9 Securitization Corporate Valuation

New
Syllabus

1 2 3 4 5
Need for Corporate Valuation 1

Meaning Features Participants Mechanism Problems 1. Information for its internal stakeholders,
2 Important Terms
2. Comparison with similar enterprises for understanding
1. P ro c e s s o f s e c u r i t i z a t i o n 1. Creation of Financial Primary Participant 1. Creation of Pool of Assets
1. Stamp Duty
management efficiency, 1. Present Value of Cash Flows
typically involves the creation of
Instruments
1. Originator
2. Taxation
3. Future public listing of the enterprise, 2. Internal Rate of Return
pool of assets from the illiquid 2. Transfer to SPV

fi n a n c i a l a s s e t s , s u c h a s 2. Bundling and 2. Special Purpose Vehicle

3. Accounting
4. Strategic planning, for e.g. finding out the value driver of the 3. Return on Investment
receivables or loans which are 3. The Investors
3. Sale of Securitized Papers

Unbundling
4. Lack of enterprise, or for a correct deployment of surplus cash,
marketable.
Secondary Participant 4. Perpetual Growth Rate
2. It is the process of repackaging 3. Tools of Risk standardization

1. Obligors
4. Administration of assets
5. Ball park price (i.e. an approximate price) for acquisition, 3
or rebounding of illiquid assets 5. Terminal Value
Management
5. Inadequate Debt etc.
into marketable securities.
2. Rating Agency
5. Recourse to Originator

3. T h e s e a s s e t s c a n b e 4. Structured Finance
3. Receiving and paying agent
Market

automobile loans, credit card Methods of Valuation

5. Trenching
4. Agent or Trustee
6. Repayment of funds
6. Ineffective
receivables, residential
mortgages or any other form of 6. Homogeneity 5. Credit Enhancer
Foreclosure laws 1 2 3
7. Credit Rating to Instruments
future receivables. 6. Structurer
Asset Based Earnings Based Cash Flow Based
Book Value = Total Assets - Long Term
Instruments
There are essentially five
6 Debt steps in performing DCF
based valuation:
Total Assets = Fixed Assets + Intangible Assets +
Current Assets – Current Liabilities 1. Arriving at the ‘Free Cash
Flow’
Pass Through Certificates (PTCs) Pay Through Securities (PTS) Stripped Securities This can also be equated to share capital plus free
reserves. 2. Forecasting of future cash
1. Originator (seller of the assets) transfers the 1. In PTCs all cash flows are passed to the 1. Stripped Securities are created by dividing the cash flows associated flows (also called
entire receipt of cash in the form of interest or
principal repayment from the assets sold.

performance of the securitized assets. To

overcome this limitation there is another
with underlying securities into two or more new securities. Those two
securities are as follows:

4 Enterprise Value Based projected future cash

flows)
2. These securities represent direct claim of the structure i.e. PTS.
(1) Interest Only (IO) Securities

investors on all the assets that has been 2. In contrast to PTC in PTS, SPV debt (2) Principle Only (PO) Securities
Enterprise
Market Value Market Value Market Value Minority Cash & Cash 3. Determining the discount

CA Mayank Kothari
securitized through SPV.
securities backed by the assets and hence it 1. Accordingly, the holder of IO securities receives only interest while PO Value = of Equity + of Preference + of Debt + Interest - Equivalent rate based on the cost of
3. Since all cash flows are transferred the capital
can restructure different tranches from security holder receives only principal. Being highly volatile in nature
investors carry proportional beneficial interest varying maturities of receivables.
these securities are less preferred by investors.

1. The Enterprise Value, or EV for short, is a measure of a company's total 4. Finding out the Terminal
in the asset held in the trust by SPV.
3. In other words, this structure permits 2. In case yield to maturity in market rises, PO price tends to fall as Value (TV) of the
4. Since it is a direct route any prepayment of desynchronization of servicing of securities borrower prefers to postpone the payment on cheaper loans. Whereas value, often used as a more comprehensive alternative to equity market enterprise
principal is also proportionately distributed issued from cash flow generating from the if interest rate in market falls, the borrower tends to repay the loans as capitalization.
among the securities holders.
asset.
they prefer to borrow fresh at lower rate of interest.
5. Finding out the present
5. Further due to these characteristics on 4. Further, this structure also permits the SPV to 3. In contrast, value of IO’s securities increases when interest rate goes up 2. Enterprise value (EV) can be thought of as the theoretical takeover price if a values of both the free
completion of securitization by the final reinvest surplus funds for short term as per in the market as more interest is calculated on borrowings.
company were to be bought. cash flows and the TV,
payment of assets, all the securities are their requirement.
4. However, when interest rate due to prepayments of principals, IO’s and interpretation of the
terminated Simultaneously. 5. This structure also provides the freedom to tends to fall.
3. The value of a firm's debt, for example, would need to be paid off by the results.
issue several debt tranches with varying 5. Thus, from the above, it is clear that it is mainly perception of investors buyer when taking over a company, thus, enterprise value provides a much
maturities. that determines the prices of IOs and POs
more accurate takeover valuation because it includes debt in its value
calculation.
9 8 7
4. Why doesn't market capitalization properly represent a firm's value? It leaves
a lot of important factors out, such as a company's debt on the one hand and
its cash reserves on the other.
Securitization in India Benefits Pricing of Instruments
I Relative Valuation
5 Other Methods
1. It is the Citi Bank who pioneered the concept of securitization in India by
bundling of auto loans in securitized instruments.
From the angle of Originator The Relative valuation, also referred to as ‘Valuation by
Economic Value Added II multiples,’ uses financial ratios to derive at the desired
2. Thereafter many organizations securitized their receivables. Although 1. Off- Balance Sheet Financing
metric (referred to as the ‘multiple’) and then compares the
started with securitization of auto loans it moved to other types of From Originator’s
receivables such as sales tax deferrals, aircraft receivable etc.
2. More specialisation in main From Investor’s Angle same to that of comparable firms.
Angle
3. In order to encourage securitization, the Government has come out with business
In the process, there may be extrapolations set to the
Securitization and Reconstruction of Financial Assets and Enforcement of The instruments Security price can be
3. Helps to improve financial desired range to achieve the target set. To elaborate –
Security Interest (SARFAESI) Act, 2002, to tackle menace of Non can be priced at a determined by
Performing Assets (NPAs) without approaching to Court.
ratios
1. Find out the ‘drivers’ that will be the best representative
rate at which discounting best Market Value Added III
4. It has become an important source of funding for micro finance companies 4. Reduced borrowing Cost
for deriving at the multiple. Drivers can be
and NBFCs and even now a days commercial mortgage backed securities originator has to estimate of expected
are also emerging.
From the angle of Investor incur an outflow future cash flows using 1. Enterprise value based multiples, which would
5. Securitization in Indian Market is that it is dominated by a few players e.g. 1. Diversification of Risk
rate of yield to maturity of Shareholders Value Analysis IV
consist primarily of EV/EBITDA, EV/Invested
ICICI Bank, HDFC Bank, NHB etc.
Capital, and EV/Sales.
a security of comparable
6. As per a report of CRISIL, securitization transactions in India scored to the 2. Regulatory requirement
Steps involved in SVA computation:
security with respect to 2. Equity value based multiples, which would comprise
highest level of approximately Rs.70000 crores, in Financial Year 2016. 3. Protection against default
(Business Line, 15th June, 2016)
credit quality and a. Arrive at the Future Cash Flows (FCFs) of P/E ratio and PEG.
by using mix of the ‘value drivers’
7. In order to further enhance the investor base in securitized debts, SEBI average life of the 2. Determine the results based on the chosen driver(s)
allowed FPIs to invest in securitized debt of unlisted companies upto a securities. b. Discount these FCF using WACC
through financial ratios
certain limit. c. Add the terminal value to the present
values computed in step (b) 3. Find out the comparable firms, and perform the
comparative analysis, and
d. Add market value of non-core assets
e. Reduce the value of debt from the result 4. Iterate the value of the firm obtained to smoothen out
in step (d) to arrive at value of equity the deviations

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