040-Niraj Parmar-Securitisation an Indian Perspective

Securitisation: An Indian Perspective

TABLE OF CONTENTS

S. No. Topic Page No.

I Executive Summary 02

II Concept and Origin 03

III Entities involved in Securitisation 05

IV Benefits of Securitisation 09

V Asset Classes and Applications of Securitisation 11

VI The Securitisation Process 19

VII The Experience so far 24

VIII Issues in India 29

IX Future Trend 46

X Conclusion 48

XI Bibliography 49

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I EXECUTIVE SUMMARY

“Just as the electronics industry was formed when the vacuum tubes were replaced by transistors,

and transistors were then replaced by integrated circuits, the financial services industry is being

transformed now that securitised credit is beginning to replace traditional lending. Like other

technological transformations, this one will take place over the years, not overnight. We estimate it

will take 10 to 15 years for structured securitised credit to replace to displace completely the

classical lending system -not a long time, considering that the fundamentals of banking have

remained essentially unchanged since the Middle Ages.”

- Lowell L Bryan

The above quote sums up the transformations and technological advancements taking place in the

world of finance. While securitisation has been in existence in the western world for more than 25

years now and is a well-developed instrument trading both in the primary and secondary markets, it

is in a nascent stage in India with the legal backing still missing. Further, the debt market is still

undeveloped and investor awareness is missing.

This paper deals with the analysis of the securitisation of assets. It describes key elements of a

typical asset securitisation; outlines the reasons for securitising assets, discusses the types of assets

that can be securitised, describes the requirements for a successful asset securitisation, examines

whether India’s taxation, legal and financial infrastructure presents any barriers to securitisation and

tries to explore the direction that the securitisation shall take in the future.

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II CONCEPT AND ORIGIN

Securitisation has been one of the most important developments in the financial markets in the

developed countries. The historical use of financial intermediaries to gather deposits and lend them

to those seeking funds was supplemented and even replaced by securitisation processes that bypass

traditional intermediaries and link borrowers directly to money and capital markets. Securitisation

began in early seventies in the United States with residential mortgages. Restrictions with regard to

lending by mortgage banks across States within America created a lot of regional imbalances with

some States being short of funds to meet the housing needs and some others having surplus funds

without an attractive investment opportunity. Securitisation corrected this imbalance effectively by

directly linking the savers with the borrowers.

Securitisation is the process of pooling and packaging Financial Assets, usually relatively illiquid,

into liquid marketable securities. Securitisation allows an entity to assign (i.e. sell) its interest in a

pool of financial assets (and the underlying security) to other entities.

Simply stated, securitisation refers to conversion of cashflows into marketable securities. Such

securities are referred to as Asset Backed Securities (ABS), which are typically highly rated and

carry a variety of credit enhancement mechanisms. ABS are primarily serviced by the securitised

cashflows and the credit enhancements available. When housing loans are securitised, the resulting

securities are referred to as Mortgage Backed Securities (MBS). The securities are also referred to as

the Pass Through Certificates (PTCs) sometimes.

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Typically, a lender advances a loan to a borrower and gets repayment along with interest over a

period of time. Traditionally, the lender would collect the periodic instalments and wait till the final

maturity of the loan to recover his full principal and interest. Securitisation allows the lender to sell

his right to receive the future payments from the borrowers to a third party and receive consideration

for the same much ahead of the maturity of the loan.

Securitisation need not be confined to lender-borrower relationships. It can be applied to supplier-

buyer relationships also. Manufacturer-sellers could supply goods to their high quality customers on

instalment basis and raise funds by securitising these instalments. If the customers are of high

quality, it is possible to have a high rating for the securitised paper leading to interest cost savings.

Thus, this may be cheaper than traditional sources of funding like bank finance.

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III ENTITIES INVOLVED IN SECURITSATION

Flows at the time of securitisation

Periodic cashflows post securitisation (repayment by borrowers passed on to

Investors)

The various entities in the structure and their brief role are given below:

Originator:

The original lender or the entity, which has generated the receivables to be securitised. The

originator is the seller of the receivables. Typically, the originator is a Bank, a Non Banking Finance

Company (NBFC), a Housing Finance Company or even a manufacturing/service company.

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Lender(Originator / Servicer)

SPVIssuer

Investors

Consideration

Consideration

Assigns loans

ABS

Trustee

Borrowers

Rating Agency


Special Purpose Vehicle (SPV):

SPVs are the issuers of securities. The main purpose of creating SPV is to alienate the assets

securitised from the originator and to ensure that the creditors of the originator do not have any claim

on the securitised assets. In the event of bankruptcy of the originator, the repayments on the ABS

depend only on the asset performance no entity other than the investors in the ABS has a claim on

the receivables. The SPV should not have any borrowings. SPVs are typically companies with small

capital or trusts formed for the specific purpose of issuing securities in securitisation transactions.

SPV uses the proceeds of the issue to buy the receivables from the originator.

Investors:

Investors are the purchasers of ABS. Banks, Financial Institutions, NBFCs, Mutual Funds, Foreign

Institutional Investors (FIIs) and even individuals could invest in ABS.

Servicer:

The Servicer collects the periodic instalments due from individual borrowers in the pool, makes

payouts to the investors and follows up on delinquent accounts. Servicer also furnishes periodic

information to the rating agency and the trustee on pool performance. There is a service fee payable

to the servicer.

Trustee:

Trustees tend to be reputed Banks, Financial Institutions or Firms of Chartered Accountants or

Solicitors. The trustees have a fiduciary role to oversee the performance of the transaction till

maturity with a view to protect investors’ interests. The trustee is vested with the necessary powers

for the same. For example, the trustee could change the servicer, if necessary.

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Rating Agency:

As most ABS are rated, rating agencies play an important role in the entire structure. Rating agencies

typically get involved right from the beginning of the transaction and help the originator with the

pool selection and structuring of the transaction. Finally, the rating agency specifies the level and

form of credit enhancement that is needed for the required rating. The agency also monitors the pool

performance based on the monthly reports from the servicer and revises the collateral level

downward if it deems fit. Rating agencies also make presentations to and hold conferences with

merchant bankers and investors to provide information and clarifications on the securitisation

programme.

Example

A finance company with a portfolio of car loans can raise funds by selling these loans to another

entity. But this sale can also be done by “securitising” its car loans portfolio into instruments with a

fixed return based on the maturity profile (the period for which the loans are given). If the company

has Rs 100 crore worth of car loans and is due to earn 17 per cent income on them, it can securitise

these loans into instruments with 16 % return with safeguards against defaults. These could be sold

by the finance company to another if it needs funds before these loan repayments are due. The

principal and interest repayment on the securitised instruments are met from the assets which are

securitised, in this case, the car loans. Selling these securities in the market has a double impact. One,

it will provide the company with cash before the loans mature. Two, the assets (car loans) will go out

of the books of the finance company once they are securitised, a good thing as all risk is removed.

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How is it different from financing through straight bond or debenture issue?

Unlike a traditional bond issue, the repayment of funds raised through securitisation is not an

obligation of the originator, or the finance company issuing the securitised instrument. In a straight

bond or debenture issue, in the event of the company going bust, the investors would have a tough

time getting their funds back, if at all. However, if one invests in a securitised instrument, investors

are assured of interest payments even if the finance company goes bust, as the securitised loans are

separated from the finance company’s books through a SPV, which holds these assets. At the same

time, as securitised instruments can be traded, the investor is provided with liquidity as the

securitised bond can be sold in the market.

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IV BENEFITS OF SECURITISATION

Securitisation offers a wide range of benefits to both originators and investors. The prominent among

these are encapsulated below:

Originator's Perspective

Securitisation offers an effective and relatively quick alternative-funding source.

Securitisation is an off-balance sheet-funding alternative. It generates cash for the originator

without any addition to borrowings thus without increasing the debt to equity ratio. Companies

that have capital adequacy pressures can undertake securitisation to raise funds.

Securitisation helps in up-fronting profits. In case of high yielding portfolios like car loans and

truck loans, there is a profit on sale, as the inherent yield in the portfolio is typically higher than

the coupon rate on ABS. Hence, there is a boost to bottom-line and Earnings Per Share (EPS) in

the year of securitisation

As securitised papers are highly rated, cost of borrowing is relatively lower. Even for originators

rated in the AA category, there is likely to be a price advantage in securitisation as AAA has a

price premium. This is all the more attractive for borrowers whose own credit ratings are lower.

Since securitisation helps to undertake larger business with the same capital, profitability and

return on investment ratios improve post-securitisation.

After securitisation, medium term assets are replaced by cash leading to mitigation of tenor

mismatch and improved asset liability management.

Banks, financial institutions (FIs) and non banking finance companies (NBFCs) who are fully

exposed to certain industries, corporates or groups can do further business without violating

exposure norms by securitising a part of the existing exposure.

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After securitisation, credit and prepayment risks are eliminated as these are passed on to the

investors.

With the advantage of a high rating, there is access to a wider base of investors.

Investors’ perspective

Traditionally, investors look at safety, liquidity and yield before making any investment

decisions. ABS is relatively more safe as they are typically highly rated. ABS could be listed in

stock exchanges like any other debt instrument thereby enhancing secondary market liquidity in

them.

Securitised instruments also provide the flexibility to structure the instrument to suit the

investors’ needs, in terms of tenor or periodicity of payment. In developed markets, several

classes of securities are issued from one asset pool to suit the varying investor preferences.

Essentially these classes of securities differ in structure, tenure, priority of payment and yield so

that the investors could choose the class that fits their requirement best.

Investors in ABS also get the benefit of a payment structure, which is closely monitored on a

monthly basis by the rating agency and the trustees, which is not available in case of other

instruments like traditional debt.

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V ASSET CLASSES AND APPLICATIONS OF SECURITISATION

All assets that generate funds over time can be securitised. These include repayments under car

loans, money due from owners of credit cards, airline ticket sales, toll collections from roads or

bridges, and sales of petroleum-based products from oil refineries. In fact, artists have even raised

funds by securitising the royalty they will get out of future sales of their records.

The characteristics of the most readily securitisable assets are:

Predictable cash flows

Consistently low delinquency and default experience

Total amortization of principal at maturity

Many demographically and geographically diverse obligors and

Underlying collateral with high liquidation value and utility to the obligors

Securitisation works well if the securitised asset (say, the pool of car loans) is homogenous (the same

kind) with regard to credit risk (how sound the borrower is) and maturity. Ideally, there should be

historical data on the portfolio’s performance and that of the issuing company with regard to credit

quality and repayment speed.

Some of the asset classes that have been securitised and other applications of securitisation are as

under:

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Residential Mortgages

Residential mortgage-backed securities (RMBS) are generally pass through securities or bonds based

on cash flows from residential home loans, as opposed to commercial real estate loans. Evidently

enough, the residential mortgage market was one of the most appropriate applications of

securitisation. That is why, for good reasons, some or the other way of refinancing mortgages has

been found in most parts of the world. If in USA, it was securitisation, in Europe, a traditional

mortgage funding instrument, Pfrandbriefe has been in vogue for almost 200 years.

There are two very strong reasons for RMBS being tuned to securitisation: one, the long maturities

of residential mortgages, and two, the fact that mortgage lending is backed by charge over real estate,

which is a strong asset-backing enabling the investors to take an independent exposure on the

receivables. The Govt. support to development of secondary markets in mortgages has also been a

strong reason, and the governments easily took this as one of their major welfare activities.

Home Equity Loans

Home equity is basically a second loan against the mortgage of a house. The possibility of such a

loan arises when the value of a house is more than the outstanding value of a mortgage - quite likely

situation after the first mortgage has been partly amortized. The second lender takes a second

mortgage over the house, normally secondary in priority over the rights of the first lender, and

provides funding. Normally, the home equity loans do not find its application in the same house:

application of the money borrowed is normally not controlled. A home equity loan could either be a

close-end loan: meaning the loan is paid off over a stated period, or it may be a line of credit, that is,

one where the borrower pays regular interest but continues to enjoy the line of credit as an overdraft

against the value of the house.

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Reverse Mortgages

As in a mortgage, the borrower pays a regular instalment to lender, in a reverse mortgage, it is the

lender who pays a regular instalment to the borrower. How it works is as follows: if I have a house

which I own, and I am old and retired, then, unless I want my posterity to enjoy my house after me, it

can turn the house to a source of a regular pension till I live. A reverse mortgage lender will agree to

give me a loan in regular monthly instalments, as long as I live, and confiscate the house when I die.

That is to say, the so-called lender is buying the house for an unspecified amount, which can be low

if I die soon enough, or could be high if I live long.

Auto loans

Ever since the emergence of the ABS market, auto loans have formed an important segment. The

interesting features of auto loan markets are high asset quality and ease in liquidation of delinquent

receivables. The emergence of an alternative in form of asset-backed commercial paper has reduced

the significance of auto loan securitisations, but the activity in this segment is still important.

Commercial Mortgages

Securitisation of commercial mortgages is one of the earliest applications of securitisation, next only

to residential mortgage securitisation. Commercial mortgage-backed securities (CMBS) are bonds or

other debt instruments secured by commercial real estate, as opposed to residential real estate.

Commercial property means property let out or managed for economic benefit as opposed to that for

self-occupation, and includes multi-family dwelling units (apartments or condominiums), retail

centers, hotels, restaurants, hospitals, warehouses, and office buildings.

In generic sense, CMBS also includes securitisation of real estate leases.

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Equipment leases

Securitisation of equipment leases forms an increasing proportion of the total ABS market. In USA

alone, in 1997, more than $7 billion of equipment lease-backed deals were completed.

The features of equipment leases will depend upon the type of leased product, transaction size etc.

Asset backed commercial paper

The distinction between asset-backed securities and asset-backed commercial paper is primarily one

of the tenure of the paper - commercial paper by definition is short-term funding, and is therefore

mostly used for short-term assets such as trade receivables.

Asset backed commercial paper (ABCP) is a device used by banks to get operating assets such as

trade receivables funded by issuance of securities. Traditionally, banks devised ABCP conduits as a

device to put their current asset credits off their balance sheets and yet provide liquidity support to

their clients.

Bank Loans, CBOs / CLOs

There is no basic distinction between generic securitisations and the CBO/ CLO issuance at the

instance of banks, except that here, the originating bank is trying to parcel out a pool of loans or

bonds held by the bank. Banks would resort to securitisation essentially with four motives, in

different combinations: sourcing cheaper funds, attaining higher regulatory capital, better asset-

liability management, and reduced non-performing or under-performing assets.

CLOs

Where the originating bank transfers a pool of loans, the bonds that emerge are called collateralised

loan obligations or CLOs.

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CBOs

Where the bank transfers a portfolio of bonds and securitises the same, the resulting securitised

bonds could be called collateralised bond obligations or CBOs.

CDOs

A generic name given to the two is collateralised debt obligations or CDOs, as in a number of cases,

the portfolio transferred by the bank could consist of loans as well as bonds, and at times, even ABS.

Credit Cards

The cult of the credit card has become well -accepted world over. The dramatic increase in the

acceptability of credit cards is revealed in the following data about outstanding credit card

receivables in the USA: from $234 billion of total receivables outstanding in 1990 to $356 billion

outstanding as at May, 31, 1998.

Hedge fund investments

Collateralised financial obligations (CFOs) use the CDO/ CLO device to securitise investments in

private equity, hedge funds or similar non-debt-type investments. The typical structure of a private

equity securitisation is by owners of limited partnership interests in private equity funds transferring

their interests in those funds to a special purpose vehicle, or SPV. The SPV then issues debt type

securities. These obligations of the SPV are backed by financial assets, hence the term CFO.

Hedge fund investments and private equity investments are investments in equity-type instruments.

By repackaging such investments into debt securities, CFOs create debt out of equity.

The hedge fund industry itself has grown rapidly over the past 10 years or so. Securitisation of hedge

fund investments seemed like a brilliant idea, a bit outlandish at once, but now it seems there are

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several transactions. It is certainly a new flavour in the structured finance market, but it seems it is

here to stay at least for a while.

Non-performing loans

During the 1990s, the problem of non-performing loans with banks became particularly acute [in

1997, Japanese banks had an estimated USD 1 trillion in nonperforming assets], and with

securitisation technology with structuring options finding increased acceptability, bankers world-

over have been looking at financial restructuring options through securitisation.

It was not until late 1999 that securitisation of non-performing loans became a reality. On 25th

November, 1999, Morgan Stanley Dean Witter (MSDW) launched and priced a JPY 21.0 billion

issue of floating rate structured notes for an SPV called International Credit Recovery - Japan One

Ltd., a Cayman Islands-domiciled. This was the first time a capital markets solution had been applied

to the problem of non-and-sub-performing loans. The MSDW deal was backed by non-performing

loans backed on Japanese real estate, a total of 700 real estate assets of various types located

throughout Japan. MSDW had been buying these loans over time.

How does it actually happen: The real miracle that securitisation does to non-performing loans is

not to turn bad into good. It is not that the bad apple becomes a good apple when sliced, but that the

good portion of the bad apple is sliced and given to outsiders, while the bad part is retained by the

originator or other enhancers. Most non-performing loans securitisations have been supported by

substantial over-collateralisation or subordinated interests retained by the originating banks. Most of

the Italian securitisations, for example, are credit-enhanced by a substantial extent of subordinated

notes, which are retained by the originator.

In case of the Korean non-performing loan securitisation, it is the put option with the Korea

Development Bank that enhances the acceptability of the bonds.

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Aircraft leases

Aircraft lease securitisations can take two forms - either securitisation of receivables out of leases

with the aircrafting remaining the legal property of the originator, or those where the aircraft itself is

sold to the SPV. The latter follows the device of Equipment Trust certificates (ETCs). While the

aircraft lease receivable securitisation (aircraft lease portfolio securitisation - ALPS) is similar to any

other securitisation, the ETC method is a unique technology applied mostly to the aircraft segment

only.

Future flow securitisation

The distinguishing feature of future flows securitisation is the fact that the asset being transferred by

the originator is not an existing claim against existing obligors, but a future claim against future

obligors. In other words, the claims are yet to be created, against obligors who are yet to be

identified. Examples can be export receivables (normally crude exports), future royalties, hotel

revenues, sports receivables, etc. Future flow securitisation essentially aims at piercing the rating of

the sovereign and having a security of the originator rated above the rating of the sovereign. If, in the

example above, the originator is an exporter, say exporting oil to US buyers, and if he securitises the

oil exports such that the receivables are trapped and deposited in an account in New York, which is

assigned to the SPV, the investors would:

not be subject to exchange risk, as the receivables are in foreign exchange

not be subject to sovereign risk as the receivables have been assigned by way of a true sale

outside the country of the originator.

The only right the sovereign has is the right of redirecting the exports, which can always be rated.

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Whole business securitisation

The whole business securitisation is a concept that emerged essentially in the UK. Given the ability

to apply this device to the cashflows of any business, the concept virtually breaks down all

limitations of securitisation and extends it to almost any business, new or old, having predictable

cashflows or otherwise.

Objectively, there is not much of difference between a plain secured borrowing and whole business

securitisation. In a plain borrowing, the borrower obliges himself to pay to the lender, and the

obvious source of payment is the cashflows of the borrower. The lender might have security interest

in all or some of the assets of the borrower to secure the loan so granted. In a securitisation, on the

other hand, the investor is given a legal right over some of the assets of the originator, which are

legally isolated from the originator. In whole business securitisation, since the idea is to make the

whole of the cashflows of the business available for liquidating the securities, there is no question of

isolating the assets of the originator. In other words, the investors are though given a claim over all

the cashflows of the originator, the cashflows remain within the legal and contractual control of the

originator, and so do the assets from which the cashflows arise. The only difference between a

secured lending and a whole business securitisation is that in the latter case, the investors acting

through the SPV will have greater legal control over the originator, such that they can even

effectively assume the control of the originator's business in an event of default.

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VI THE SECURITISATION PROCESS

We shall now look into the various steps and structures involved in a securitisation deal:

1. Identification and / or Accumulation of Assets

These assets could include anything from airline ticket receivables, hire-purchase rental

receivables, sales cash flows of any commodity, et al. Values are represented by future cash

flows and it is essential to recognize a specific timeframe for this purpose. The market for each

security will define what is investor-relevant information. This information is normally checked

through credit-rating agencies that verify the credibility of the projected cash flows and the

stability of their sources.

2. Transfer or Insulation of Assets from Transferor’s creditors:

Assets are isolated usually through a ‘true sale’ or ‘clean transfer’ by the originator to a

bankruptcy-remote SPV that will issue the securitised bonds. The issuing SPV may be either a

limited purpose company, or a trust established under a restrictive deed. In both cases the SPV

will be manage by an independent trustee, so that the issuer ahs no conflict of interest with the

security. Also acceptable is the assignor retaining legal title to the underlying asset but holding

such a title subject to the equitable interest of the assignee. This effectively means that the title to

the asset will be held by the borrower (assignor) subject to the first charge in favour of the lender

(assignee).

3. Issuance of Bonds:

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The issue of debt bonds is how the anticipated cash flows from the assets are transformed into

cash in hand either by an SPV offering bonds to the public or the private investor market. The FI

as an underwriter will take an initial investment position in the debt and later offload it in the

market, thus making a margin. This creates a huge market for term lending and improves the

performance of the FIs. Every securitisation requires the appointment of a servicer or

administrator to collect and distribute obligor payments from the asset’s performance, manage

the collection of recoveries for defaulted monitor and report on receivables. The administrator is

entitled to receive a fee for the services, paid out of the collections on the assets. This fee

represents one of the methods to compensate an originator for transferring its rights to the assets.

4. Enhancement and Support to the Assets and / or Securities

The advantages of isolating cash flows and using them to service issued debt obligations may

justify securitisation. Nevertheless, ABS and MBS investors may prefer structures to contain

explicit enhancements that may improve the asset’s performance. Others may boost the

performance of the structure, or guarantee payments to investors. The amount of credit

enhancement that is required for any securitisation transaction is determined by a number of

factors, such as:

Desired credit rating

Estimated delays in collections from the pool

Estimated collection efficiencies ( Collections/Billings)

Estimated level of delinquent assets in the pool

Cash flow pattern of the pool

Estimated prepayment levels

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There are various forms of credit enhancements that are used in securitisation transactions. In

order to arrive at the most efficient and most cost-effective structure, it is common for a

transaction to employ several different credit enhancement techniques.

There are two distinct classes of credit enhancement techniques. Internal credit enhancements

rely solely on the pool of receivables being securitised to provide support while External credit

enhancements look to the credit of an independent third party.

The choice among the various techniques of credit enhancement will depend on a number of

considerations. Chief among these are:

Relative costs of enhancement mechanisms

Excess spread available on assets

Investor preference

Seller’s cost of capital

Availability of suitably rated third party credit enhancement suppliers

Complexity of structure/time available to complete transaction.

The various forms of internal and external credit enhancement techniques are listed below:

Internal Credit Enhancement External Credit Enhancement

- Overcollateralisation

- Cash collateral/Liquidity Reserve

- Credit tranching

- Excess Interest Spread

- Reserve funds

- Amortization triggers

- Related party guarantee

- Letter of credit

- Monoline Insurance

- Multiline Insurance

The Special Purpose Vehicle

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As opposed to a general purpose vehicle or a trading corporation, a Special purpose vehicle, as the

name suggests, is formed for a special purpose: therefore its powers are limited to what might be

required to attain that purpose and its life is destined to end when the purpose is attained. When a

corporation, call it the sponsor of the SPV, wants to achieve a particular purpose, for example,

funding, by isolating an activity, asset or operation from the rest of the sponsor's business, it hives

off such asset, activity or operation into the vehicle by forming it as a special purpose vehicle. This

isolation is important for external investors whose interest is backed by such hived-off assets, etc.,

but who are not affected by the generic business risks of the entity of the originating entity. Thus

SPVs are housing devices - they house the assets etc transferred by the originating entity in a legal

outfit, which is legally distanced from the originator, and yet self-sustained as not to be treated as the

baby of the originator.

By its very nature, an SPV must be distanced from the sponsor both in terms of management and

ownership, because if the SPV were to be owned or controlled by the sponsor, there is no difference

between a subsidiary and an SPV. Being an independent, an SPV is responsible for its own funding,

risk capital and management decisions. Most SPVs, for example, securitisation SPVs, run on a pre

punched program and do not have to take any management decision: they are almost "brain dead".

Typical structures of Asset Backed Securities (ABS):

There are different types of ABSs, each utilizing a slightly different structure:

Asset-backed certificates are pass-through certificates issued by a trust representing undivided

fractional interests in a pool of receivables such as automobile loans or credit card receivables.

Except for any recourse provision, the assets are sold outright by the selling company to the trust.

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Asset backed obligations (ABOs) are debt securities of a special purpose corporation, owned

either by the selling company or by unaffiliated third parties, and collateralised by a pool of

financial assets. They are similar to collateralised mortgage obligations (CMOs) because they

often utilize multiple tranches, but, unlike CMOs, they may issue either pay through or fixed pay

securities (i.e. prepayment risk is eliminated for investors).

Asset backed preferred stock is issued by a special purpose, bankruptcy-proof subsidiary which

purchases assets such as trade and consumer receivables or inter-company notes from its parent

or affiliates. The assets are often supported by a direct pay letter of credit or surety bond in

favour of the subsidiary issued by a AAA rated commercial bank wit the result that the

subsidiary’s preferred stock is able to obtain the highest credit ratings.

Asset backed commercial paper involves the sale of financial assets to a SPV which, in turn,

issues commercial paper. Proceeds from the issuance of the commercial paper finance the

purchase of the assets. The commercial paper is supported by the cash flow from the assets, the

issuance of new collateralises commercial paper or from borrowings under a liquidity facility.

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VII THE EXPERIENCE SO FAR

The US Scenario

Securitisation in its present form originated in the mortgage markets in USA. Till 2002, the

outstanding securitised debt in international market was above $ 5 trillion. The Mortgaged Backed

Securitisation (MBS) market was above $ 4 trillion. The US alone accounted for $435 billion of the

total ABS issuance. Also outstanding Securitised debt for ABS is 25% of total outstanding

borrowings in the United States.

In the US, securitisation was promoted with the active support of the government. The government

wanted to promote secondary markets in mortgages to allow liquidity for mortgage finance

companies. GNMA was the first one to buy mortgages from mortgage companies and to convert

them into pass through securities - this was 1970. Other US government agencies, FNMA and

Freddie Mac jumped in later. The first securitisation of receivables outside the mortgage markets

happened in 1975 when Sperry Corporation securitised its computer lease receivables.

The federal agencies purchase mortgages from banks and thrift institutions, repackage them in the

form of securities, and sell them to investors as mortgage pools. Investors in mortgage-backed

securities are, in fact, purchasing a piece of a mortgage pool, taking into consideration such factors

as maturity and the spread between the yield on the mortgage security and the yield on 10-year

treasuries. Investors in mortgage backed securities assume little default risk because most mortgages

are guaranteed by one of the government agencies. However, these securities present investors with

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uncertainty because they can receive varying amounts of monthly payments depending on how

quickly homeowners pay-off their mortgages. Although the stated maturity can be as long as 40

years, the average life of these securities to date has been much shorter. Ginnie Mae a wholly owned

government agency issues fully backed securities (i.e., they are full faith and credit obligations of the

US Government) in support of the mortgage market. The GNMA passthrough securities have

attracted considerable attention in recent years because the principal and interest payments on the

underlying mortgages used to collateralise them are “passed through” to the bondholder monthly as

the mortgages are repaid.

As a result of the trend to securitisation, other asset-backed securities have proliferated as financial

institutions have rushed to securitise various types of loans. Car loans, credit-card receivables, railcar

leases, small-business loans, photocopier leases, aircraft leases, and so forth have backed marketable

securities. New asset types include royalty streams from films, student loans, mutual fund fees, tax

liens, monthly electric utility bills, and delinquent child support payments.

Examples of recently securitised assets include: Auto loans, leases and installment sales contracts

Home equity loans, Home improvement loans, Manufactured housing installment sales contracts,

Credit card receivables, Tax liens, Future royalty income and Equipment leases and Utility charges.

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Asset Class Breakup

The Indian Scenario

Securitisation began in India in the early nineties. The first securitisation deal took place in 1991

when Citibank securitised a pool from its autoloan portfolio and placed the paper with GIC Mutual

Fund. The volume involved was about Rs. 16 crore. Since then, much hype and hoopla has

surrounded the securitisation market in India.

The securitisation market in India is about Rs.100 bn with a meager 1.6% of the total debt. There has

been a lot of discussion about the potential of securitisation in India, actual deal activity has never

reached the potential. ICICI, TELCO and Citibank have been actively pursuing securitisation, but

most of their transactions are privately placed with a majority of them being bilateral fully bought

out deals.

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Asset Class Breakup

`

In terms of the asset profile, in the securitisation of hire purchase receivables from vehicles, truck

hire-purchase receivables account for most of the transactions with the rest being accounted for by

car loan / hire purchase receivables. Higher yields and relatively low delinquencies in autoloans in

general are the main reasons for this asset category being preferred for securitisation. Because of the

inherent higher yields in autoloans, the originators could offer attractive yields to the investor and

still book profits on securitisation.

Securitisation of housing loan receivables has also taken off in India in 2000 with National Housing

Bank issuing mortgage backed securities (MBS) backed by housing loan receivables of Housing

Development Finance Corporation Limited (HDFC) and LIC Housing Finance Limited (LICHFL).

Both the issues were rated by CRISIL and successfully placed resulting in LICHFL and HDFC going

in for second tranches of MBS were also rated by CRISIL.

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Originators

The originators in the rated auto-loan securitisation transactions include Citibank, several NBFCs

and a few financial institutions. Balance sheet management, alternate funding, tenure mis-match

correction, exposure and NPA management and profit booking have been the main motivating

factors for these originators.

Investors

Investors in ABS in the past have been FIs, NBFCs, Multinational Banks, Insurance companies and

Mutual Funds.

Costs of securitisation

Different costs involved in a securitisation transaction are the interest rate (discount rate) on ABS,

cost of maintaining cash collateral, stamp duty, SPV expenses, legal fee and the rating fee. The

interest rate is the rate used to discount the future cashflows of the pool to arrive at the consideration

to be paid to the originator. The cost of maintaining cash collateral is the interest income foregone

due to blocking of funds in the collateral. Stamp duty differs among States. In Maharashtra, Gujarat,

West Bengal, Karnataka and Tamil Nadu, stamp duty on securitisation involving certain asset classes

has been reduced to 0.1%. SPV expenses would be the fees payable to the SPV. Often it may not be

necessary to form a company to act as the SPV, if one of the existing investment companies could be

used as the SPV. The legal fee is normally a lump sum, not directly related to the volume of the

transaction. Rating fee has two components viz. initial rating fee and surveillance fee. CRISIL’s

initial rating fee is currently 0.1% of future receivables for the first year and the surveillance fee is

0.05% of remaining receivables for every year of surveillance. If other forms of credit enhancement

like over-collateralisation is used, interest loss on cash collateral could be reduced thereby reducing

the overall cost.

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Extent and form of credit enhancement

The level of credit enhancement has usually varied between 5% and 30% of the receivables

securitised for an AAA rating depending upon the quality of the portfolio and the pool. The extent of

credit enhancement has shown a decline over the years. The form of credit enhancement has been

cash collateral, over collateralisation, sub-ordination and guarantee.

Liquidity

Some of the recently rated securitisation programs were listed in the National Stock Exchange and a

mechanism of market making was also incorporated. Liquidity in general for all debt instruments

could be better in India. Lack of awareness could further reduce the liquidity in case of ABS.

VIII ISSUES IN INDIA

Tax Issues

The tax incidence would usually depend on how the documents relating to the transaction are

structured. The main entities involved in the securitisation transaction are the Originator, the SPV

and the Investors.

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Taxability of the Originator

It would depend on:

1. Whether the securitisation transaction results in the legal transfer of property in the assets being

securitised; and

2. Whether the gain or loss (in the case where there is a transfer of the property) is treated as a

business gain or a capital gain by the tax authorities

Where there is a legal transfer of property (true sale) in the assets to be securitised

Tax depends on whether the tax authorities construe it as a capital gain or as a business gain.

- If the tax authorities construe the securitisation transaction as a transfer of capital assets or as

a conversion of the assets into stock-in-trade: Capital Gains tax would be applicable.

- On the other hand, where the profit/gain on the securitisation transaction is treated as

profit/gain of business, it would be chargeable to tax under the head “Profits and Gains of

Business” under Section 28(i) of the Act.

Where there is no legal transfer of property in the assets to be securitised

- The tax authorities may characterize the securitisation transaction as “a method of financing”

on the security of the receivables

- and levy tax on the Originator, on the gains if any, under the head “Profits and Gains of

Business" under Section 28(i) of the Act.

- The discount charged by the SPV on the receivables would be allowable as a type of a

finance expense and deducted from the net amount received by the Originator, which would

be liable to tax as business income.

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Where the income in the assets has been transferred without a transfer of the property

Section 60 of the IT Act

- Where only the receivables in the securitisation transaction and not the asset is transferred:

(e.g. in securitisation of lease receivables, housing rent or hotel receipts):-

The income would be deemed to accrue to the asset-owner (Originator) and he would be

liable to tax thereon. However, the asset-owner could claim capital allowances on the asset,

and

- Where the asset itself is transferred: (e.g. in securitisation of hire purchase receivables, where

the only asset claimed by the asset-owner is the right to receive installments and such asset is

transferred):-

On transfer, the income generated from the receivable would be deemed to have been

transferred to the transferee and he would be liable to pay tax on such income.

The gain, i.e. the difference between the sum received from the transferee and the value of

the asset at which it is outstanding, less any expenses incurred by the asset-owner would be

considered as either business profit of the asset-owner or capital gains of the asset-owner,

depending on whether the asset being transferred is a non-capital or capital asset.

Taxability of the SPV

There are three alternative approaches

2. SPV regarded a conduit between the Originator and the ultimate investor ‘Pass through

Structure’:

In this case, it would receive income flows from the underlying assets and would use the same to

service the instruments issued by it. Thus, it would not earn any income nor would it make any

profits and would not be liable to pay any tax.

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2. SPV may be regarded as a representative assessee of the investors:

The SPV generally acts as the trustee of the investors, and in such cases, relevant provisions of

the Act, dealing with the concept of a representative assessee may apply to the SPV.

Accordingly, the SPV may be taxed for the income received by it on behalf of the several

investors. However, such tax would be revenue-neutral since the tax payable by the SPV cannot

exceed the tax payable by the investors on such income. Under certain circumstances, the SPV

would be liable to pay tax at the maximum marginal rate applicable to individuals. The Act

enables the representative assessee to recover the tax paid by the representative assessee from the

person/s on whose behalf such tax is paid. Thus, ultimately, the SPV, which is regarded as a

representative assessee, may have no tax incidence.

3. SPV may be characterized as an independent taxable entity or in case of a ‘Pay through

structure’:

(Example: Where the SPV re-configures the cash flows received by it by reinvesting them, so as

to pay the investors on fixed dates, which do not match with the dates on which the transferred

receivables are collected by it)

Where the SPV is treated as an independent entity, any income received or deemed to be received

by the SPV would be deemed to be its income. The income distributed by the SPV in the form of

interest would be deemed to be the expense of the SPV and income in the hands of the investors .

Where the payments made by the SPV are towards equity or towards distribution or application

of income, such payment would not be a tax-deductible expense for the SPV. The SPV would be

liable to pay dividend distribution tax on the dividends paid.

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Taxability of the Investors

1. Where the SPV is regarded as a pass through entity:

Each individual investor would be liable to pay tax on the income earned in proportion to his

investment.

2. Where the SPV is characterized as a representative assessee:

The SPV is taxed and the tax paid by it is deemed to have been paid by the investors. Thus, the

investors would not be liable to pay tax individually and the SPV would be entitled to recover the

tax paid by it, from the investors.

3. Where the SPV is characterized as an independent entity:

Investors would be taxed on what they would earn, by holding the instruments issued by the SPV

or by transferring the same.

Withholding Taxes

The Concept:

A person responsible for making payments, which are chargeable to tax, is required to deduct tax as

per the applicable rate and remit the same to the Government of India.

In a securitisation transaction, there would be three situations when the issue of deducting tax in

certain circumstances at source would arise. These are:

1. When the transferee/SPV makes payments to the Originator, for transfer of the assets:

No requirement of any withholding tax since the SPV pays for the discounted value of the

receivables purchased and there is no income element in the nature, which requires deduction of

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tax at source. If the transaction results in taxable profit or gain, it would be on account of

business profit or capital gain, for which the tax would be payable by the Originator

2. When the transferee/SPV collects payments from the debtors in relation to the securitised

asset:

Withholding taxes may be applicable depending on the nature of payments collected from the

debtors.

The securitisation transaction does not change the character of the original transaction between

the Originator and the debtors and thus any withholding tax applicable to the payment to be made

by the debtor to the Originator, under the original transaction would continue to be applicable.

3. When the transferee/SPV makes payments to the investors

Withholding tax would be applicable, when such payment is made in the form of interest to the

investor. Where the SPV is treated as a mere conduit, it is likely that the payments made by it

would not be treated as interest payments and thus not liable to any withholding taxes.

Legal Issues

Stamp Duty

Stamp duty is different in various Indian states and ranges from a low of 0.1 per cent of the value of

loans transferred in certain states to more than 3 per cent in other states. Most states had stamp duty

regimes that were unclear on how exactly a securitised instrument may be classified.

In certain circumstances the trust/SPV may also be treated as a non-banking financial company and

be subject to the regulations framed by the RBI under the Reserve Bank of India Act, 1948 in this

regard. In such a situation, stamp duty may be leviable not only on the assignment of the original

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pool of loans but also on the securitised instrument. However, stamp duty on transfer of securitised

assets by the lender can be reduced or avoided by careful structuring of the transaction.

Insolvency Issues

True Sale

The principal concern in a securitisation transaction is the legal isolation of the assets securitised

from the bankruptcy risks associated with the entities involved. To achieve this, the assets securitised

must be legally transferred to the SPV, so that the SPV is not affected in a situation where there are

any claims against the Originator.

It is thus the key to securitisation transactions that the SPV and the assets are remote from the risk of

bankruptcy/insolvency of the originator.

In order to achieve this, the transfer of the assets to the SPV must be regarded as a “true sale” and not

merely as being a transfer for obtaining finance. Where the transaction is not regarded as a true sale,

it may be treated as a method of financing or a loan by the SPV, in which case, if the Originator goes

bankrupt, the liquidator of the Originator would have rights against the underlying assets.

Bankruptcy of the SPV

The bankruptcy risks of the SPV need to be mitigated. This may be achieved by restricting the

business activities of the SPV so as to decrease the chances of there being other creditors who could

cause the winding up of the SPV. The activities of the SPV should be restricted by incorporating

relevant provisions in the constituent and transaction documents.

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Fraudulent preference

Certain provisions of the Indian Provincial Insolvency Act, 1920 and the Presidency Towns

Insolvency Act, 1909 provide that certain transfers of property, if made immediately before

bankruptcy of an entity would be annulled or avoided under law, if it is held that the transfers were

made in contemplation of bankruptcy. The Provincial Insolvency Act states that where a transferor is

adjudged insolvent, within two years of the property being transferred, then the Court may annul

such a transfer of property.

However, transfers made in good faith and for valuable consideration are excluded.

There is a preference period whereby any transfer of property moveable or immovable, made, taken

or done by, or against a company within six months before the commencement of its winding up,

may in the event that the company is wound up, be treated as a fraudulent preference and be invalid

accordingly. Generally in establishing a case of fraudulent preference it must be shown that the

dominant motive of the debtor must be to prefer a creditor and the motive must also be tainted with

an element of dishonesty

Priority of claims

There may be a situation where a true sale has been achieved. However, the underlying assets are

subject to an overriding interest (prior claims) created in favour of creditors of the Originator. Where

such prior claims exist, the SPV’s rights would be subject to such prior claims.

In certain situations such as bankruptcy under the Indian law, the liquidator is first required to

discharge statutory preferential payments before discharging other claims. Further, the liquidator is

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also under an obligation not to part with any of the assets of the company without setting aside an

amount equal to the tax which is payable or likely to be payable thereafter by the company.

Set-off

One concern related to insolvency risk is whether or not setting-off of exposures would be permitted

in India. The law is well settled that a creditor claiming to prove debt against an insolvent company

in liquidation, is entitled to set-off its related claims.

Dealing with the question of set-off, the Supreme Court has taken the view that section 529 and

section 530 of the Indian Companies Act, 1956 must be read together when a creditor seeks to prove

his debt against the company in liquidation. The effect of such a reading would permit a creditor to

take the benefit of the rule enacted in section 46 of The Provincial Insolvency Act, 1920 “whereby

only that amount which is ultimately found due from him at the foot of the account in respect of

mutual dealings should be recoverable from him and not that the amount due from him should be

recovered fully while the amount due to him from the company in liquidation should rank in

payment after the preferential claims”

Assignment of Actionable Claims

Actionable claims refers to a claim to any debt, other than a debt, which is secured by mortgage of

immovable property or by hypothecation or pledge of movable property or to any beneficial interest

in movable property not in the possession, whether such debt or beneficial interest be existent,

accruing, conditional or contingent. For example, receivables on account of leases are actionable

claims. In India, receivables are taken as actionable claims.

As such, transfer of actionable claims is possible only by execution of an instrument in writing, as

per section 130 of the Transfer of Property Act. As per this section, transfer on an actionable claim

shall be effected only by the execution of an instrument in writing, signed by the transferor, and such

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transfer shall be complete and effectual upon the execution of such instrument, whether a notice to

the debtor is given or not. On the strength of such an instrument, the transferee of an actionable claim

gets lawful rights to recover the claim from the debtor, in his own name, without any reference to the

transferor. The Indian law differs from the English law, as under the Indian law, notice of assignment

(transfer) is not a pre-requisite, although it is advisable.

The Transfer of Property Act states that assignment of a debt should be in whole and not be a part

assignment. Further, both the Transfer of Property Act and the Sale of Goods Act hold that only a

property currently in existence is capable of being transferred. These laws impede the development

of securitisation of future receivables, as transfer of a future property does not fall under the

definition of debt.

Accounting for Securitisation

In the Books of the Originator

The accounting depends upon whether the Originator has lost control of the securitised asset

Loss of control

The originator has not lost control where

1. The creditors of the Originator are entitled to attach or otherwise deal with the securitised assets;

2. The SPV does not have the right (to the extent it was available to the Originator) to pledge, sell,

transfer or exchange for its own benefit the securitised asset;

3. The Originator has the right to reassume control of the securitised asset except:

a) Where it is entitled to do so by a Call Option, where such Call Option can be justified on its

own commercial terms as a separate transaction between the SPV and the Originator, for

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instance, where the Call Option is exercisable at fair value of the asset on the date of exercise

of the Option; or

b) Where it is entitled to do so by a Clean-up Call Option

Some other relevant points:

Where originator is also the servicer: there is loss of control

An obligation on the originator to repurchase (as in a recourse obligation): is not an entitlement

to ownership and there is a loss of control

An entitlement and obligation of the originator to repurchase: No loss of control

When the Originator looses entire control of the securitised assets:

Securitised asset should be derecognised in the books of the Originator

The difference between the book value of the securitised asset and consideration received should

be treated as gain or loss arising on securitisation and disclosed separately in the statement of

profit and loss

The entire expenses incurred on the transaction, say, legal fees, etc., should be expensed at the

time of the transaction and should not be deferred

If the Originator has accepted recourse or similar obligation, e.g., the Originator has granted a

Put Option at a predetermined price to the SPV, then the contingent loss arising therefrom,

should be accounted for as per Accounting Standard (AS) 4, ‘Contingencies and Events

Occurring After the Balance Sheet Date’

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When there is no loss of control over the securitised assets

Securitised asset should NOT be derecognised in the books of the Originator

Consideration received for the asset so transferred should be accounted for as a borrowing

secured there against.

The expenses incurred on the transaction should either be amortised over the term of the secured

borrowing or recognised immediately in the statement of profit and loss.

Partial Loss of Control

This can be done in two ways:

1. Where a proportionate share of the asset is transferred:

Example: the Originator may transfer a proportionate share of loan (including right to receive

both interest and principal), in such a way that all future cash flows, profit/loss arising on loan

will be shared by the Originator and the SPV in fixed proportions

If the Originator transfers a proportionate part of the asset, the previous carrying amount of

the asset is apportioned among the part transferred and the part retained on the basis of

proportion transferred and proportion retained. For example, if the originator transfers 75% of

an asset to the SPV, 75% of the carrying amount of the asset should be considered as

securitised. Where the securitised part of the asset qualifies to be derecognised, the entity

would continue to recognise the remaining part of the asset at 25% of the carrying amount

If any new interest has been created as a result of securitisation transaction, such as a Call

Option, the new interest should be recognised in the books in accordance with the relevant

accounting principles.

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2. Where the asset comprises the rights to two or more benefit streams and one or more of such

benefit streams is/are transferred while retaining the others:

The carrying amount of such financial asset should be apportioned between the part(s)

transferred and the part(s) retained on the basis of their relative fair values as on the date of

transfer.

Future Receivables

The Originator may securitise or agree to securitise future receivables, i.e., receivables that do not

exist at the time of agreement but which would be arising in future.

The future receivables are estimated at the time of entering into the transaction and the purchase

consideration for the same is received by the Originator in advance.

Any purchase consideration received is accounted for as an advance, since the assets proposed to

be securitised would not be existing at the time of the agreement, but would arise in future.

The cost of bringing these assets into existence would also be incurred in future. In such cases,

the criterion for derecognition prescribed should be applied as and when the relevant assets come

into existence. Till such time the amounts received, if any, on account of the proposed

securitisation should be reflected as an advance.

Revolving Period Securitisation

Securitisation can also be in the form of ‘Revolving Period Securitisation’ where future receivables

are transferred as and when they arise or at specified intervals; the transfers being on prearranged

terms

All requirements except the one pertaining to future receivables applies

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Measurement of the Consideration

When consideration is not in cash: (example in the form of securities issued by the SPV)

The consideration should be measured at the LOWEST of:

a. the fair value of the consideration;

b. the net book value of the securitised assets; and

c. the net realisable value of the securitised assets

When the consideration is received partly in cash and partly in a form other than cash

The non-cash component of the consideration should be measured at the lowest of the

a. the fair value of the non-cash component;

b. the net book value of the securitised assets as reduced by the cash received; and

c. the net realisable value of the securitised assets as reduced by the cash received.

What is the fair value?

The fair value is the price that would be agreed upon between knowledgeable, willing parties in an

arm’s length transaction.

Normally we consider the following as fair value:

Quoted market price

If quoted market price is not available: an estimate based on the market prices of assets similar to

those received as consideration

In case the market prices of similar assets are also not available: an estimate based on generally

accepted valuation techniques such as the present value of estimated future cash flows.

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In the Books of the SPV

When the Originator has lost control over the securities assets:

Recognise the asset received under a securitisation transaction only if the Originator loses control

over the securitised asset

The asset should be recognised at the amount of consideration, if the consideration has been paid

in cash

In case the consideration has been paid in a form other than cash, e.g., securities, the asset so

received should be recorded either at its intrinsic value or at the fair value of the consideration,

whichever is more clearly evident. If both the values are equally evident the asset should be

valued at the lower of the two values.

When beneficial ownership in the securitised asset has not been transferred to the SPV or the

Originator has not lost control over the asset

Do not recognise the asset received.

The consideration paid should be recorded as a lending secured against the financial asset

received under securitisation transaction

The amount received by the SPV on issue of PTCs or other securities should be shown on the

liability side of the balance sheet, with appropriate description, keeping in view the nature of

securities issued.

In the Books of the Investor

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Account for the PTCs and/or debt securities acquired by it as an investment in accordance with

Accounting Standard (AS) 13, ‘Accounting for Investments’.

Disclosures

In the financial statements of the Originator

The nature and extent of securitisation transaction(s), including the financial assets that have

been derecognised.

The nature and the amounts of the new interests created, if any.

Basis of determination of fair values, wherever applicable

In the financial statements of the SPV

The nature of the securitisation transaction(s) including, in particular, a description of the rights

of the SPV vis-à-vis the Originator whether arising from the securitisation transaction or a

transaction associated therewith.

Basis of determination of fair values, wherever applicable.

In the financial statements of the Investor

The Investor should make disclosure of investments in PTCs and/or debt securities as required by

Accounting Standard (AS) 13, ‘Accounting for Investments’.

Other issues concerning securitisation transactions

Lack of third party servicers

In securitisation transactions, normally, the originator acts as the servicer for the securitised pool of

assets. To that extent dependence on the originator continues even after the sale of receivables.

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Though the agreement provides for the investors to change the servicer in case they are not satisfied

with the performance of the servicer, in India, the efficacy of alternate servicer needs to be fully

tested.

Lack of data across economic cycles

Lack of long track record of performance of assets over economic cycles is not available in India.

This is because housing and consumer loans in the organised sector are not as old in India as it is in

the developed countries. In the United States for example, the historical performance of mortgages

for decades including the great depression of 1930 are available. This kind of database helps one to

predict the behaviour of assets in adverse conditions better.

Lack of sophisticated information systems

A sophisticated information system is very important for securitisation. The information requirement

of rating agencies is fairly detailed both at the time of initial rating and subsequent surveillance.

Currently, not all originators’ systems are fully geared to meet the information requirement.

Co-mingling of cash flows

The risk that the cashflows from the securitised pool would get mixed with those of the originator is

referred to as co-mingling risk. If the originators short-term rating is not high this presents a problem.

Internationally, a time limit is specified within which the pool cashflows should be transferred to the

designated account. This could pose a problem, if the contracts in the securitised pool are

geographically dispersed across many states and regions. There is a lack of quick fund transfer

systems in India. Hence, more time may have to be allowed for the transfer of funds.

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Debt market

Lack of a sophisticated debt market is always a drawback for securitisation for lack of benchmark

yield curve for pricing. The appetite for long ended exposures (above 10 years) is very low in the

Indian debt market requiring the Originator to subscribe to the bulk of the long ended portion of the

financial flows. The development of the Indian debt market would naturally increase the

securitisation activity in India.

Lack of Investor Appetite

Investor awareness and understanding of securitisation is very low. RBI, key drivers of securitisation

in India like ICICI and Citibank and rating agencies like CRISIL and ICRA should actively educate

corporate investors about securitisation. Mandatory rating of all structured obligations would also

give investors much needed assurance about transactions. Once the private placement market for

securitised paper gathers momentum, public retail securitisation issuances would become a

possibility.

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IX FUTURE TREND

Since late eighties, when securitisation made its beginning in India, the number as well as the size of

transactions has grown over the years. This trend is likely to continue and the market would witness

considerable growth in the coming years.

It would help in the development of ABS market particularly the mortgage backed securities (MBS)

market, if incentives are given to these instruments. For example, MBS could be declared as eligible

investments by provident funds and pension funds and the concessions available to infrastructure

bonds could be extended to MBS.

So far, companies securitised assets to raise funds without adding to borrowings. This helped

companies, which had high gearing levels. The motivating factor in some securitisation transactions

in the past was the ability to book profits upfront. While these would continue to be demand drivers

for securitisation, securitisation is likely to be increasingly used for better asset liability management.

As securitisation replaces long to medium term assets by cash, the weighted average maturity of

assets for the company comes down. This is a big comfort, as typically, NBFCs were funding three-

year assets with one year fixed deposits.

Traditionally in the fund based business segment of the financial services sector in India, a single

entity was engaged in the entire gamut of activities viz. raising funds, locating borrowers, credit

appraisal of the borrowers, servicing of the loans and recovery. Owing to the rapidly changing

environment, realignment is likely to happen in this sector. One could see specialisations emerging in

the market. In developed markets like USA, particularly in the mortgage market, there is a

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considerable amount of specialisation. Typically, in these markets, a single entity does not perform

more than one or two of the activities mentioned earlier. The trend of specialisation is also in line

with the increasing emphasis on “core competence”. Instead of an entity engaging in all the

activities, it would make sense to focus on a few areas where it has competitive advantage.

The trend is already visible in the autoloans sector. Owing to the regulatory changes with respect to

the quantum of fixed deposits that NBFCs could mobilise and the linking of the same with the credit

rating, a number of NBFCs are finding it difficult to raise funds at competitive rates. These NBFCs,

however, have a relatively low cost distribution network in place to originate and service loans. On

the other hand, large companies and Foreign Banks find that it is not economical to create a large

distribution network in terms of extensive branch network across the country due their high cost

structure. However, these companies, given their size, parent support, managerial talent and a high

credit rating have a much stronger funding capability.

Securitisation could be effectively used to combine these two complementary pools of resources.

NBFCs could originate loans and securitise them and sell to large companies. And they could use the

proceeds of the sale to originate more loans and the process could go on. The small NBFCs could

continue to service the loans, which would ensure a steady flow of fee income.

While many transactions are under way in the auto loan sector, this trend is likely to extend to

housing finance sector as well. As regards housing finance, the funding required is of a much longer

tenure and thus far more difficult to raise.

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X CONCLUSION

The securitisation market in India, though in its infancy, holds great promise especially in the MBS

area. While more complex securitisation transactions and public issuance of securitised paper are still

a distant dream, appropriate legislation and investor education can give the securitisation market in

India a much-needed thrust.

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XI BIBLIOGRAPHY

Reference to various books and numerous web site searches have led to the successful completion of

the paper.

Books and Articles

[1] P.P. Vora (2001), “NHB - Promoting A Sound, Healthy, Viable And Efficient Housing Finance

System”

[2] Modak, Anand, (2001), “Securitisation - A boon for Investors and Borrowers, Investime,

September 2001”

[3] Thompson, J.K., (1995), Securitisation: An International Perspective, OECD

[4] Business India Feb 4-17, 2002)

[5] Vinod Kothari. (2002), Securitisation: The Financial Instrument of the New Millennium

[6] The Securitisation and Reconstruction of Financial Assets and Enforcement Of Security Interest

Act, 2002.

[7] ICAI, Guidance Note on Accounting for Securitisation

[8] Income tax –V.K Singhania

Web Sites

[1] www.vinodkothari.com

[2] www.economictimes.com

[3] www.shilpabichitra.com

[4] www.valuemoney. com

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040-Niraj Parmar-Securitisation an Indian Perspective

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