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STRUCTURED FINANCING ( SECURITIZATION ) IN INDIA

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Globalisation, deregulation of financial markets and growing cross border business transactions has reset
the ambience among financial institutions, increasing manifold opportunities for financial engineering.
Securitisation increases the lending capacity of an FI without having to find additional capital or deposits.
Securitisation facilitates specialisation and is gaining wide acceptance as the most innovative form of
asset financing. A significant impact of securitisation is the profiling and placement of different risks and
rights of an asset with the most efficient owners. It provides capital relief, improves market allocation
efficiency, expands opportunities for risk sharing and risk pooling, increases liquidity, improves the
financial ratios of FIs and banks, creates multiple streams of cash flows for the investors, is tailored to the
risk profile of a number of customers and facilitates asset-liability management. The requirements for
Santosh Parashar capital adequacy in recent years have also motivated financial institutions and banks to securitise. On the
demand side, investors are motivated to buy these securities as they view these as having risk
Program Coordinator
characteristics, compatible with the profile.
Dept. of Finance,
IAMR, Ghaziabad.

BACK GROUND Structured finance is a broad term used to describe a


sector of finance that was created to help transfer risk
using complex legal and corporate entities. This risk
The idea of Securitisation was born in the 1970s when transfer as applied to securitization of various financial
government mortgage agencies in the United States - assets (e.g. mortgages, credit and receivables, autoloans
Freddie Mac, Fannie Mae, and Ginnie Mae – issued etc.)has helped to open up new sources of financing.
mortgage based pass-through securities to investors; thus
fostering a secondary market in home mortgages. This idea
evolved as an outcome of the financial institutions’ inability Securitisation is the process of conversion of existing
to keep pace with the growing demand for housing finance. assets or future cashflows which are not marketable one
Traditionally, these were funded either by way of bank into marketable securities. In other words, it is the process
deposits and other financial institutions or by debt. of pooling and repackaging of homogeneous illiquid
Traditionally, these were funded either by way of bank financial assets into marketable securities that can be sold
deposits and other financial institutions or by debt. to investors.
Financial innovations towards increasing the availability of
mortgage finance led to investment bankers coming up with Mode of Securitisation
an investment vehicle, which isolated the mortgage pools,
segmented the credit risk, and structured the cash flows
Securitisation in India largely adopts a trust structure with
from underlying loans. Subsequently, this vehicle caught
the underlying assets being transferred by way of sale to a
the eye of the investors and the concept of asset
trustee company. The SPV, formed as a Trustee Company,
securitisation came into existence. What developed as a
issues securities that are either Pass through Certificates or
technique for the mortgage market was applied for the first
Pay through Certificates (PTC).The trustee is the legal
time in 1985 to auto loans which proved to be a better
owner of the underlying assets in both the scenarios. The
match for structured finance as their maturities were
investors holding Pass through Certificates are entitled to a
shorter compared to mortgage loans that made these pools
beneficial interest in the underlying assets held by the
of assets more ammendable to the structured products.
trustee. Investors holding Pay through Certificates are
entitled to a beneficial interest only in the cash flows
IndianExperience attained from the underlying securities to the extent of the
obligation agreed with the holders of primary and
secondary tranches of PTC.
Securitisation is a new development in India. With advent
of the Recovery of Debts Due To Banks and Financial Securitisable Assets : Typically, any asset that produces
Institutions Act, 1993 there was a great hope within the a predictable stream of cash flows can be securitised. The
banking circle that most of the Non Performing Assets types of assets that are securitised today include:
(NPA) shall be easy to recover. The banks, under the
conventional system of recovery of loans, had a
considerable amount of money blocked in form of • Mortgage-backed
unproductive assets. This act intended to provide for
expeditious adjudication and recovery of debts due to o Residential mortgage-backed securities (RMBS)
banks and financial institutions. But this effort of the o Commercial mortgage-backed securities (CMBS)
government was not enough. To fight the menace of the
NPAs the Indian banks required more teeth. With an object o Retail Loan Pools
to give the banks more powers and skill the government
decided to bring in the Securitisation and Reconstruction of
o Equipment lease / loan receivables
Financial Assets and Enforcement of Security Interest Act,
o Student loan receivables
2002. Prior to 2002 there was no provision for facilitating
securitisation of financial assets and the power to take o Credit card receivables
possession of securitised assets and selling them off. This o Auto loan receivables
act has come as a boon for the Indian banking companies o Trade receivables
which enables them to take over of assets of borrowers o Toll receipts
without first resorting to courts. In recent years ,
securitization market has grown to as high as Rs.50,000
crore per year.
• Risk Transfers • External Credit Enhancer: Underwriters sometime
resort to external credit enhancements to improve
o Insurance risk the credit profile of the instruments. There are
o Weather risk various types of external credit enhancements such
o Credit risk as surety bonds, third-party guarantees, letters of
credit (LC) etc.

Participants/Players involved in a Securitisation


Primarily there are three parties to a securitisation Structurer: Normally, an investment banker is responsible
transaction: for bringing together the Originator, credit enhancer, the
investors and other partners to a securitisation deal. He
also helps in structuring the deals along with the Originator.
• The Originator: This is the entity on whose books
the assets to be securitised exist and is the prime Process of Securitisation The segmentation of roles of
mover of the deal. The entity designs the necessary different parties to the securitisation deal helps in building
structures to execute the deal. In a true sale of the specialisation and introducing efficiencies. The entire
assets, the Originator transfers both the legal and process is broken into distinct parts with different parties
the beneficial interest in the assets to the SPV. concentrating on origination of loans, raising funds from the
capital markets, servicing of loans, etc.The figure given
• The SPV: This entity is the issuer of the below shows a simple securitization process.
bond/security paper and is typically a low-capitalised
entity with narrowly defined purposes and activities.
It usually has independent trustees / directors. The
SPV buys the assets to be securitised from the
Originator, holds the assets in its books and makes
upfront payment to the Originator.

• The Investors: The investors could be either


individuals or institutions like financial institutions
(FIs), mutual funds, pension funds, insurance
companies, etc. The investors buy a participating
interest in the total pool of assets and receive their
payments in the form of interest and principal as per
an agreed pattern.

Apart from these three primary players, others involved in


a securitisation transaction include:

• The Obligor(s): The obligor is the Originator’s


debtor or the borrower of the original loan. The
credit standing of the Obligor is very important in a
securitisation transaction, as the amount
outstanding from the Obligor is the asset that is
transferred to the SPV.

• The Rating Agency: The rating process assesses


Advantages of securitization:
the strength of the cash flows and the mechanism
designed to ensure full and timely payment. In this
regard the rating agency plays an important role as 1. The receivables are moved “off-balance sheet” and
it assesses the process of selection of loans of replaced by cash equivalents.
appropriate credit quality, the extent of credit and 2. The originators does not have to wait until it receives
liquidity support provided and the strength of the payment of the receivables to obtain funds to continue
legal framework. its business and generate new receivables.
3. The securities issued in the securitization are more
• Administrator or Servicer: Also called as the highly rated by participating rating agencies, thus
receiving and paying agent, it collects the payment reducing the cost of funds to the originators compared
due from the Obligor(s) and passes it to the SPV. It to traditional forms financing.
also follows up with delinquent borrowers and 4. In non-revolving structure and those with fixed interest
pursues legal remedies available against defaulting rate receivables, assets and related liabilities can be
borrowers. matched, eliminating the need for hedging.
5. Since the originator usually acts as servicer, there is
• Agent and Trustee: It oversees that all the parties normally no need to give notice to the persons with
involved in the securitisation transaction perform in whom it does business.
accordance with the securitisation trust agreement.
Its principal role is to look after the interests of the
investors.
Some examples of securitisation in the Indian context are:

• First securitisation deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160 mn
• L&T raised Rs 4,090 mn through the securitisation of future lease rentals to raise capital for its power plant in 1999.
• India’s first securitisation of personal loan by Citibank in 1999 for Rs 2,841 mn.
• India’s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in 2001.
• Securitisation of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through offshore SPV.
• India’s first sales tax deferrals securitisation by Govt of Maharashtra in 2001 for Rs 1,500 mn.
• India’s first deal in the power sector by Karnataka Electricity Board for receivables worth Rs 1,940 mn and placed
them with HUDCO.
• India’s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002
• India’s first floating rate securitisation issuance by Citigroup of Rs 2,810 mn in 2003. The fixed rate auto loan
receivables of Citibank and Citicorp Finance India included in the securitisation
• India’s first securitisation of sovereign lease receivables by Indian Railway Finance Corporation (IRFC) of Rs 1,960
mn in 2005. The receivables consist of lease amounts payable by the ministry of railways to IRFC
• India’s largest securitisation deal by ICICI bank of Rs 19,299 mn in 2007. The underlying asset pool was auto loan
receivables.

Current Scenario

In the recent months, securitisation deals have come down dramatically, given the regulatory uncertainty surrounding
such products. Low appetite, among prospective buyers in the aftermath of credit crisis, has also played a spoiler. Early
this year, a loan advanced to pharma major Wockhardt changed hands a number of times in the course of a few days.
With Wockhardt defaulting on its obligations, most of these PTCs became worthless. RBI hopes that a minimum
“seasoning period” will reduce the incidence of such reckless securitisation. This would mean that the security remains on
a bank’s balance sheet for a reasonable period would boost sentiment for the market.

The Reserve Bank of India, in its credit policy announced on 27th Oct 2009 has put up two requirements for securitisation
– a minimum 10% originator retention, and a minimum seasoning of 12 months. Obviously, the RBI is meaning to be
overly stringent when it comes to securitisation. In the wake of the subprime crisis, at some forums, RBI officials self-
complimented saying that India had not suffered due to securitisation as RBI was sufficiently prudent. The fact, actually, is
that if we are crawling, you cannot feel happy at the fact that the other guy who was riding a horse fell.

Even while international regulators are imposing a minimum of 5% risk retention for securitisation the RBI just doubles
that number. Of course, it is not clear from the credit policy whether the 10% slice is a vertical slice or horizontally lower
slice. If it is vertical slice, it would make no difference at all, and in fact, would defeat the very purpose of laying down risk
retention. If it is lower horizontal 10%, it would be one of the most impractical stipulations to lay down, as, if there is 10%
risk of losses in a pool of assets, then the very idea of securitisation, nay, the very idea of banking, should fail. Banks
globally require 4% Tier 1 capital, and 8% total capital, with the understanding that it is unlikely that unexpected portfolio
losses should exceed 8% of assets. Note that capital requirements are only for unexpected losses – as expected losses are
anyway taken care of by credit spreads. If originators were to keep a 10% first loss piece in a pool, they are keeping more
risk to themselves than there, whereas a securitisation should result into at least some extreme loss risk. There is simply
no basis to explain that number 10%. It is clearly the product of over-enthused regulation, unmindful of the Concept of
economic capital.

What makes the 10% risk stipulation acute is that this is over and above the excess spreads, which are usually anyway
retained in securitisation pools. The excess spreads should logically take care of expected losses. If unexpected losses
exceed 10%, there is no point in bankers creating loan pools, not to speak of securitizing them.
Equally illogical is the minimum seasoning requirements.

Though the fine print of the RBI stipulation is yet to come, one would not be surprised, if the guidelines remain limited to
“securitisation” and not a transfer of a loan. Past guidelines have made a stupid reference to “securitisation” meaning a
transfer of financial assets to SPVs, thereby excluding from its scope such transactions as do not involve SPVs.

In short, the RBI move will simply kill the securitisation market in India.

Reference Sources: 1.The Economic Times 22 oct 2009


2. www.vinodkothari.com
3. http://www.bseindia.com/downloads/Securitisation.pdf
4. http://www.legalserviceindia.com
5. Book: Clifford Gomez;Financial Markets,Institutions and Financial Services