Asset Securitisation - IRM

8/10/2019 Asset Securitisation - IRM

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Bankers Training College

Reserve Bank of I ndia

Securitisation has grown at ascorching pace internationally

2002 issuance of asset backed paper worldwide was closeto $ 700 billion

Compounded growth of more than 20% p.a. over thelast 3 years

The list of assets securitised is growing daily

E.g. diamonds, intellectual property, school fees, etc.

The number of participants is constantly increasing

Pension funds, insurance companies, mutual funds,banks, FIs are some of the largest investors

The sophistication of products has increased e.g. creditderivatives


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Securitisation Some latest facts

Last year, German Govt. securitised its Russian loandues

UK Chancellor of Exchequer has proposed securitisingfuture aid flows to developing countries

From traditional receivables securitisation (on balancesheet items), future flow securitisation (of cash flows tobe generated in future) has been gaining momentum

In India, during 2004-05, Rs. 25,000 crore is theaggregate amount of assets securitised.

Volumes are bound to increase as growing asset classeslike HLs, car / vehicle loans are ideally suited forsecuritisation

CRISIL estimates Rs. 60000 crore securitisationpotential in 2003


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Retail Portfolio of Banks(As at end-March 2004)

Items AmountOutstanding (Rs.

crore)

Impaired Credit

as % of

outstanding loans

Net NPAs as % of

outstanding Loans

(i) Housing Loan 85436 1.9 1.4

(ii) Consumer

Durables6256 6.6 4.0

(iii) Credit Card

Receivables6167 6.3 2.4

(iv) Personal Loans

89537 2.6 1.6(v) Total Retail Loans

[(i) + (ii) + (iii) + (iv)]189041 2.5 1.6

(vi) Total Loans &

Advances880312 7.4 2.8


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Global Structured Finance Issuance by Year

($ Billions)

Worldwide Growth of the ABS market

Sources: JPMS, MCM CorporateWatch, and Bloomberg.

0

200

400

600

800

1000

1200

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 YTD

US Public US Private Europe Asia

$88

$124

$216

$287

$347

$414

$455

$580

$710

$792

$355

$1,137

3

$ Bn


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Securitisation The Concept

Is a process through which illiquid assets are transferredinto a more liquid form of assets and distributed to abroad range of investors through capital markets

In other words, securitisation deals with the conversion of

assets which are not marketable into marketable ones Is the process of conversion of existing assets or future

cash flows into marketable securities

The conversion of existing assets into marketable

securities is known as asset-backed securitisation (ABS)and the conversion of future cash flows into marketablesecurities is known as future-flows securitisation (FFS)


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ABS / CDOs / MBS

Some of the assets that can be securitised are loans likecar loans, housing loans (MBS), etc., and future cashflows like ticket sales, credit card payments, car rentalsor any other form of future receivables

Asset Backed Securities All assets are of a uniformnature (like car loans or housing loans)

Collateralised Debt Obligations Assets from adiversified pool

Mortgage Backed Securities Refers to housing loans


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Securitisation The Process

The lender (or originator) segregates loans / lease / receivables intopools which are relatively homogenous in regard to types of credit,maturity and interest rate risk

The assets are transferred by the originator to a special purpose vehicle(SPV) usually constituted as a Trust / Subsidiary / Limited Company /Joint Venture with other banks / FIs, etc.

The SPV is a separate entity formed exclusively for the facilitation of thesecuritisation process and providing funds to the originator

The SPV will act as an intermediary which divides the assets of theoriginator into asset-backed marketable securities. This could be with orwithout recourse

These securities issued by the SPV to the investors and are known aspass-through-certificates (PTCs)


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Securitisation The Process (Contd.)

Interest and principal payments on the loans, leases andreceivables in the underlying pool of assets are collectedby the servicer (who could also be the originator) andtransmitted to the investors

The difference between rate of interest payable by theobligor and return promised to the investor investing inPTCs is the servicing fee for the SPV

Credit enhancement can add features to boost investor

confidence. This could be in the form of a provision ofrecourse, a guarantee requiring the originator to coverlosses, a letter of credit from a bank, or overcollateralisation


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Typical transaction structure

Sale

Consideration

Sale of Debt

service receivables

Originator

Obligor

SPV

Investor

Loan/Receiv

able

Servicingofno

tes


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Whats the utility of the SPV

Helps in Credit tranching

Addresses different investor classes

ABS enables SPVs to get a superior credit rating than the

loan-originating firm could earn on its own Enables various credit enhancement mechanisms

Over-collateral

Excess spread

Liquidity lines Arms length relationship with the originator

Addresses bankruptcy issues


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Steps in securitisation

Identification

of assets

Resolving

asset relatedlegal issues

Transaction

structuring

SPV

structuring

System due

diligence and

upgradation

Legal vetting

anddocumentation

Transaction

rating

SPV formation

and document

execution

Syndication


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Traditional commercial banking system

New system

Originate Underwrite Book Fund

Originate StructureCredit

EnhancePlace Trade Service

Thrift

Commercial

bank

Retail

securities

firm

Investment

bank

Retail

securities

firm

Insurance

company

Pension fund

Thrift

Insurance

company

Individual

Investment

bank

Commercial

bank

Investment

bankCommercial

bank

Specialist

payments

processor*This diagram taken from

Breaking Up the Bank, by Lowell L. Bryan


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Generic deal diagram

SPV Investors

Originator

Obligors

Credit

EnhancementProviders

Rating Agency

Structurer

Issue of securities

Collections Credit enhancement

Rating Subscription to securities

Cash flows

Servicing

of securities

Contracts

Ongoing cash flows

Initial cash flows

Servicer

Original

Loan

Sale of

asset

Purchase

consideration Arranger


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Why Securitisation

The Issuer / Originator

Ability to raise cheaper / longer / more finance

Receivables being replaced by cash thereby improving the liquidityposition

Ability to finance structures which would not get financed throughnormal banking products

Freeing of capital capital relief

Enables a trim (manageable level of assets) and transparent(identification of assets) balance sheet -

Manage ALM mismatches & reduces market risk (by reducinginterest rate mismatches)

Enables off-balance sheet financing

Strategic / Tax reasons

Concentration / Exposure related issues

Improve RoA / RoE by recycling of assets / funds


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Why Securitisation

The Investor

Access an asset class which is normally not available

Well structured assets show more resilience as compared toplain vanilla assets

Usually available at a relatively higher yield to plain vanilla assetof similar credit rating

Avenue for relatively risk-free investment

Credit enhancement provides an opportunity to acquire goodquality assets and to diversify their portfolios

Opportunity for matching cash flows and managing ALM since asecuritised instrument carries regular monthly cash flows andhas varying maturities

Prevalence of secondary markets would offer liquidity

Enables isolation of risks


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Why Securitisation

The financial system

Increases the number of debt instruments in themarket

Provides additional liquidity in the market

Facilitates unbundling, better allocation andmanagement of project risks

Widens the market by attracting new players

Removes dullness in the markets

Can usher in tailor-made products Removes burden of bad / problem loans

Risk diversification across various players


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Securitisation The Risks

The way the PTCs are structured, the cash flows are unpredictable asthere will always be a certain percentage of obligors who won't pay upand this cannot be known in advance. Though various steps are taken totake care of this, some amount of risk still remains

In order to facilitate a wide distribution of securitised instruments,evaluation of their quality is of utmost importance. Thus rating thesecuritised instrument which will acquaint the investor with the degree

of risk involved is absolutely necessary Greater legal and operational risks to the originator if all concerns are

not addressed If true sale has not been achieved, the selling bank might be forced to

recognise some or all of the losses if the assets subsequently cease toperform

Funding risks and constraints on liquidity may arise if assets designedto be securitised have been originated, but because of disturbances inthe market, the securities cannot be placed

Potential conflict of interest if a bank originates, sells, services andunderwrites the same issue of securities

B k T i i C ll


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Enacted in December 2002

Guidelines issued by RBI to SC / RCs along withguidance notes based on the recommendations of thetwo Working Groups set up by RBI Monitored byDNBS

Guidelines to banks / FIs on sale of assets to SC / RCsregistered under the Act and related issues Issued byDBOD

SARFAESI Act, 2002

B k T i i C ll


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Securitisation as per SARFAESI Act

Acquisition of financial assets by any SC / RC fromany originator, whether by raising of funds by suchSC /RC from qualified institutional buyers by issue ofsecurity receipts representing undivided interest in

such financial assets or otherwise


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B k T i i C ll


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Registration of SCs / RCs under SARFAESI

SC / RC cannot commence or carry on without

(a) obtaining a CoR from RBI

(b) having owned fund (OF) of not less than two crore rupees

Requirement of Rs 2 crore for Registration purpose but forCommencement or Carrying on Business enhanced OF to 15% ofassets acquired or to be acquired or Rs.100 crore, whichever is

less

B k T i i C ll


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Conditions for Registration

(a) SC / RC has not incurred losses in any of the three preceding financial years

(b) SC / RC has made adequate arrangements for realisation of the financialassets and shall be able to pay periodical returns and redeem investmentsmade by QIBs on respective due date

(c) The directors of SC / RC have adequate professional experience in mattersrelated to finance, securitisation and reconstruction

(d) The BoD of SC / RC does not consist of more than half as nominees of anysponsor or associated in any manner with the sponsor or any of itssubsidiaries

(e) Any of its directors has not been convicted of any offence involving moralturpitude

(f) A sponsor, is not a holding company of the SC / RC, or, does not otherwisehold any controlling interest in the SC / RC

(g) SC / RC is in a position to comply with prudential norms

(h) SC / RC has complied with one or more conditions specified in the guidelinesissued by RBI

B k T i i C ll


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Registration related matters

Registered SC / RC can undertake both securitisationand asset reconstruction activities

SC / RC cannot accept deposits

SC / RC not to undertake any activity other than

securitisation and asset reconstruction

An entity not registered may conduct the business ofsecuritisation or asset reconstruction outside the purview

of the Act

B k T i i C ll


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Asset Acquisition Policy

SC / RC with the approval of BoD to frame a FinancialAsset Acquisition Policy within 90 days of grant of CoRwhich should cover

Norms and procedures for acquisition Types and the desirable profile of assets Valuation procedure assets acquired to have

realisable value In the case of financial assets acquired for asset

reconstruction, the broad parameters for formulationof plans for their realisation BoD may delegate powers to a Committee Deviation from policy to be made with the approval of

BoD



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Asset Acquisition Guidelines

Transactions to take place in a transparent manner andat a fair price in a well informed market

Transactions are executed at arms length in exercise ofdue diligence

Financial assets due from a single debtor to variousbanks / FIs to be considered

Acquisition not to include takeover of outstandingcommitments of the originator

Valuation to be done in scientific and objectivemanner, by internal or independent agencies



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Asset Reconstruction

SC / RC acquires assets from banks and FIs by issue ofdebenture or bond or any other security or by anagreement

SC / RC may undertake the following measures for thepurpose of reconstruction :

* Change in or take over of management * Sale or lease of part or whole of the business

Rescheduling of payment of debts Enforcement of security interest Settlement of dues payable


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Asset Classification

Assets to be treated as standard asset during theplanning period.

On expiry of plan period, after taking into account thedegree of well-defined credit weaknesses and extent

of dependence on collateral security for realisation,classify the assets into :

(a) Standard assets

(b) Non-Performing Assets



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Disclosures in the Balance Sheet

SC / RC in addition to the requirements of schedule VI of the Companies Act,1956, to prepare the following schedules and annex them to its balance sheet -

The names and addresses of the banks / FIs from whom financial assets wereacquired and the value at which such assets were acquired from each such bank/ FI

Dispersion of various financial assets industry-wise and sponsor-wise

Details of related parties and the amounts due to and from them A statement clearly charting therein the migration of financial assets from

standard to non-performing

Accounting policies if not in conformity with the Directions, the particulars ofdepartures together with the reasons therefor and the financial impact on

account thereof shall be disclosed An inappropriate treatment of an item in B/S or P&L A/c cannot be deemed to

have been rectified by disclosure B/S and P&L A/c



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Trusts

SC / RC to transfer assets acquired to the Trust at the

price at which acquired from the originator

The trusteeship vests with SC / RC only

SC / RC to formulate a policy for issue of SRs, to beapproved by BOD

SRs transferable only in favour of QIBs

Disclosures to be made in the offer document relatingto issuer of SRs, terms of offer, rating



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Issues - Retail Assets

Difficult to sell on account of peculiar features

Numerous loans

Servicing issues

Collection issues

Diversification

Use historical behaviour, Cherry picking



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Issues in Securitisation

Offshore securitisation

Permit FIIs to invest in SRs ?

True Sale ?

Originating institution investing in SRs / PTCs

Sale of PAs to SCs / RCs

Securitisation outside the Act



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Guidelines on Purchase / Sale of NPAs

Issued on July 13, 2005 Applicable to banks / FIs / NBFCs

Includes accounts under multiple / consortium arrangement if classifiedas NPA by selling bank

Purchase / Sale

As per Board mandated policy Only on without Recourse basis

Should not enjoy any credit enhancements / liquidity facilities in anymanner from the seller

Only on cash basis

The estimated cash flows are normally expected to be realised within3 years and not less than 5% of the cash flows in each half year

Should be NPA for atleast 2 years in the books of the selling bank

Purchasing bank should hold the asset for atleast 15 months before sale



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Guidelines.(Contd.)

Staff Accountability should continue to be examined Standard Asset for 90 days in the books of the purchaser. Existingclassification of the same obligor need not be re-examined

If guidelines not completely adhered to, the asset status would becarried forward to the books of the purchaser

Any restructuring / rescheduling / rephasing of repayment schedule/ cash flow of the NPFA by the purchaser will render the account asNPA

Sale below NBV Debit to P&L A/c.

Sale more than NBV Excess provisions not to be reversed

Recoveries adjusted first against acquisition cost and then to profit

Compliance with exposure norms required.

100% RW for Capital Adequacy

Sufficient disclosure required in the Notes to Accounts

Submit all relevant reports to RBI and CIBIL



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The China Experience

Huarong AMC sold NPLs worth USD 1.3 bn inNov 2001 purchased from the Industrial andCommercial Bank of China (total assets USD 500bn)

International investors Morgan Stanley,Lehman Brothers, Salmon Smith Barney andKTH Capital Management

Innovative structuring : Initial investment ofUSD 120 mn (9% of asset value); recoveries inexcess of initial Investment would be sharedequally between Huarong and investors



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Draft Guidelines on Securitisation ofStandard Assets

Issued on April 4, 2005 Yet to be finalised

2 stage approach

Pooling & transferring of assets to a bankruptcyremote SPV

Repackaging & selling the security interests to thirdparty investors

Sale to be true sale illustrative criteria included

Arms length relationship between originator & SPV

PTCs to be independently rated by an ECAI updatedatleast every 6 months

Includes banks, FIs and NBFCs



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Draft Guidelines . (Contd.)

No recourse to originator.

Originator cannot repurchase except where

residual value falls to less than 10% of originalamount sold to the SPV

Originator can provide certain services (like creditenhancement, underwriting, hedging, liquidity support,asset-servicing, etc.) would not violate true sale

SPV can pass on surplus income to originator would

not violate true sale Legal opinion to be obtained by originating banks /service providers signifying true sale

SPV not to have any formal recourse to the originator



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Originator should not purchase the PTCs issued by the SPV which arebacked by its own assets sold. However, originator can purchase

senior-most tranche of the securities at market value, forinvestment purposes

such purchases should not exceed 5% of the original amount ofissue or 10% of total investment in non-SLR securities, whichever is

lower the issue should be atleast investment grade

Any reschedulement / renegotiation / restructuring effected after saleto SPV should be with express consent of investors / service providers /credit enhancement providers

Originating banks not to hold substantial interest in the SPV (Rs. 5lakh in equity or 10% of capital of the trustee coy., whichever is less)

Trustee coy. not to resemble in name or indicate any relationship withthe originator

Trustee coy. can perform only trusteeship functions in relation to SPV



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PTCs should be compulsorily rated by a rating agency

registered with SEBI updated atleast every 6 months SPV should provide sufficient disclosures Credit enhancement in the form of guarantees off B/S item

with 100% conversion factor First Loss Facility reduced from the capital

Second Loss Facility reduced from the capital Liquidity facility repaid within 90 days, else to be fully

provided. To the extent drawn, 100% RW and to the extentnot drawn, 100% conversion factor

Capital charge for credit & market risk for banks / FIsinvesting in PTCs governed by extant RBI guidelines

Valuation of PTCs As applicable to non-SLR securities Exposure norms to be adhered to by investors if individual

obligors constitute 5% or Rs. 5 crore, whichever is lower



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Any Questions ??



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a e s a g Co ege

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