Securitization

Securitization
DR. SEEMA PANDIT

FBA ( NRBBA)
Meaning & Process ( Video)
2
 Securitization -Meaning & Process.mp4
Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Meaning
3
 Process by which the financial assets such as loan
receivables, mortgage backed receivables, credit card

balances, hire purchase debtors, lease receivables,
trade debtors etc. are transformed into securities
 Conversion of existing or future cash in-flows of
any person into tradable security, which can

then may be sold in the market

Meaning
4
 Process of liquidizing the assets appearing in the
balance sheet of a bank or a financial institution which

represent long term receivables by issuing marketable
securities there against
 Conversion of cash flows from a portfolio of assets in
negotiable instruments or assignable debts which are

sold to investors

Features
 By doing securitization, financial
5 assets ( loan assets,
mortgages, lease receivables, credit card balances etc.) are
converted into Special Purpose Entity or Vehicle (SPE/SPV).
On these SPV, immediate cash payment can be made
 When financial assets are converted into SPVs/ SPEs, these
newly converted SPVs/SPEs are financed through issue of
securities like pass through certificate (PTCs) and debt
securities to the investors

Features
 Credit rating agency gives rating to these securities which
6
give investor an idea about the effectiveness of issuer to make
scheduled payments
 After completing the rating process of these securities, now
timing and pricing of the issue is determined with the help of

qualified merchant banker
 Investors make payment to SPV and buy these securities and
originator of the securities receives payment on the due date

against securities

Scope
 The name securitization is derived from the fact that the form of
7
financial instruments used to obtain funds from the investors is
securities. All assets can be securitized so long as they are
associated with cash flow. Hence securities which are the
outcome of securitization process are termed as asset backed
securities (ABS). From this perspective , securitization could also
be defined as a financial process leading to an issue of ABS
 The need for the legal framework on securitization can be traced
back way from 1991 onwards where various committees
recommended to have a law on securitization and enforcement.
This was followed by the enactment of the Securitization and
Reconstruction of Financial Assets and Enforcement of Securities
Act, 2002
Dr. Seema (SARFAESI Act 2002)
Pandit-FBA(NRBBA) 9/29/2021
Scope
 The Act encompasses the areas of : securitization of financial assets,
8
reconstruction of financial assets, recognition of any security interest created for
due repayment of loan as security interest under the Securitization Act
 Banks, financial institutions have the power to enforce the security without the
intervention of the court, setting up the Central Registry for registration of the
transactions of securitization, reconstruction and creation of security interests.
 Securitisation has become a global financing tool in various countries like Mexico,
Brazil, USA, Canada, UK, France, Australia, Hong Kong, Netherlands, Japan,
Germany etc
 Assets securitised include credit card receivables, residential mortgages, car loans,
swap contracts, trade and export receivables, oil and gas receivables etc.

Scope
 Securitization is a relatively new concept in India but is gaining
9
ground rapidly
 CRISIL rated the first securitization program in India in 1991
when Citibank securitised a pool from its auto loan portfolio and
placed the paper with the GIC Mutual Fund. Since then,
securitization f assets has began to emerge as a clear option of
fund raising by the corporates and a few transactions of well
rated companies have taken place in the country.
 Given this background, securitization in India is mainly seen in:
 Housing loans (specifically affordable housing).
 Commercial vehicle loans.
 Microfinance loans.
Originato
r
10
Structure
SPV
r
Agent Parties to
and Securitizatio Investors
Trustee n Transaction
Administ
Obligor(s
rator or
)
Servicer
Credit
Rating
Agency

Parties to Securitization
 Originator : This is the entity on whose books, the assets to
11
be securitized exist. It is the prime mover of the deal, i.e., it
sets up the necessary structures to execute the deal. It sells
the assets on its books and receives the funds generated from
such sale. The originator transfers both the legal and the
beneficial interest in the assets of the SPV

 SPV : The issuer also known as the SPV is the entity, which
12
would typically buy the assets ( to be securitised) from the
Originator. It is a low capitalised entity wit narrowly defined
purposes and activities and usually has independent trustees/
directors. As one of the main objectives of Securitisation is to
remove the assets from the balance sheet of the Originator,
the SPV plays a very important role in as much as it holds the
assets in its books and makes the upfront payment for them
to the Originator

 Investors: may be in the form of individuals or institutional
13
investors like mutual funds, provident funds, pension funds,
insurance companies et. They buy a participating interest in
the total pool of receivables and receive their payment in the
form of interest and principal as per agreed pattern
 Obligor(s) : 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 is of paramount importance in the
securitization transaction
 Credit Rating Agency: The rating process would assess the
14
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
 Administrator or Servicer : It collects the payment due from
the Obligor/s and passes it to the SPV, follows up with delinquent

borrowers and pursues legal remedies available against the
defaulting borrowers. Since it receives the instalments and pays it
to the SPV, it is also called the Receiving and Payment Agent

 Agent and Trustee: It accepts
15 the responsibility for overseeing
that all the parties to the Securitisation deal perform in accordance

with the Securitisation trust agreement. Basically, it is appointed to
look after the interest of the investors
 Structurer : Normally, an investment banker is responsible as
structurer for bringing together the Originator, credit enhancer/s,

investors and other partners to a Securitisation deal. It also works
with the Originator and helps in structuring deals

Process of Securitization
16
Process of Securitization.jpg

• The originator pools the similar set of asets that
generate a predictable stream
17 of payment and sells/
assigns them to special purpose vehicle (SPV). Any
asset having a cash flow profile over a period of time
can be securitized. Some of the assets that can be
securitized are housing loans, car loans, term loans,
export credits and future receivables like credit card
payments, ticket sales, car rentals, electricity and
telephone bills receivables. These assets are known as
financial assets
• Under section 5 (1) of the SARFAESI Act 2002, only banks
18
and financial institutions can securitize their financial assets,
thereby restricting the originator of the securitization. The
SPV converts the financial assets into the securities for the
purposes of selling them to the investors.
• Broadly, securitization transaction can be divided into main
players and the facilitators. The main being the Originator,
Obligor, SPV and Investors ( also known as QIBs – qualified
institutional buyers). The facilitators of securitization can be
considered as credit rating agency, the insurance company or
under writers, trustees and receiving and paying agent.
• The very inception of securitization transaction starts from the originator.
19
Originator is the one who owns the financial assets by making loans to the
borrowers or obligors. In India, the originator can only be banks and
financial institutions
• The Obligor or the borrower can by any person including legal person,
who takes loan from originator, which are to be returned to the originator
• The SPV can be institutionalized in the form of trust or company with the
main object to support the securitization transaction. Its main objective is

to buy the receivables from the originator and convert them into security
receipts which are sold to the investors
• Investors under section 7 of the Act are restricted to only the QIBs, who
can invest in the security receipts

• Facilitators play a very important role in enhancing the credit worthiness
20
of the financial assets. Credit rating agency evaluates the securitized
instruments and their credit worthiness
• The trustees owes a responsibility towards the beneficiary i.e. the
investors. This relationship gives the right to the trustee to have the
priority interest in the financial asset of their beneficiaries. The trustee
can protect the investor’s interest by way of reviewing the assets,
distributing cash flow to the investors and taking legal action to protect
the investor's’ interest
• The role of receiving and the paying agent is played by the originator
themselves. The agent has to make sure that the periodic payments are
received from the obligor and transferred to the investors
Pass and Pay Through Structures
• The nature of the investor’s interest in the underlying assets
21
determines whether a Securitisation structure is “Pass Through” or
“Pay Through” structure
• Under the mechanism of Pass-Through Certificates, all the cash
flows are received by the originator and passed on directly to the
investor through an intermediary known as the SPV. The
assignment may or may not be with recourse. If the assignment
contains a ‘with recourse’ clause, then the originator can be hauled
up by the SPV in case of defaults in the payment of inflows from
the underlying assets. In such an eventuality, the originator regains
his rights in the receivables. This is the mechanism commonly
prevalent in India.

22
 In a pass through structure, the SPV issues Pass Through

Certificates, which are in the nature of participation certificates
that enable the investors to take a direct exposure on the
performance of the securitized assets
• In Pass Through structure, investors are serviced as and when
cash is actually generated by the underlying assets. Delay in cash
flows is shielded to the extent of credit enhancement. Pre-
payments are passed on to the investors who have to tackle re-
investment risk

23
• Pay-Through Certificates: Under the mechanism of Pay-
Through Certificates, all cash flows received by the
originator are reinvested by the SPV in gilts or other
securities (which bear a fixed rate of interest). Proceeds
from such investments are utilised by the SPV to make p
• Pay through gives investors only a charge against the
securitized assets. While assets themselves are owned by
the SPV. The SPV issues regular secured debt instrument.
The term PTC has been used in the report referring to pass
through as well as pay through certificates
24
• Pay Through structures permit de synchronization of
the securities from the underlying cash flows. In Pay

through structure, the SPV is given discretion to re-
invest short term surpluses, a power that is not
available to the SPV in the case of Pass Through
structure. Further under this structure, the different
issues of securities can be ranked and hence priced
differentially
Asset and Mortgage Backed Securities
• A security created by pool of loans 25
excluding residential mortgage loans and
commercial mortgage loans is referred to as an Asset Backed Security.
 There are broadly two types of assets that have been securitised
 Consumer Asset-Backed Securities This includes:

 Auto loans
 Credit card receivables
 Student loans
 Commercial Asset Backed Securities

 Trade receivables
 Equipment leasing
 Operating assets (Aircraft, Marine cargo)
 Entertainment assets
 Small business loans

Asset Backed Securities
26
• A security created by pool of loans excluding

residential mortgage loans and commercial mortgage
loans is referred to as an Asset Backed Security.

27
ABS Example:
 ICICI Bank has given out car loans to individuals for a total of Rs 10,00,000.
The car loans have maturity periods from one year to three years. ICICI Bank
pools these loans into one security that has an average maturity of 2 years
with final maturity of three years. The car loan pool is transferred to an SPV.
 Investors interested in the car loan pool can bid for the security also known
an Pass Through Certificate (PTC), that gives the investor the right to the cash
flows of the car loan pool. The investor bids at market yields for the PTC. A
rating agency rates the PTC based on the performance of the underlying car
loans. ICICI Bank can extend guarantees for the loans to get higher ratings for
the PTC, which will lower the yield on the security.

28

Mortgage Backed Securities
29
 Mortgage backed securities (MBS) are pool of mortgage loans and
claims on cash flows from it. MBS are formed by securitization.
 Mortgage-backed securities include Pass-Through Participation
Certificates, which claims share of all principal and interest

payments made on the pool of loan assets and Collateralized
Mortgage Obligations (CMO), which has claim on cash flows of
Mortgage Backed Securities.

30

Securitisation in India
• Securitisation in India began31in the early nineties.
• Initially started as a device for bilateral acquisitions of

portfolios of finance companies. These were forms of quasi
securitization, with portfolios moving form the balance
sheet of one originator to that of another.
• Originally these transactions included sale of loan through
direct assignment route. Through direct assignment and
securitization, these institutions get upfront cash payments
against selling their loan assets. Most of them have been
bilateral one-to-one and unrated transactions
Securitisation In India
• CRISIL rated the first securitisation
32 program in India in 1991 when
Citibank securitised a pool from its auto loan portfolio and

placed the paper with GIC Mutual Fund.
• Since then, securitisation of assets has begun to emerge as a clear
option of fund raising by corporates and a few transactions of well-
rated companies have taken place in the country.
• While some of the securitisation transactions which took place earlier
involved sale of hire purchase or loan receivables of non-banking
financial companies (NBFCs), arising out of auto-finance activity,
many manufacturing companies and service industries are now
increasingly looking towards securitizing their deferred receivables
and future flows also.
33
• The need for securitization in India exists in three major
areas:
1. Mortgage Backed Securities ( MBS)
2. The Infrastructure Sector
3. Other Asset Backed Securities

• Mortgage Based Securitization
34 ( MBS) in India has been
used sparingly. National Housing Bank ( NHB) along with
HDFC and LIC Housing Finance issued India’s first MBS. The
potential of MBS in India is very bright and big.
• NHB aims to develop Secondary Mortgage Market (SMM)
in India, which means MBS has the potential to overtake all
other securitization transactions in India.
• But the problem in the current legal framework sets back the
whole process. There is still a lack of mortgage foreclosure
norms and the high incidence of stamp duty for assignment of
mortgage necessary for securitization
35
• In the Indian context, the funds requirement in the
housing sector is immense. A part of it would be financed
by the formal sector.
• It is unlikely that this gap can be filled out of budgetary
allocation or regular bank credit. Securitisation allows this
gap to be bridged by directly accessing the capital markets
without intermediation.
• Securitisation tends to lower the cost at which the housing
sector accesses funds. It also facilitates a sufficiently deep
long term debt market.
36
• Infrastructure Finance: A famous structured finance transaction

in India was by the India Infrastructure Developers Ltd. (IIDL)
• IIDL incorporated an SPV through which they set up the building and
operating power plant for IPCL.
• IIDL raised finances on its future receivables from IPCL & L&T.
transaction was rated ‘AA’ by CRISIL.
• Further ICICI has been involved in various bilateral asset backed
securitization deals, some of the norworthy securitization transactions
by ICICI are where it securitized the receivables of Department of
Telegraph from Sterlite Industries and Usha Beltron

SARFAESI ACT 2002
• Securitization and 37
Reconstruction of Financial Assets and
Enforcement of Security Interest Act 2002
• Narasimham Committee I and II and Andhyarujina Committee was constituted by

the Central Government for the purpose of examining banking sector reforms .
They considered the need for changes in the legal system in respect of these
areas. Amongst the other committees, these Committees have made suggestions
to form new legislation for securitization and empowering banks and financial
institutions to gain possession of the securities and to sell them without any
intervention of the court here.
• The SARFAESI Act was constituted as per the recommendations of this two
committees

SARFAESI ACT 2002
38
 “An act to regulate securitization and reconstruction of financial assets and

enforcement of security interest and to provide for a central database of security
interests created on property rights and for matters connected therewith or
incidental thereto.”

Features of Securitization Act
39
Incorporation of SPV, namely securitization company or

reconstruction company
Facilitating Securitization of financial assets of the banks or

financial institutions
Promotion of seamless transferability of financial assets by the ARC

to acquire financial assets of banks and financial institutions through
issuance of debentures or bonds or any other security as a debenture

40
Entrusting the Asset Reconstruction

Companies to raise funds by issue of
security receipts to qualified buyers
Enforcing Security Interest, i.e., taking

over the assets given as security for the
loan

41
Establishment of the central registry for regulating and registering

securitization transactions. One objective of Securitization Act is to provide
for the enforcement of security interest, that is, taking the possession of the
assets given as security as loan. Section 13 of the Act contains elaborate
provisions for a lender to take possession of the security given by the
borrower
Classification of the borrower’s account as a non-performing asset in

accordance with the directions given or under guidelines issued by the
Reserve Bank of India from time to time

42
The officers authorized will exercise the rights of a

secured creditor in this behalf in accordance with
the rules made by the Central Government
An appeal against the action of any bank or financial

institution to the concerned Debts Recovery Tribunal
and a second appeal to the Appellate Debts Recovery
Tribunal

43
Offences and penalties
Application of the proposed legislation initially to banks and

financial institutions and empowerment of the Central
Government to extend the application of the proposed legislation
to non-banking financial companies and other entities

44
Non-application of the proposed legislation to security interests in agricultural lands,

loans less than rupees one lakh and cases where eighty per cent, of the loans, is repaid
by the borrower
Banks can sell the following financial assets to the securitization company:
An NPA, including a non performing debenture/ bond
A “ Standard Asset” .[

Dr. Seema Pandit-FBA(NRBBA) 45 9/29/2021
Issues/ Problems facing the Indian
Securitization Market
46
Taxation
Foreclosure
Stamp duty related
Laws
issues
Issues under
SARFAESI Legal issues
Act 2002

 Stamp duty :
47
 One of the major hurdles facing the development of securitization market is the
stamp duty structure in India
 In India, stamp duty is payable on any instrument which seeks to transfer rights
or receivables. Therefore, the process of transfer of receivables from originator to

SPV involves an outlay on account of stamp duty, which can make securitization
commercially unviable in states that still have a high stamp duty
 If the securitised instrument is issued as a bond or debenture, it would attract
stamp duty but if it is structured as a Pass Through Certificate, then it would not
attract stamp duty.
 Some states do not distinguish between conveyances of real estate and that of
receivables, and levy same rate of stamp duty
 The margins in securitisation transaction are so thin that a high stamp duty can
only frustrate
48
 Foreclosure Laws
 Foreclosure is a legal process in which a lender attempts

to recover the balance of a loan from a borrower, who has
stopped making payments to the lender, by forcing the sale
of the asset used as the collateral for the loan.
 Lack of effective foreclosure laws also prohibits the growth
of securitisation in India
 The existing foreclosure laws are not lender friendly and
increase the risk of MBS by making it difficult to transfer
property in case of default
 Taxation Related Issues:
49
 The tax laws related to securitisation transactions are not clear because the
concept, although rapidly gaining in popularity, is still fairly new in India. There
are no specific provisions under the Income Tax Act, 1961 (“ITA”) addressing the
peculiarities of securitisation transactions.
 Taxation will normally depend on how the documents relating to the transaction
are structured, the characterization of the transaction by the income tax

authorities and other issues
 Income in relation to securitisation transactions could be characterized as

business income, interest income, income from capital gains or income from other
sources.
 There is ambiguity in the tax treatment of mortgage based securities, SPV trusts
and NPL trusts.

50
 Taxation Related Issues:
 Presently the investors or the buyers (PTC or SR holders) pay

tax on the earnings from the SPV trusts. As a result, the trustee
makes income pay outs to the investors without any payment of
tax
 The tax issues relating to the SPV would differ according to
three approaches. If the SPV acts only as a medium/channel
between the originator and the investors, it would not earn any
income nor make any profits, and it would not be liable to tax.
 The tax liability of the SPV will also differ on the basis of the
type of its constitution – as trust or as company.
51
 Issues under SARFAESI Act:
 A Security Receipt ( SR) gives its holder a right to tittle 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 certificates.
 However, the rationale fails in the case of pay through certificates with
different classes of primary and secondary rights to the cash flow
 Also SARFAESI Act has been structured such that SRs can be issued
and held only to Qualified Institutional Buyers ( QIBs)
 There is a need to expand the investor base by including NBFCs, Non-
NBFCs, private equity funds etc
52
 Legal Issues:
 Investments in PTCs are typically held to maturity. As there is no

trading in these instruments, the yield on PFCs and demand for longer
tenures especially from the mutual funds is dampened
 Earlier, Pass Through Certificates were not explicitly covered under
The Securities Contracts (Regulation) Act, definition of securities
 This was however amended with a view to providing a legal
framework for enabling listing and trading of securitised debt
instruments. This will bring about listing of PTCs which in turn will
support market growth

Advantages of Securitization
53
 To the Investors :
1. Securitization is a new investment avenue
2. Though investors face credit risk, the securities are tied

to definite asset
3. As the securities are rated by credit rating agencies, it
becomes easier for the investors to compare the risk
return profile and make informed investment decision
4. Securitization helps to convert the stream of cash
receivables into a source of long term finance
Advantages of Securitization
54
 To the Originator :
1. Securitization result in shifting the assets off the balance sheet

and thus, gives the originator recourse to off balance sheet
funding. For example, a bank may need to reduce its exposure
to credit so as to meet the capital adequacy norms.
2. It converts illiquid assets into liquid portfolio
3. If facilitates better balance sheet management as assets are
transferred off balance sheet facilitating satisfaction of capital
adequacy norms
4. The credit rating of the originator enhances
Dr. Seema Pandit-FBA(NRBBA) 55 9/29/2021

Securitization

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Securitization

DR. SEEMA PANDIT

 Securitization -Meaning & Process.mp4

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

receivables, mortgage backed receivables, credit card

 Conversion of existing or future cash in-flows of

any person into tradable security, which can

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

balance sheet of a bank or a financial institution which

 Conversion of cash flows from a portfolio of assets in

negotiable instruments or assignable debts which are

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

mortgages, lease receivables, credit card balances etc.) are

converted into Special Purpose Entity or Vehicle (SPE/SPV).

On these SPV, immediate cash payment can be made

 When financial assets are converted into SPVs/ SPEs, these

newly converted SPVs/SPEs are financed through issue of

securities like pass through certificate (PTCs) and debt

securities to the investors

 After completing the rating process of these securities, now

timing and pricing of the issue is determined with the help of

 Investors make payment to SPV and buy these securities and

originator of the securities receives payment on the due date

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

 Obligor(s) : Obligor is the Originator’s debtor ( borrower of

the original loan). The amount outstanding from the Obligor

 Administrator or Servicer : It collects the payment due from

the Obligor/s and passes it to the SPV, follows up with delinquent

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

that all the parties to the Securitisation deal perform in accordance

 Structurer : Normally, an investment banker is responsible as

structurer for bringing together the Originator, credit enhancer/s,

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

main object to support the securitization transaction. Its main objective is

can invest in the security receipts

• The trustees owes a responsibility towards the beneficiary i.e. the

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

 In a pass through structure, the SPV issues Pass Through

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

the securities from the underlying cash flows. In Pay

 Consumer Asset-Backed Securities This includes:

 Commercial Asset Backed Securities

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

• A security created by pool of loans excluding

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

claims on cash flows from it. MBS are formed by securitization.

 Mortgage-backed securities include Pass-Through Participation

Certificates, which claims share of all principal and interest

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

Dr. Seema Pandit-FBA(NRBBA) 9/29/2021

• Initially started as a device for bilateral acquisitions of

Citibank securitised a pool from its auto loan portfolio and

• The need for securitization in India exists in three major

1. Mortgage Backed Securities ( MBS)

2. The Infrastructure Sector

3. Other Asset Backed Securities