Securitisation Ppt

SECURITIZATION IN INDIA

CONVENTIONAL BOND STRUCTURE

Structure of a normal debt instrument

A debt instrument is the obligation of the issuer

Normally, the credit profile of the issuer depends on the aggregated earnings power of its businesses in the context of its financial risk profile and management capability

It is these businesses that would need to generate the cash flows for bond redemption

Earnings Power etc

Issuer Investor

Bonds

Cash

LIMITATIONS OF CONVENTIONAL DEBT

FUNDING Limited flexibility to enhance the credit quality of the

borrower

Largely standardized loan products homogenizing credit quality across cross-section of asset side inflows and liability side outflows

Firms unable to package out different levels of risk to meet varying needs of investors

Consequently, cost of funds linked to average credit profile of different cash flows

Are alternatives available?

SECURITIZATION - BASICS

Securitization is the pooling of “homogeneous”, “financial"," cash flow producing”, “illiquid” assets and issuing claims on those assets in the form of marketable / tradable securities

Typically, a lender / originator advances a loan to borrower and over a period of time, he expects to receive repayment of principal and interest.

In securitization, the lender / originator sells the right to receive the future receivables to a third party and receives the present value of the receivables at the initiation of the transaction

The higher yield associated with these securities attracts investors who are willing to bear the associated credit, prepayment and liquidity risk


The basic principles of direct assignment remain the same - the only difference being that the investor records the transaction as ‘loans’ in its books and doesn’t invest in a tradable security

The originator also provides an upfront credit enhancement in the transaction to cover for the shortfalls in the pool because of borrower defaults;

The primary advantage of securitization is the flexibility provided in terms of unbundling of risks and allocation of the same to various parties who are able to manage those risks


Securitization involves sale, transfer, pledge of specified assets to a Bankruptcy-remote Special Purpose Vehicle (SPV)

The SPV in turn issues Notes (Pass Through Certificates) to investors in order to fund the purchase of the assets

Investors (banks, insurance companies, and specialised funds) rely on the cash flows (principal, interest and sale proceeds when sold after foreclosure) generated by the underlying assets to pay interest and principal on the notes

The risk associated with the assets is stratified by looking at historical default and loss information

Generally, the Originator remains the Servicer of the pool of the assets it had sold to the SPV

SECURITIZATION VS. TRADITIONAL DEBT

Securitization

Isolation of pool – true sale

Claim only against the pool – no impact of issuer bankruptcy

Typically both principal and interest repaid monthly

Credit enhancement helps in getting a higher rating than the issuer

Traditional Debt

The issuer holds the assets – provides security

Claim against the issuer company

Monthly interest; bullet principal payments

Rating cannot be higher than the issuer debt rating

Securitization vs Bilateral Assignment

Receivables based financing

Securitization through issue of tradable instruments would attract a wider investor base and thereby result in lower cost of funds to the Originator

Full RecourseOn Balance SheetNo capital ReliefNo gain on SaleBilateral or CMI

Limited RecourseOff Balance SheetRelease of capitalPossible gain on SaleNo capital market investors

Limited RecourseOff Balance SheetRelease of capitalPossible gain on SaleBanks and capital market investors

Loan/Advance Debenture Backed by charge & Escrow

Bilateral Assignment of receivables between Originator & Purchaser

Securitization vide issue of tradable instruments by an SPV

Bilateral Assignment: Structure Diagram

Originator Obligors

Purchaser/ Investor

Servicer

Credit Rating Agency

Credit Enhancement

Lease/Loan/Other Agreements

Payment towards Obligation

Purchase ConsiderationAssignment

Of

Receivables

Credit enhancement and rating may be optional in a bilateral transaction depending on the comfort of the purchaser / investor

PARTIES TO A SECURITISATION

OriginatorInitial owner of the assetsSells its asset to the SPV

Obligor Contractual debtor to Originator Pays cashflows that are securitised

SPVSet up specifically for transaction

Purchases assets from Originator Company/Trust/ Mutual Fund

InvestorsSubscribe to securities

issued by SPV


Servicer Collects monies from Obligors, monitors and maintains assets

Receiving & Paying Agent

Banker for the deal. Manages inflows& outflows, invests interim funds, accesses cash collateral

Credit enhancement

provider

Provides credit enhancement by way of swaps, hedges, guarantees, insurance etc.

Merchant banker

As structurer for designing& executing the transaction and as arranger for the securities


(CONTD.)Credit Rating

AgencyProvides a rating for the deal based on structure, rating of

parties, legal and tax opinion etc

Legal & Tax Counsel

Provide key opinions on the structure & underlying contracts

AuditorAppointed for conducting due diligence both initial and

during tenor of deal

CustodianR&T Agents

Appointed for safe custody of the underlying documents and registration/ transfer of securities

EXCHANGE OF FUNDS - INITIAL

Finance Company Ltd. (Originator) Trust (SPV) Investors

Trustee

Rating AgencyBorrowers

Trust Agreement

Asset-BackedSecurities

ProceedsProceeds

Rating with specified credit enhancement

Sale of assets

Loan agreement Servicing Agreement

EXCHANGE OF FUNDS - ONGOING

Finance Company Ltd. (acting as servicer) Trust (SPV) Investors

Trustee

Rating AgencyBorrowers

Trustee Responsibilities

Monthly investorpayments

Monthly loan repayments

RatingLoan repayments

Monthly reports

Collection reports

Form of SPV and role of Trustee are critical in a securitization

Tranching of Liabilities

Cash flows from securitized assets

6 month PTCs

1 year PTCs

5 year PTCs

Originator SPV Investors

Cash flows from securitized assets

Senior PTCs

AAA(SO)Originator SPV Investors

Retained Unrated Tranche

PAR AND PREMIUM STRUCTURES

Par StructuresPar Structures

Investor pays a consideration equal to the principal outstanding (par value) of the poolInvestor pays a consideration equal to the principal outstanding (par value) of the pool

Typically, interest generated on the pool is higher than the yield to the investor, the difference is called excess interest spread (EIS)

Typically, interest generated on the pool is higher than the yield to the investor, the difference is called excess interest spread (EIS)

EIS provides credit support to the investors. the originator retains a subordinated right to receive the EIS.EIS provides credit support to the investors. the originator retains a subordinated right to receive the EIS.

In return, investor is entitled to receive scheduled principal repayments along with a contracted yieldIn return, investor is entitled to receive scheduled principal repayments along with a contracted yield

Premium StructuresPremium Structures

Investor pays a consideration equal to the present value of future cash flows. The investor pays a premium to receive the excess interest spread

Investor pays a consideration equal to the present value of future cash flows. The investor pays a premium to receive the excess interest spread

No excess interest in the structureNo excess interest in the structure

The rating takes care of the fact that the investor payouts are higher and credit enhancement is calculated accordinglyThe rating takes care of the fact that the investor payouts are higher and credit enhancement is calculated accordingly

In return, investor receives the entire cash flows generated from the poolIn return, investor receives the entire cash flows generated from the pool

Prepayments in the underlying pool are passed on to the investorPrepayments in the underlying pool are passed on to the investor

As investor principal outstanding is higher than the pool principal, the credit enhancement is utilized to cover the prepayment shortfallAs investor principal outstanding is higher than the pool principal, the credit enhancement is utilized to cover the prepayment shortfall

BENEFITS OF SECURITIZATION

Efficient use of capital

Off balance sheet treatment and hence release of a portion of capital tied up by these assets

Allows the company to continuously churn assets and expand business volumes even when capital availability is scarce

Balance sheet management

Off-balance sheet treatment and upfront profit generated has a positive impact on financial results like Return of Assets, Earnings per share, Net spread etc.

Alternate Source of Funding

Securitization is an alternative source of funding that does not use up limits set up by banks / institutions on the company and allows allocation of funds by investors over and above these limits

BENEFITS OF SECURITIZATION

Rating enhancement resulting in lower cost of funds

Capital markets and other investors demand yields linked to the rating of the issuers for direct debt investment

Securitization enables a company to achieve a rating several notches above its standalone rating and thereby lower its cost of funding

Converting illiquid assets to liquid assets

Preserving customer relationships

Securitization allows transfer of credit risk while preserving existing relationships with customers

Typically, the originator acts as servicer for the transaction and hence continues to be the point of interaction with the obligors.

ORIGINATOR’S OBJECTIVES

Each originator should define the objectives desired to be achieved through the proposed securitization transaction in order of priority

Access to an alternate source of funds / investor class

Optimization of regulatory capital requirement

Rating enhancement and reduction in cost of funds

Balance sheet management : liquidity, asset-liability matching, debt-equity ratio

Limited recourse financing

Risk management – Sector exposure / company exposure

Structure of securitization may vary significantly based on the priority of objectives of the originator

WHAT CAN BE SECURITIZED

“Financial Asset” means debt or receivables and includes

Claim to any debt or receivables, secured or unsecured

Debt or receivables secured by mortgage or charge on immovable property

Mortgage, charge, hypothecation or pledge of movable property

Right or interest in the security underlying such debt or receivables

Beneficial interest, whether existing, future, accruing, conditional or contingent

Any financial assistance

Retail Assets Securitization

ABS market dipped in 2009

Absence of banks from this market

De-growth in retail originations

Tight liquidity

Concerns on asset quality

Largely becoming a liquidity providing instrument

Securitisation is a key resource raising avenue for NBFCs

CVs emerged as dominant asset class largely driven by Shriram, Tata Motors finance and Magma

Microfinance loans and gold loans are the emerging asset classes

0

200

400

600

800

1000

1200

1400

FY2003

FY2004

FY2005

FY2006

FY2007

FY2008

FY2009

0

20

40

60

80

100

120

Disbursement Issuance (Rs bil) No. of transactions

13%

4%2%4%

4%

5%

New / used Cars and UV Two wheeler

Personal loan SME loan

Mixed pool Others

Source: ICRA Research & Industry

TOP ABS ORIGINATORS

Banks have largely been non-existent in ABS market for last one year as the retail asset growth has been minimal / negative ABS continues to be a viable resource raising avenue for NBFCs focusing on asset finance Top originators for 2009-10 till date are Reliance Capital, Tata Motors Finance and Shriram Transport Finance Limited

Source: CRISIL report

WHAT AN ORIGINATOR LOOKS FOR

Advantages of securitization over traditional funding

Managing Asset liability mismatch

Capital relief

Off-balance sheet funding

Reducing concentration risk

Direct access to capital markets

Improved RoA / RoE

But, originators prefer to retain customer relationship and servicing

SECURITIZATION’S ANCILLARY BENEFITS

Securitization creates incentives for originator for

Developing transparent credit approval process

Efficient collection procedures, and for strong mechanisms to control this process

Clear and efficient processes invariably lead to lower credit enhancement

Public availability of information about pool performance adds to confidence in securitized paper

BENEFITS TO INVESTORS

Premium over equivalent rated plain securities

Focused risks associated with securities Portfolio diversification Tailored cash flow structures Flexible range of maturities Experienced risk assessment

BENEFITS TO THE FINANCIAL SECTOR

New forms of securities – market completion

Assists development of capital markets

Attracts conservative buyers

Draws international capital

Facilitates efficient allocation of risks

Originators – Incentive, Impacts

Secured Assets (100% risk weight and 9% capital), Unsecured Asset (125% risk weight and 9% capital)Capital

Relief 12%, 10% in case of Asset Finance CompaniesBa

nkN

BFC

Standard Provisioning – Secured Assets (0.4%), Unsecured Assets (2%). NPA are provided as per the RBI norms

Provisioning Relief No standard provisioning requirement. Relaxed provisioning

norms compared to Banks. Hence longer collection cycles, higher delinquencies compared to Banks

Bank

NBF

C


As per Basel – Rated piece (typically BBB) as per rating (typically 100% risk weight & 9% capital). Unrated to be fully deducted. No reset. Capital knock

off for Collateral To be fully deducted out of capital. No reset allowed. Basel

applicability??

Profit (IRR from pool – Sell down rate – expected collection cost – Expected credit losses) to be amortised by the seller

Profit Profit (IRR from pool – Sell down rate – expected collection

cost – Expected credit losses) to be amortised by the seller

Bank

Bank

NBF

CN

BFC


Proceeds from securitisation have no CRR/SLR requirement

Reduces priority sector requirementCost of funds Reduces cost of funds. More important in case of Non Asset

Finance NBFCs where provisioning requirement by Banks is leading to higher costs

Bank

NBF

C

BANKRUPTCY REMOTENESS

True sale of assets from the seller to the trustee

Legal separation of assets from the seller is achieved – investor is not exposed to credit worthiness of seller

Credit enhancement and liquidity facility – bankruptcy remoteness achieved through rating triggers

An independent legal opinion is taken post the transaction to cover all such legal issues

PERFORMANCE OF SECURITISATIONS IN INDIA

Unlike US, the rise in delinquencies has not led to widespread downgrades or defaults in securitised papers

Rating agencies largely pre-empted the deterioration in asset quality and have increased the credit enhancement requirement suitably

Safety cover for investors has remained robust

Till date, approximately 700 pools have been rated in India

38 pools have been downgraded so far

Only 3 of which have been downgraded to speculative grade

Some of these 38 pools have been upgraded back to AAA because of stable performance at later stages

Securitisation Ppt

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