Download SECURITIZATION IN INDIA

S ECURITIZATION IN I NDIA
Group Members
S. Venkatakrishnan – 82038
Neeraj Srivastava – 82025
Sharad Sachan – 82042
Subhash Sen – 82043
Vivek Kumar - 82045
C ONVENTIONAL
Structure of a
normal debt
instrument
Earnings
Power
etc
BOND STRUCTURE
Bonds
Issuer
Investor
Cash

A debt instrument is the obligation of the issuer

Normally, the credit profile of the issuer depends on the aggregated
earnings power of its businesses in the context of its financial risk
profile and management capability

It is these businesses that would need to generate the cash flows for
bond redemption
L IMITATIONS
OF CONVENTIONAL
DEBT FUNDING

Limited flexibility to enhance the credit quality of the
borrower

Largely standardized loan products homogenizing
credit quality across cross-section of asset side inflows
and liability side outflows

Firms unable to package out different levels of risk to
meet varying needs of investors

Consequently, cost of funds linked to average credit
profile of different cash flows
Are alternatives
available?
W HAT ARE THE ALTERNATIVES

Third party credit support

Full financial guarantee/ Bond Insurance

Letter of Credit

Partial Financial Guarantee

Escrowing of cash flows

Pledging/Assignment of future flows

Securitization

Pledging/sale of a pool of retail receivables into a SPV

Pledging/sale of liquid assets

Pledging/sale of receivables from highly rated regular customers
into a SPV
T HIRD PARTY CREDIT SUPPORT
Any support provided to conventional bond structure such that

The debt instrument can achieve a rating higher than that implied by the
aggregate earnings power of the issuer who deploys the cash proceeds
of the bonds in its businesses
Earnings
Power
etc
Issuer
Bonds
Credit Support
Cash
Investor
T HIRD PARTY CREDIT SUPPORT

Full financial guarantee, letter of credit, bond insurance

Instruments rating is equated to the credit rating of the facility provider

Full credit support yet to commence as a commercial activity in India.
Instances of full credit support usually a consequence of past
relationships

International full credit support suppliers

Letters of credit- Commercial Banks


Bond insurance/ financial guarantees- monoline insurers
Partial Guarantee

Bond rating lies between the rating of the guarantor and the issuer

Initially provided by multilateral entities like IFC Washington, FMO
T HIRD PARTY CREDIT SUPPORT
Non Guaranteed
1
2
3
Guaranteed
4
5
6
7
8
9
10 equal annual installments with the last 6 installments
fully guaranteed by a AAA entity
Rating of obligor
BBB +
Weighted average Tenor
5 years
% Guarantee
75%
BBB + Pricing
433 bps over G-sec
AA Pricing
114 bps over G-sec
Guarantee Cost
150 bps ( approx)
10
THIRD PARTY CREDIT SUPPORT…
 Applications
 Weak entities that are a part of a stronger business groupsguaranteed issuance, especially CP
 Entities with appetite for long tenor projects, where investor
comfort is restricted to short tenor lending
 Entities that enjoy long-term standing relationships with
banks- letter of credit backed issuance
 Entities that fit into the framework of multilateral agencies
like IFC can approach them for partial guarantee
E SCROWING OF CASH FLOWS

Escrow mechanism captures future sales to
 Highly rated customers, or
 A Pool of large numbers of customers

Applicable to corporate issuers when
 Escrowed revenues are exclusively made available for debt
servicing
 All operating expenses can be met out of remaining
revenue sources

Can achieve a rating enhancement of upto 2 notches due to
prioritization achieved without impacting operations
E SCROWING OF CASH FLOWS
Rating of company
A+
Credit enhancement
Escrowing of cash flows
Rating of structure
AA
Pricing differential between A+ and AA
130 bps over comparable G-Sec
ESCROWING OF CASH FLOWS

Applied several times for entities that are unlikely to go bankrupt
like municipalities, governments and statutory bodies, for eg.


Escrow of energy sales by SEBs, property or other taxed by
Municipalities
In addition, BPO, rent receivables have also been escrowed
Applications

Entities with a high asset turnover ratio where escrowing a small
portion pf revenues could benefit a significant portion of the
funding mix

Entities having a regular inflow of stable non-operating cash flows
like rentals
ASSIGNMENT
FLOWS
OF
FUTURE
•
Future sales of goods with a ready market and relative price stability are assigned to
an SPV. These are usually commodities or utilities
•
Key risks: Price risk and generations risk
•
Generation Risk of the said good/service is linked to the likelihood of continuance in
operations of the facility operated can be mitigated by standby operator
Generated and assigned over a period. Cash
paid upfront
Earnings
Power
etc
Receivables
User
Responsibility for operating facility
to generate receivables
Bonds
SPE
Cash
Investor
Cash
Standby Operator
A SSIGNMENT

OF FUTURE FLOWS
Applications

Entities with take or pay contract with a highly rated
customer for any good or service

Entities producing a highly marketable commodity like oil,
gas etc.
S ECURITIZATION -
BASICS

Securitization is the pooling of “homogeneous”, “financial"," cash flow
producing”, “illiquid” assets and issuing claims on those assets in the form of
marketable / tradable securities

Typically, a lender / originator advances a loan to borrower and over a period
of time, he expects to receive repayment of principal and interest.

In securitization, the lender / originator sells the right to receive the future
receivables to a third party and receives the present value of the receivables
at the initiation of the transaction

The higher yield associated with these securities attracts investors who are
willing to bear the associated credit, prepayment and liquidity risk
S ECURITIZATION -
BASICS

The basic principles of direct assignment remain the same - the
only difference being that the investor records the transaction
as ‘loans’ in its books and doesn’t invest in a tradable security

The originator also provides an upfront credit enhancement in
the transaction to cover for the shortfalls in the pool because of
borrower defaults;

The primary advantage of securitization is the flexibility
provided in terms of unbundling of risks and allocation of the
same to various parties who are able to manage those risks
S ECURITIZATION -
BASICS

Securitization involves sale, transfer, pledge of specified assets to a
Bankruptcy-remote Special Purpose Vehicle (SPV)

The SPV in turn issues Notes (Pass Through Certificates) to investors in order
to fund the purchase of the assets

Investors (banks, insurance companies, and specialised funds) rely on the cash
flows (principal, interest and sale proceeds when sold after foreclosure)
generated by the underlying assets to pay interest and principal on the notes

The risk associated with the assets is stratified by looking at historical default
and loss information

Generally, the Originator remains the Servicer of the pool of the assets it had
sold to the SPV
Key Features of
Securitization

All the risks and rewards associated with
underlying pool are transferred to the buyer

The transaction structure should be such that the
bankruptcy of the seller does not affect the
underlying pool

There is no recourse to seller once the underlying
pool is sold
Key Features of
Securitization

Pass Through – Refers to securitization structure where the SPV makes payments,
or rather, passes payments to the investors, on the same periods, and subject to
the same fluctuations, as are there in the actual receivables viz. amount collected
every month is passed through to investors, after deducting fees and expenses.

Pay Through – Where the payment to the investors are routed through SPV who
does not strictly pay the investors only when the receivables are collected by it,
but keeps paying on the stipulated dates irrespective of the collection dates. In
order to allow for smoothed payment to investors by removing the fluctuations in
its collections, the SPV uses a guaranteed investment contract or credit
enhancements or both.

Credit enhancements – Refers to one or more initiatives taken by the originator in
a securitization structure to enhance the security, credit or the rating of the
securitised instrument.

Loan to value ratio – In case of asset based lending, means the amount of loan as
a percent of the value of the asset on which the loan is secured.
S ECURITIZATION VS .
TRADITIONAL DEBT
Securitization

Isolation of pool – true sale

Claim only against the pool –
no
impact
of
issuer
bankruptcy
Traditional Debt

The issuer holds the assets –
provides security

Claim against
company
the
issuer

Typically both principal and
interest repaid monthly

Monthly
interest;
principal payments

Credit enhancement helps in
getting a higher rating than
the issuer

Rating cannot be higher than
the issuer debt rating
bullet
Securitization vs Bilateral
Assignment
Receivables based financing
Loan/Advance
Debenture Backed
by charge & Escrow
Full Recourse
On Balance Sheet
No capital Relief
No gain on Sale
Bilateral or CMI
Bilateral Assignment of
receivables between
Originator & Purchaser
Limited Recourse
Off Balance Sheet
Release of capital
Possible gain on Sale
No capital market
investors
Securitization vide
issue of tradable
instruments by an
SPV
Limited Recourse
Off Balance Sheet
Release of capital
Possible gain on Sale
Banks and capital
market investors
Securitization through issue of tradable instruments would attract a wider
investor base and thereby result in lower cost of funds to the Originator
Bilateral Assignment: Structure
Diagram
Originator
Lease/Loan/Other
Agreements
Obligors
Purchase
Consideration
Assignment
Of
Receivables
Credit Rating
Agency
Payment towards
Obligation
Purchaser/
Investor
Servicer
Credit
Enhancement
Credit enhancement and rating may be optional in a bilateral transaction
depending on the comfort of the purchaser / investor
PARTIES TO A SECURITISATION
Originator
Initial owner of the assets
Sells its asset to the SPV
Obligor
Contractual debtor to Originator
Pays cashflows that are securitised
SPV
Set up specifically for transaction
Purchases assets from Originator Company/Trust/ Mutual Fund
Investors
Subscribe to securities
issued by SPV
PARTIES TO A
SECURITISATION
Servicer
Collects monies from Obligors, monitors and maintains assets
Receiving &
Paying Agent
Banker for the deal. Manages inflows& outflows,
invests interim funds, accesses cash collateral
Credit
enhancement
provider
Provides credit enhancement by way of swaps, hedges,
guarantees, insurance etc.
Merchant
banker
As structurer for designing& executing the transaction and
as arranger for the securities
PARTIES TO A SECURITISATION
( CONTD .)
Credit Rating
Agency
Provides a rating for the deal based on structure, rating of
parties, legal and tax opinion etc
Legal & Tax
Counsel
Provide key opinions on the structure & underlying contracts
Auditor
Appointed for conducting due diligence both initial and
during tenor of deal
Custodian
R&T Agents
Appointed for safe custody of the underlying documents and
registration/ transfer of securities
E XCHANGE OF FUNDS - INITIAL
Rating Agency
Borrowers
Loan agreement
Servicing Agreement
Finance Company Ltd.
(Originator)
Rating with specified
credit enhancement
Proceeds
Proceeds
Trust (SPV)
Sale of assets
Asset-Backed
Securities
Trust Agreement
Trustee
Investors
E XCHANGE
OF FUNDS
Rating
Loan
repayments
Collection reports
ONGOING
Rating Agency
Borrowers
Finance Company Ltd.
(acting as servicer)
-
Monthly loan
repayments
Trust (SPV)
Monthly investor
payments
Investors
Trustee Responsibilities
Trustee
Form of SPV and role of Trustee are critical in a securitization
Monthly
reports
Tranching of Liabilities
Originator
Cash flows from
securitized
assets
6 month PTCs
SPV
1 year PTCs
Investors
5 year PTCs
Originator
Cash flows from
securitized
assets
Retained
Unrated
Tranche
Senior PTCs
SPV
AAA(SO)
Investors
PAR AND PREMIUM STRUCTURES
Par Structures
Premium Structures
Investor pays a consideration equal to the principal
outstanding (par value) of the pool
Investor pays a consideration equal to the present value of future
cash flows. The investor pays a premium to receive the excess
interest spread
In return, investor is entitled to receive scheduled principal
repayments along with a contracted yield
In return, investor receives the entire cash flows generated from the
pool
Typically, interest generated on the pool is higher than the
yield to the investor, the difference is called excess interest
spread (EIS)
No excess interest in the structure
EIS provides credit support to the investors. the originator
retains a subordinated right to receive the EIS.
The rating takes care of the fact that the investor payouts are higher
and credit enhancement is calculated accordingly
Prepayments in the underlying pool are passed on to the
investor
As investor principal outstanding is higher than the pool principal, the
credit enhancement is utilized to cover the prepayment shortfall
B ENEFITS OF SECURITIZATION


Efficient use of capital

Off balance sheet treatment and hence release of a portion of capital tied up by these
assets

Allows the company to continuously churn assets and expand business volumes even
when capital availability is scarce
Balance sheet management


Off-balance sheet treatment and upfront profit generated has a positive impact on
financial results like Return of Assets, Earnings per share, Net spread etc.
Alternate Source of Funding

Securitization is an alternative source of funding that does not use up limits set up by
banks / institutions on the company and allows allocation of funds by investors over
and above these limits
B ENEFITS OF SECURITIZATION

Rating enhancement resulting in lower cost of funds

Capital markets and other investors demand yields linked to the rating of the
issuers for direct debt investment

Securitization enables a company to achieve a rating several notches above its
standalone rating and thereby lower its cost of funding

Converting illiquid assets to liquid assets

Preserving customer relationships

Securitization allows transfer of credit risk while preserving existing
relationships with customers

Typically, the originator acts as servicer for the transaction and hence continues
to be the point of interaction with the obligors.
O RIGINATOR ’ S

Structure of
securitization
may vary
significantly
based on the
priority of
objectives of
the originator
OBJECTIVES
Each originator should define the objectives desired to be achieved
through the proposed securitization transaction in order of priority

Access to an alternate source of funds / investor class

Optimization of regulatory capital requirement

Rating enhancement and reduction in cost of funds

Balance sheet management : liquidity, asset-liability matching, debtequity ratio

Limited recourse financing

Risk management – Sector exposure / company exposure
What can be
Securitized
Receivables
Example
Existing/Overdue
Trade Receivables
Accruing
Lease Receivables
Future- with off take
Power Purchase
Future- without off take
Credit Card/MTNL Billing
Assignability




Future- without framework Air India Ticket Sales
?
Mere expectancy
X
Offerings at a shrine
Types of receivables
RECEIVABLES
CURENT RECEIVABLES
(no performance risk of Originator for eg.
Lease, hire purchase, loans)
RETAIL RECEIVABLES
(Diversified Obligor base) for eg. Car/ CV
Financing
FUTURE RECEIVABLES
(performance risk of Originator for eg. Future
Sales Receivables)
CORPORATE RECEIVABLES
(Concentrated Obligor base) for eg. Car/ CV
Financing
CONTRACT BACKED RECEIVABLES
for eg. Long term supply contracts
RECEIVABLES WITHOUT
UNDERLYING CONTRACTS
for eg. Tea Sales at Auctions
SECURED RECEIVABLES
UNSECURED RECEIVABLES
for eg. Secured Corporate Loans
for eg. Utility Charges
Retail Assets Securitization
1400
120
1200
100
1000

 Absence of banks from this market
80
800
60
 De-growth in retail originations
600
40
400
 Tight liquidity
20
200
 Concerns on asset quality
0
0
FY
2003
FY
2004
Disbursement
FY
2005
FY
2006
FY
2007
Issuance (Rs bil)
FY
2008
FY
2009
13%
4%
4%
2%
New / used Cars and UV
Personal loan
Mixed pool

Largely becoming a liquidity providing instrument

Securitisation is a key resource raising avenue for NBFCs

CVs emerged as dominant asset class largely driven by
Shriram, Tata Motors finance and Magma

Microfinance loans and gold loans are the emerging asset
classes
No. of transactions
5%
ABS market dipped in 2009
4%
Two wheeler
SME loan
Others
Source: ICRA Research & Industry
TOP ABS ORIGINATORS
Source: CRISIL report



Banks have largely been non-existent in ABS market for last one year as the retail
asset growth has been minimal / negative
ABS continues to be a viable resource raising avenue for NBFCs focusing on asset
finance
Top originators for 2009-10 till date are Reliance Capital, Tata Motors Finance and
Shriram Transport Finance Limited
WHAT AN ORIGINATOR LOOKS
FOR
Capital relief
Managing Asset liability
mismatch
Advantages of
securitization over
traditional funding
Off-balance sheet funding
Reducing concentration risk
Direct access to capital markets
Improved RoA / RoE
S ECURITIZATION ’ S ANCILLARY
BENEFITS

Securitization creates incentives for originator for

Developing transparent credit approval process

Efficient collection procedures, and for strong mechanisms to
control this process

Clear and efficient processes invariably lead to lower credit
enhancement

Public availability of information about pool performance adds
to confidence in securitized paper
But, originators prefer to retain customer relationship and
servicing
B ENEFITS






TO INVESTORS
Premium over equivalent rated plain
securities
Focused risks associated with securities
Portfolio diversification
Tailored cash flow structures
Flexible range of maturities
Experienced risk assessment
BENEFITS TO THE
FINANCIAL SECTOR

New forms of securities – market completion

Assists development of capital markets

Attracts conservative buyers

Draws international capital

Facilitates efficient allocation of risks
Bank
NBFC
Provisioning
Relief
 12%, 10% in case of Asset Finance Companies
Bank
Capital
Relief
 Secured Assets (100% risk weight and 9% capital), Unsecured
Asset (125% risk weight and 9% capital)
 Standard Provisioning – Secured Assets (0.4%), Unsecured
Assets (2%). NPA are provided as per the RBI norms
NBFC
Originators – Incentive, Impacts
 No standard provisioning requirement. Relaxed provisioning
norms compared to Banks. Hence longer collection cycles,
higher delinquencies compared to Banks
Bank
NBFC
 To be fully deducted out of capital. No reset allowed. Basel
applicability??
Bank
Capital knock
off for
Collateral
 As per Basel – Rated piece (typically BBB) as per rating
(typically 100% risk weight & 9% capital). Unrated to be fully
deducted. No reset.
 Profit (IRR from pool – Sell down rate – expected collection
cost – Expected credit losses) to be amortised by the seller
NBFC
Originators – Incentive, Impacts
 Profit (IRR from pool – Sell down rate – expected collection
cost – Expected credit losses) to be amortised by the seller
Profit
NBFC
Cost of
funds
Bank
Originators – Incentive, Impacts
 Proceeds from securitisation have no CRR/SLR requirement
 Reduces priority sector requirement
 Reduces cost of funds. More important in case of Non Asset
Finance NBFCs where provisioning requirement by Banks is
leading to higher costs
BANKRUPTCY
REMOTENESS

True sale of assets from the seller to the trustee

Legal separation of assets from the seller is achieved – investor is
not exposed to credit worthiness of seller

Credit enhancement and liquidity facility – bankruptcy
remoteness achieved through rating triggers

An independent legal opinion is taken post the transaction to
cover all such legal issues
P ERFORMANCE OF S ECURITISATIONS IN I NDIA


Unlike US, the rise in delinquencies has not led to widespread downgrades or
defaults in securitised papers

Rating agencies largely pre-empted the deterioration in asset quality and have
increased the credit enhancement requirement suitably

Safety cover for investors has remained robust
Till date, approximately 700 pools have been rated in India

38 pools have been downgraded so far


Only 3 of which have been downgraded to speculative grade
Some of these 38 pools have been upgraded back to AAA because of stable
performance at later stages
Key Risks


Credit Risk

It is the risk of non-payment of underlying obligors, which is dependent on
underlying obligor’s ability and willingness to pay.

The underlying obligor’s ability to pay is primarily driven by adequacy and
stability of income

Loan to value ratio and income generating capability of the underlying asset will
indicate the obligor’s willingness to pay.
Market Risk

Macro Economic Risk – affects underlying asset valuation, income generating
capacity, borrower’s income, market interest rates, change in regulations etc.

Asset Risk - general risk perception of the asset; historic performance

Prepayment Risk – prevailing and expected market interest rates and expected
income levels will influence the prepayment rates

Interest Rate Risk – mismatch may arise in case where the collections from
underlying borrowers are based on fixed rate and the payouts to investors are
based on floating rate and vice versa.
Key Risks

Counterparty Risk
 Servicer Risk – the ability of the servicer to service the
pool over the tenure of the transaction
 Commingling Risk – The time lag between the
collections from the underlying obligors and deposit
into collection account give rise to commingling risk.
 Other Counterparty Risk – The presence of other
counterparties like collection account bank, credit
collateral provider etc. give rise to performance risk.

Legal Risk