDOs).Investors are rapid from the
principle and interest cash flow collected from the underlying debt and redistributed through
the capital structure of the new financing.

Definition of securitization.
Securitization is the process of through which an issuer creates a financial instrument by
combining other financial assets and then marketing different levels of the repackaged
instruments to investors. Asset securitization is the process whereby interests in loans and sold
in the form of ABS asset backed securities.

Securitization is the process conversion of receivable and cash flow generated from a collection
or pool of financial assets like mortgage loans, auto loans, credit card receivable etc. into
marketable securities. . The principal and interest on the debt, underlying the security, is paid
back to the various investors regularly. Securities backed by mortgage receivables are called
mortgage-backed securities (MBS), while those backed by other types of receivables are asset-
backed securities (ABS).

Explanation.
Securitizations refer to the process of turning assets into securities. In securitization the
companies holding the loans, also known as the originator, gather the data on the assets it
would like to remove from its associated balance sheets.

Mortgage-backed securities are a perfect example of securitization. By combining mortgages

into one large group, the issuer can divide the large pool into smaller pieces based on each
individual mortgage's inherent risk of non-payment and then sell those smaller pieces to
investors. Use of mortgage backed security example, an individual retail investors are able to
buy mortgage as a type of bond. Without the securitization of mortgages, retail investor may
not be able to buy into a large pool of mortgages.

Securitization Act 2002.

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The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
(SARFAEST) Act 2002 is a legislation that the helps financial institution to ensure asset quality in
multiple ways .The Act enforce the security interest without the court’s intervention.

• The Act provides the legal framework for securitization activities in India.
• It gives procedures for the transfer of NPAs to reconstruction companies for the
reconstruction of assets.
• The Act gives detailed provisions for the formation and activities of Asset Securitization
Companies (SCs) and Reconstruction Companies (RCs).
• The Act give power to banks and financial institutions to take over the immovable
property that is charged to enforce the recovery of debt.

Types of Asset Securitization

1) Asset Backed Securities (ABS)
2) Residential Mortgage Backed Securities (MBS)
3) Commercial Mortgage Backed Securities (MBSC)
4) Collateralized Debt Obligations(CDO)
5) Future Flow Securitization

1. Asset backed securities

The bonds which are supported by underlying financial assets .The receivables which are
converted into ABS include credit card debts, student loans, home equity etc. Asset backed
securities also known as ABS, are pool of loans that are packaged and sold to investors as
“securitization”.

• ABS help in removing debt from balance sheet and help in generate capital
which would be used for new loan disbursement.
• SVP would have higher credit rating and issue ABS at lower price.
• Investor gets exposure to new class of debt instruments.

2.Residential Mortgage Backed Securities.

Residential Mortgage Backed Securities are those bonds which are secured by mortgage
of house, jewelry, property, land and various other valuable belongings.

3. Commercial Mortgage Backed Securities.

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These are bonds that are backed by pool of commercial assets mortgage like industrial
land, factory, plant, office building etc.

4. Collateralized Debt Obligation.

These are bonds which are designed out of re-pooling the personal debts for marketing
in secondary market for investors.

5. Future Flow Securities.

These are the securities issued against future debt receivables. All principal and interests
are met by company out of its routine business activities.

Process of Securitization.
Through securitization process debts are factored and discounted in a structured and
sophisticated manner which allows for the availability of funds or repayment of the debt
obligations through the creation of an insolvency remote vehicle which is separate, distinct and
independent of the Originator.

The process of securitization leads to the creation of financial instruments that represent
ownership interests in, or are secured by a segregated income producing assets or pool of
assets. This pool of assets collateralizes securities. These assets are generally secured by
personal or real property automobiles, real estate, or equipment loans, but in some cases are
unsecured credit card debt, consumer loans, and insurance product. The process of
securitization can be described in steps from asset origination to sell of securities.

1. Assets are originated by a company, and funded on that company's balance sheet. This
company is normally referred to as the "Originator".

2. Once a suitably large portfolio of assets has been originated, the assets are analyzed as a
portfolio, and then sold or assigned to a third party which is normally a special purpose vehicle
company formed for the specific purpose of funding the assets. The SPV is sometimes owned by
a trust, or even, on occasions, by the Originator.

3. Administration of the assets is then sub-contracted back to the Originator by the SPV.
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4. The SPV issues traceable "securities" to fund the purchase of the assets. The performance of
these securities is directly linked to the performance of the assets - and there is no recourse
back to the Originator.

5. Investors purchase the securities, because they are satisfied that the securities will be paid in
full and on time from the cash flows available in the asset pool. A considerable amount of time
is spent considering the different likely performances of the asset pool, and the implications of
defaults by borrowers on the corresponding performance of the securities. The proceeds upon
the sale of the securities are used to pay the Originator.

6. The SPV agrees to pay any surpluses which arise during its funding of the assets back to the
Originator - which means that the Originator, for all practical purposes, retains its existing
relationships with the borrowers and all of the economics of funding the assets (i.e. the
Originator continues to administer the portfolio, and continues to receive the economic
benefits of owning the assets.

7. As cash flows arise on the assets, these are used by the SPV to repay funds to the investors
in securities.

In the process of securitization, the biggest flaw is the asset quality or pool of assets being
securitized, because the investor’s repayment depends solely on the performance of the
securitized asset or the cash flow from the securitized assets i.e. for the repayment of the
amount invested, investors do not depend on the SPV or Originator. In securitization, investors
rely on the credit quality of the securitized assets and if the originator has compromised with
the quality of asset in order to increase business volume, it directly affects the cash flow of the
securitized asset due to high default rate on those pools of asset thereby, affecting the
investor’s confidence and ease of securitization process.
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The process of securitization typically characterized by the following steps:

• Identification Process: The lending financial institution either a bank or any other
institution for that matter which decides to go in for securitization of its assets is called
the ‘originator’. The originator might have got assets comprising of a variety of
receivables like commercial mortgages, hire purchases etc. The originator has to pick up
a pool of assets of homogeneous nature, considering the maturities, interest rates
involved frequency of repayments and marketability. This process of selecting a pool of
loans and receivable from the asset portfolios for securitization is called ‘identification
processes. This is known as identification process.

• Transfer Process: After the identification process is over the selected pool of assets are
then ‘passed through’ to another institution which is ready to help the originator to
convert those pools of assets into securities. This institution is called special purpose
vehicles or the trust. The pass through transaction between the originator and the SPV
is either by way of outright sale basis. This process is passing through the selected pool
of assets by the originator to a SPV is called transfer process and once this transfer
process is over the assets are removed from the balance sheet of the originator.
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• Issue Process: After this process is over the SPV takes up the onerous task of converting
these assets to various type of different maturities. On this basis SPV will issue securities
to investors. The SPV actually splits the packages into individual securities of smaller
values and they are sold to the investing public. The SPV gets itself reimbursed out of
the sale proceeds. The securities issued by the SPV are called by different names like
‘Pay through Certificates’, ‘Pass through Certificates’. Interest only Certificate, Principal
only Certificate. The securities are structured in such a way that the maturity of these
securities may synchronies with the maturity of the securitized loans or receivables.

• Redemption Process: The redemption and payments of interest on these securities are
facilitated by the collections by the SPV from the securitized assets. The task of
collection of dues is generally entrusted to the originator or a special service agent can
be appointed for this purpose. This agency paid certain commission for the collection
service rendered. The servicing agent is responsible for collecting the principal and
interest payments on assets pooled when due and he must pay a special attention to
delinquent accounts. Usually the originator is appointed as the service. Thus under
securitization the role of the originator gets reduced to that of the collection agent on
behalf of SPV in case he is appointed as a collection agent. A pass through certificate
may be either ‘with recourse’ to the originator or ‘without recourse’. The usual practice
is to make it ‘without recourse’. Hence the holder of a pass through certificate has to
look the SPV for payment of the principal and interest on the certificate held by him.
Thus the main task of the SPV is to structure the deal raise proceeds by issuing pass
through certificates and arrange for payment of interest and principal to the investors.

• Credit Rating Process : The passed through certificate have to be publicly issued, they
required credit rating by a good credit rating agency so that they become more
attractive and easily acceptable. Hence these certificates are rated at least by one credit
rating agency at the end of process of securitization. The issues could also be
guaranteed by external guarantor institutions like merchant bankers which would
enhance the credit worthiness of the certificates and would be readily acceptable to
investors. Of course this rating guarantee provides to the investor with regard to the
timely payment of principal and interest by the SPV.

Securitization is not considered to be an excellent investment opportunity by many

investors since the However; if the creditworthiness of the borrower and the prevailing
investment opportunity is analyzed proficiently it may generate high returns for the in

So this is the process of securitization. This is including many steps.

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The securitization process involves a number of participants. The roles of major participants in
securitization process are given following.

1. Originator

The party behind a securitization is the originator. This entity generates (originates) or owns the
defined or identifiable cash flow (that is, an income stream from receivables). An example of an
originator with assets that can be securitized is a retail bank. Following assets are typically
securitized: mortgages, automobile loans, credit card receivables, trade receivables,
educational loans, etc. Securitized assets often have some or all of the following features:

(i) large pool that permits diversification;

(ii) insensitivity to interest rate change;
(iii) limited prepayment risk;
(iv) short maturity; and
(v) Relatively homogeneous pools.

2. Arranger

Originator usually appoints an arranger, which is typically a financial institution (e.g. investment
bank), to design and set up the securitization structure. An arranger:

(i) determines the structure of the risk profile of the receivables to create different
tranches of security;
(ii) sets up a SPV;
(iii) designs credit enhancement and liquidity support

3. Special Purpose Vehicle.

The legal status of the SPV depends on the jurisdiction where it is established. In many
jurisdictions it is a thinly capitalized corporate entity (that is, a company that has a very low
equity capital compared to the amount of debt it owes) and someone other than the originator
holds SPV’s shares, typically a trust. In other jurisdictions, such as those where the trust
concept is not recognized, there may be legislation governing securitization and the SPV may be
set up according to its provisions. Such legislation may provide, example, that the SPV can be
established as a fund, without legal personality, mutually owned by investors, or as a corporate
entity with limited liability .
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4. Investors

Typically, financial institutions, insurance companies, pension funds, hedge funds,

companies, high net worth individuals. Investors purchase the securities issued by the SPV
according to their risk/return preferences. Trenching offers investors the opportunity to
diversify their investment portfolio by purchasing securities with different seniority and yield.
Market liquidity of securities is very important to investors, so that they do not have to hold the
security to maturity but can instead sell it on a public market.

5. Servicers

SPV appoints the servicer to administer and collect the underlying receivables in the
capacity of SPV’s agent for a servicing fee stipulated under the servicing agreement. The
originator or a company within the originator’s group is often appointed as servicer (so that the
profit from securitization can be extracts from the SPV to the originator trough service
agreement). However, sometimes a third party servicer is appointed.

6. Rating Agencies

The SPV engages the rating agencies to rate the creditworthiness of the securities.
Rating agencies rate the securities to indicate whether the SPV has a strong or weak capacity to
pay interest and principal. The rating is provided after detailed statistical analysis on the
probability of default and the effects of such default on the ability of the SPV to comply with its
payment obligations in respect of the securities.

Rating agencies play a pivotal role in the securitization process as the ultimate appraiser
of the underlying pool of collateral. In their process of appraising and evaluating the likelihood
of default by subjecting the cash flows of the pool of underlying assets to stress tests under
severe market conditions, various risks are priced to determine the fair market value of the new
securities. Investors’ acceptance of the ratings as a well-defined standard, as well as the
appropriateness of the amount of credit enhancement, are paramount for a successful
securitization process for ABS, as they need not perform individual appraisals for the new
instruments that could be prohibitively costly. Assuming credit risk analysis is undertaken for a
rated security, the decision to invest turns into consideration of market or interest rate risk, and
analysis of duration and convexity of the underlying instrument.

There are three main credit rating agencies: (i) Standard & Poor’s; (ii) Moody’s Investor
Services; and (iii) Fitch Ratings.

7. Enhancement Providers
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Investors usually demand very high investment grades for asset-backed securities (ABS).
The assets themselves do not earn these grades without enhancements that reduce risks of
credit, liquidity, currency and prepayment.

Credit enhancement reduces the risk of default of the debtors on the underlying assets.
Credit enhancement is used to improve the liquidity, marketability, appeal, and safety of the
underlying cash flows (interest and principal) of a new instrument in the capital market. It is a
form of dressing up an illiquid asset by beefing up its pay-off, while reducing the variability of
cash flows so that wider classes of investors find the rate of return commensurate with risk. The
amount and type of credit enhancement depends on the extent to which one wishes to make
the new instrument in par to a highly-rated security. This enhancement is provided internally
by (i) underwriters or dealers that agree to buy the entire subordinated tranche or (ii) banks or
insurers that provide unconditional guarantees which the SPV can draw if debtors default.

Liquidity enhancement reduces the risk of failure of the servicer to timely transfer
debtors’ payment to the SPV, which might ultimately prevent ABS investors from being paid.
Liquidity enhancement can also address the risks of set-off, prepayment, discounts and other
reductions of payment, as well as invalid assignments of underlying assets. This enhancement is
provided in the same manner as the credit enhancement.

Financial institutions specializing in swap transactions enter into swap contracts with
the SPV to take on risks of interest rates changes, currency movements or defaults and other
non-payment events with respect to underlying assets (effectively providing insurance to SPV
against these risks).

Many jurisdictions have now legislated to make securitization possible or to promote

their securitization market. Regulatory issues that may arise (whether as part of securitization
legislation or otherwise) include: (i) issues affecting the originator, such as accountancy
practices and capital adequacy requirements; (ii) the structuring of the SPV; (iii) whether any of
the parties must be licensed or are subject to supervision by a regulatory body; (iv) the rules on
offering and trading securities; (v) laws governing the underlying receivables (e.g. consumer
lending obligations); (vi) data protection restrictions impacting on the proposed transfer of
customer information accompanying the transfer of receivables.

Motive of Securitization.

1.Advantages to issuer
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Advantages of Securitization

To Investor
T To Issuer

➢ Reduce Funding Cost

➢ Opportunity to
➢ Reduces Assets Liability invest in specific
R mismatch pool of higher rate
of interest.
➢ Lower Capital
Recruitments ➢ Portfolio
Locking in Profits diversification

➢ Transfer of Risk ➢ Isolation of credit

risk from the parent
➢ off Balance Sheet entity

➢ Better Returns
➢ Earnings
➢ Benefits for Small
➢ Liquidity Investors

➢ Admissibility

➢ Reduces funding costs: Through securitization, a company rated BB but with AAA
worthy cash flow would be able to borrow at possibly AAA rates. This is the number one
reason to securitize a cash flow and can have tremendous impacts on borrowing costs.
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The difference between BB debt and AAA debt can be multiple hundreds of basis points.
For example, Moody's downgraded Ford Motor Credit's rating in January 2002, but
senior automobile backed securities, issued by Ford Motor Credit in January 2002 and
April 2002, continue to be rated AAA because of the strength of the underlying
collateral and other credit enhancements.

➢ Reduces asset-liability mismatch: "Depending on the structure chosen, securitization

can offer perfect matched funding by eliminating funding exposure in terms of
both pricing basis." Essentially, in most banks and finance companies, the liability book
or the funding is from borrowings. This often comes at a high cost. Securitization allows
such banks and finance companies to create a self-funded asset book.

➢ Lower capital requirements: Some firms, due to legal, regulatory or other reasons, have
a limit or range that their leverage is allowed to be. By securitizing some of their assets,
which qualifies as a sale for accounting purposes, these firms will be able to remove
assets from their balance sheets while maintaining the "earning power" of the assets.

➢ Locking in profits: For a given block of business, the total profits have not yet emerged
and thus remain uncertain. Once the block has been securitized, the level of profits has
now been locked in for that company, thus the risk of profit not emerging, or the benefit
of super-profits, has now been passed on.

➢ Transfer risks: Securitization makes it possible to transfer risks from an entity that does
not want to bear it, to one that does. Two good examples of this are catastrophe
bond and Entertainment Securitizations. Similarly, by securitizing a block of business
(thereby locking in a degree of profits), the company has effectively freed up its balance
to go out and write more profitable business.

➢ Off balance sheet: Derivatives of many types have in the past been referred to as "off-
balance-sheet. This term implies that the use of derivatives has no balance sheet
impact. While there are differences among the various accounting standards
internationally, there is a general trend towards the requirement to record derivatives
at fair value on the balance sheet. There is also a generally accepted principle that,
where derivatives are being used as a hedge against underlying assets or liabilities,
accounting adjustments are required to ensure that the gain/loss on the hedged
instrument is recognized in the income statement on a similar basis as the underlying
assets and liabilities. Certain credit derivatives products, particularly Credit Default
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Swaps, now have more or less universally accepted market standard documentation. In
the case of Credit Default Swaps, this documentation has been formulated by
the International Swaps and Derivatives Associations (ISDA) who has for long time
provided documentation on how to treat such derivatives on balance sheets.

➢ Earnings: Securitization makes it possible to record an earnings bounce without any real
addition to the firm. When a securitization takes place, there often is a "true sale" that
takes place between the Originator (the parent company) and the SPE. This sale has to
be for the market value of the underlying assets for the "true sale" to stick and thus this
sale is reflected on the parent company's balance sheet, which will boost earnings for
that quarter by the amount of the sale. While not illegal in any respect, this does distort
the true earnings of the parent company.

➢ Admissibility: Future cash flows may not get full credit in a company's accounts (life
insurance companies, for example, may not always get full credit for future surpluses in
their regulatory balance sheet), and a securitization effectively turns an admissible
future surplus flow into an admissible immediate cash asset.

➢ Liquidity: Future cash flows may simply be balance sheet items which currently are not
available for spending, whereas once the book has been securitized, the cash would be
available for immediate spending or investment. This also creates a reinvestment book
which may well be at better rates.

Disadvantages to issuer
➢ May reduce portfolio quality: If the AAA risks, for example, are being securitized out,
this would leave a materially worse quality of residual risk.

➢ Costs: Securitizations are expensive due to management and system costs, rating fees
and ongoing administration. An allowance for unforeseen costs is usually essential in
securitizations, especially if it is an atypical securitization.

➢ Size limitations: Securitizations often require large scale structuring, and thus may not
be cost-efficient for small and medium transactions.
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➢ Risks: Since securitization is a structured transaction, it may include par structures as

well as credit enhancements that are subject to risks of impairment, such as
prepayment, as well as credit loss, especially for structures where there are some
retained strips.

Advantages to investors
➢ Opportunity to invest in a specific pool of high quality assets: Due to the stringent
requirements for corporations (for example) to attain high ratings, there is a dearth of
highly rated entities that exist. Securitizations, however, allow for the creation of large
quantities of AAA, AA or A rated bonds, and risk averse institutional investors, or
investors that are required to invest in only highly rated assets, have access to a larger
pool of investment options.

➢ Portfolio diversification: Depending on the securitization, as well as other institutional

investors tend to like investing in bonds created through securitizations because they
may be not corralled to their other bonds and securities.

➢ Isolation of credit risk from the parent entity: Since the assets that are securitized are
isolated from the assets of the originating entity, under securitization it may be possible
for the securitization to receive a higher credit rating than the "parent", because the
underlying risks are different. For example, a small bank may be considered more risky
than the mortgage loans it makes to its customers; were the mortgage loans to remain
with the bank, the borrowers may effectively be paying higher interest (or, just as likely,
the bank would be paying higher interest to its creditors, and hence less profitable).

Risks to investors
➢ Credit/default: Default risk is generally accepted as a borrower’s inability to meet
interest payment obligations on time. For ABS, default may occur when maintenance
obligations on the underlying collateral are not sufficiently met as detailed in its
prospectus. A key indicator of a particular security’s default risk is its credit rating.
Different tranches within the ABS are rated differently, with senior classes of most
issues receiving the highest rating, and subordinated classes receiving correspondingly
lower credit ratings. Almost all mortgages, including reverse mortgages, and student
loans, are now insured by the government, meaning that taxpayers are on the hook for
any of these loans that go bad even if the asset is massively over-inflated. In other
words, there are no limits or curbs on over-spending, or the liabilities to taxpayers.
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➢ However, the credit crisis of 2007–2008 has exposed a potential flaw in the
securitization process – loan originators retain no residual risk for the loans they make,
but collect substantial fees on loan issuance and securitization, which doesn't encourage
improvement of underwriting standards.

Event risk
➢ Prepayment/reinvestment/early amortization: The majority of revolving ABS are
subject to some degree of early amortization risk. The risk stems from specific early
amortization events or payout events that cause the security to be paid off prematurely.
Typically, payout events include insufficient payments from the underlying borrowers,
insufficient excess spread, a rise in the default rate on the underlying loans above a
specified level, a decrease in credit enhancements below a specific level, and
bankruptcy on the part of the sponsor or servicer.

➢ Currency interest rate fluctuations: Like all fixed income securities, the prices of fixed
rate ABS move in response to changes in interest rates. Fluctuations in interest rates
affect floating rate ABS prices less than fixed rate securities, as the index against which
the ABS rate adjusts will reflect interest rate changes in the economy. Furthermore,
interest rate changes may affect the prepayment rates on underlying loans that back
some types of ABS, which can affect yields. Home equity loans tend to be the most
sensitive to changes in interest rates, while auto loans, student loans, and credit cards
are generally less sensitive to interest rates.

Contractual agreements
➢ Moral hazard: Investors usually rely on the deal manager to price the securitizations’
underlying assets. If the manager earns fees based on performance, there may be a
temptation to mark up the prices of the portfolio assets. Conflicts of interest can also
arise with senior note holders when the manager has a claim on the deal's excess
spread.

➢ Servicer risk: The transfer or collection of payments may be delayed or reduced if the
servicer becomes insolvent. This risk is mitigated by having a backup servicer involved in
the transaction.

Disadvantages of Securitization
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Securitization requires proper analysis and expertise; otherwise, it may prove to be quite
unsound to the investors. Let us now discuss its various drawbacks:

• Lack of Transparency: The SPV may not disclose the complete information about the
assets included in a securitized bond to the investors.

• Complex to Handle: The whole process of securitization is quite complicated involving

multiple parties; also, the assets need to be blended wisely.

• Quite Expensive: When compared to share flotation, the cost of a securitized bond is
usually high, including underwriting, legal, administration and rating charges.

• Investor Bears Risk: The non-repayment of debts by the borrower would ultimately end
up as a loss to the investors. Therefore, the investor is the sole risk-bearer in the
process.

• Inaccurate Risk Assessment: Sometimes, even the originator fails to identify the value
of underlying assets or the associated credit risk.

• Loss from Prepayment: If the borrower pays off the sum earlier than the defined period,
the investors will not make superior gains on their investment value

• Expensive: Expenses associated with securitization bonds is higher as compared to

share floatation.

The Development of Securitization in India

When undertaken by banks, financial institutions and non-banking financial companies
("NBFCs"), securitization in India is regulated and governed by the Reserve Bank of India
("RBI") under the provisions of the 2006 and 2012 Guidelines on Securitizations of
Standard Assets ("RBI Guidelines") for standard assets and by the securitizations and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
("SARFAESI Act") for stressed financial assets.

While the term "securitization" is defined under each of these regulatory regimes, both
regimes envisage securitization as a ring-fenced and bankruptcy-remote true sale of
financial assets (or a pool of such assets) in return for immediate cash payment. Under
the true sale mechanism, the assets move from the balance sheet of the originator to
the balance sheet of a special purpose vehicle ("SPV") or asset reconstruction company,
and are pooled, sub-divided, repackaged as traceable securities backed by such pooled
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assets and sold to investors either as pass through certificates ("PTCs") or security
receipts ("SRs"), which represent claims on incoming cash flows from such pooled
assets.

Banks and financial institutions in India also often enter into direct assignments of non-
stressed financial assets under the provisions of the RBI Guidelines. Such direct
assignment structures would not involve an SPV, the pooling of assets or the issuance of
PTCs, and are often preferred in the Indian market by banks and financial institutions
when selling down to other banks or financial institutions.

securitization as a structured finance mechanism has several commercial advantages,

including balance sheet and risk management, increased liquidity, cost-efficient
financing, marketability of the resulting securities and an opportunity for portfolio
diversification, which has remained an attractive option for banks, NBFCs and financial
institutions in India.

India's foray into securitization can be traced back to 1991, when CRISIL rated the first
securitizations programmed in India, where Citibank securitized a pool from its auto
loan portfolio and placed the paper with GIC Mutual Fund (source: RBI Report of the In-
House Working Group on Asset securitization dated 29 December 1999).

The first significant legislation in this field in India was the SARFAESI Act, notified in
2002, which even today remains the principal legislation for the securitizations of non-
performing loans and financial assets.

Under Indian stamp laws (which differ from state to state across India), securitization
and assignment transactions are subject to stamp duty, which would need to be
factored into the cost of the securitizations. In several states, a deed of assignment
attracts significant stamp duty, which is paid on an ad valorem basis, and in some states
no distinction is made between conveyances of real estate and transfers or assignments
of receivables, with both attracting similarly high stamp duties. To ensure that the
stamp duty is not prohibitive and to render such transactions commercially viable and
encourage securitization, several states have issued notifications for the remission
and/or reduction of stamp duties on debt assignment or securitization transactions.
Several states now have a cap on the stamp duty payable on instruments assigning loans
or securitizing debt with underlying security to INR100, 000. A 2016 amendment to the
SARFAESI Act also eased the pricing of securitization transactions by exempting
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instruments securitizing or assigning non-performing financial assets in favor of asset

reconstruction companies.

So far, the SARFAESI Act has provided for the securitization of non-performing assets
only. In 2006, the RBI introduced the RBI Guidelines to regulate the securitization of
standard assets (ie, non-stressed assets) by banks, NBFCs and financial institutions, to
ensure the healthy development of the securitization market in India (source: RBI
notification dated 4 April 2005 releasing the draft RBI Guidelines). This was a further
step towards opening up the Indian markets to securitization transactions while
providing a robust regulatory framework for such transactions. The RBI Guidelines also
provide for the originator to act as servicing agent to the assignee or investors for the
collection of payments due under the securitized assets on behalf of the assignee or
investors.

In the wake of the global financial crisis of 2008 center around sub-prime lending and
securitization, regulators across the globe put more robust mechanisms in place to
regulate their markets. To insure against a misuse of securitization in India, the RBI
introduced revisions to the RBI Guidelines in 2012 mandating banks, NBFCs and financial
institutions securitizing their standard assets to retain "skin in the game" and have a
continuing stake in the performance of the securitized assets, referred to as the
minimum retention requirement ("MRR"). It was also mandated that such assets had to
be held by the originating entity for a minimum length of time, being the minimum
holding period ("MHP") that the loan or financial asset must stay on the books of an
originator before it can become a part of the pool to be securitized. The MRR and MHP
provided for a more effective screening of loans, requiring the originator to show a
proven record of performance prior to the securitizations or assignment of such assets.
Despite the stricter regulation, securitizations have remained of interest to banks and
financial institutions through the years, for both securitization and direct assignment.

In September 2018, the Indian NBFC sector suffered a setback with Infrastructure
Leasing & Financial Services Limited ("IL&FS"), a large infrastructure and development
finance company, defaulting on several of its debt obligations (amounting to
approximately INR 94,000 Core). The resulting panic in the market saw traditional
sources of funding disappear for other NBFCs, and raised concerns on debt servicing.
With such a sudden drop in willing lenders, NBFCs looked to securitize their standard
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assets to finance their funding requirements, and the Indianan market witnessed a
growth in the volume of securitization.

The financial sector faced another roadblock in 2019, when housing finance company
Dewan Housing Finance Limited ("DHFL") failed to make interest payments of INR1,150
Crore to its bond holders, leading to its credit rating being downgraded to "D". Prior to
such downgrade, DHFL had, as an originator, assigned some of its standard assets to
certain other financial institutions under the RBI Guidelines. DHFL continued to service
the assigned assets by collecting the receivables in respect of such assigned assets as a
servicing agent for and on behalf of the assignees. On DHFL's default in payments as
mentioned above, some of its creditors obtained a court-imposed stay vide order dated
10 October 2019 of the High Court of Judicature at Bombay on DHFL making payments
to any of its creditors (except for certain payments on a pro-rata basis to all its secured
creditors). This order brought to the fore concerns about the efficacy of securitization
and assignment transactions and their true bankruptcy remoteness. Subsequently, the
High Court of Judicature at Bombay vide order dated 13 November 2019 (in Reliance
Nippon Life Asset Management Limited v/s Dewan Housing Finance Corporation Limited
& Others) clarified that the stay would not apply in respect of assets assigned by DHFL
under the assignment agreements, thereby reinforcing the well-settled principle of the
bankruptcy remoteness of assets assigned under the RBI Guidelines.

The public backlash on the IL&FS cases, the increasing defaults by NBFCs and the lack of
an insolvency regime to hold such NBFCs more accountable to their creditors prompted
the government in November 2019 to extend the applicability of the Insolvency and
Bankruptcy Code, 2016 ("IBC") to NBFCs with a minimum asset size of INR500 Core. The
notification by the Ministry of Corporate Affairs of the Insolvency and Bankruptcy
(Insolvency and Liquidation Proceedings of Financial Service Providers and Application
to Adjudicating Authority) Rules, 2019 ("Rules") currently only lists such NBFCs as
financial service providers ("FSP") under the ambit of the IBC, and provides a mechanism
for the RBI to initiate an insolvency resolution process against such an NBFC in case of a
default in payment of its debt. Smaller NBFCs, banks and other financial institutions
currently continue to remain shielded from the IBC regime.

The RBI initiated insolvency proceedings against DHFL, which, on 3 December 2019, was
admitted by the Mumbai bench of the National Company Law Tribunal against DHFL and
 19

a moratorium has been imposed inter alia on the transfer, alienation or disposal of any
assets of DHFL. In order to ensure that such moratorium applies only to assets owned by
the FSP, the Rules clarify that the moratorium will not apply to third party assets or
property in the custody or possession of the FSP held in trust by the FSP for the benefit
of third parties. It would therefore appear that the latest insolvency regime in India also
adequately protects the rights of assignees or investors in assignment and securitization
transactions.

securitization Trends in India

The last few years especially have seen major developments in the area of securitization
and direct assignments, which are further augmented by commercially astute law and
regulation, be it stamp duty relaxations, the RBI modifying its guidelines from time to
time or the IBC and the Rules. Other measures that have fueled the securitization
market in India include the RBI temporarily relaxing the MHP requirements for NBFC
originators/ assignors, which has, as of 31 December 2019, been further extended until
30 June 2020. The relaxation allows a larger asset pool to be eligible for securitization by
NBFCs.

The NBFC crisis has clearly led to a surge in securitization and assignment transactions
across the financial services sector in India. Over the years, there has been greater
variation in the pool of assets being securitized or assigned – auto and vehicle loans,
finance lease receivables, microfinance, retail and consumer durable loans, and
education loans. As NBFCs continue to innovate new and varied products and portfolios,
the securitization market too will see an increased spread across asset classes and
products.

Banks, NBFCs and financial institutions remain interested in securitization to meet their
minimum priority sector lending requirements. With better reach to these sectors,
NBFCs remain by and large the originators, while banks with a smaller branch network
often prefer to satisfy their priority sector lending commitments using the securitization
route as an investor instead of originating loans directly to this sector. Investors or
assignees through securitization have access to a broader asset base across sectors,
enabling the diversification of risk. For NBFC originators, the securitization option –
especially after the IL&FS and DHFL crisis – provides access to alternative sources of
 20

funding where traditional sources may not be as easily available. The past year has also
seen assignments and securitization transactions by unregulated entities (i.e., other
than banks, financial institutions and NBFCs) falling outside the purview of the RBI
Guidelines and the SARFAESI Act.

Closing Remarks

The RBI has constituted a committee to review the existing state of mortgage-backed
securitization in India and recommend specific measures to facilitate second market
trading in such instruments. The report of the committee dated 5 September 2019 has
been released and recommends various measures to improve the securitization market
in India. The legislative and regulatory clarity so far, especially on the IBC front and the
regulator's willingness to further develop the market should bolster investor and
assignee confidence and appetite for securitization and assignments across asset
segments.

In its press release dated 15 July 2019, ICRA Limited (a rating agency), announced that,
in the first quarter of the financial year 2019-2020, the Indian securitization market
clocked the highest issuance volumes seen in the first quarter of any financial year (with
56% year-on-year growth over the same period in the previous fiscal year).

With the continuing need for liquidity by NBFCs, the growing appetite of investors and
the developments on the regulatory front, securitization is likely to remain on the
upward curve in the near future.

Conclusion.

• Securitization is a means to provide liquidity to financial assets.

• The securitization transaction offer investors:
o Optimization of returns for the level of risk assumed.
o Diversified exposure.
o Protected exposure.
o Improve stability of exposure.
o Ability to create rating or performance profile.
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• securitization in is at the crossroads. A lot has been heard about in 1990. We are familiar
with the sad Indian story of minor irritants playing a major role in development. But just
as the revolution in India was outcome of import liberalization for computers so it is an
only matter of time before high quality securitization forms the backbone of housing,
infrastructure, and trade finance in India.

• The cycle of securitization: Securitiarian discourses legitimate the use of security

technologies, which in turn sustain the legitimacy of those discourses.

• Security can be an argument for less restrictive migration policies.