CAPITAL MARKET & SECURITY ANALYSIS

PROJECT ON SECURITISATION IN INDIA

SECURITISATION
Securitisation is a process whereby non-tradable or illiquid financial assets are transformed into tradable securities. It involves the transfer of an asset or a pool of assets, directly or indirectly, by the owner of the assets (Originator) to a special purpose vehicle (SPV) which is funded through an issue of debt securities or notes backed by the cash flows generated by the assets. Asset-backed securitisation can be defined to mean pooling of assets, which have an income stream, a forecast of which can be made with reasonable accuracy and repackaging of such assets, in the form of marketable securities or derivative product for sale or participation to or by investors or lenders. Securitisation generally pre-supposes that the Originator has a bulk of its assets in the form of selfamortising financial assets, either with or without underlying security. It is also imperative that these assets should have a clearly established repayment schedule.

Market Participants
In India, issuers have typically been private sector banks, foreign banks and non-banking financial companies (NBFCs) with their underlying assets being mostly retail and corporate loans. The key motivations for Indian banks include:

Liquidity: Securitisation is an easy route than raising deposits that are subject to reserve requirements Regulatory issues: Constrains arising out of Provisions, priority sector norms, etc

Capital Relief: Major investors are mostly mutual funds (money market/liquid schemes), close-ended debt schemes and banks. Long term investors like insurance companies and provident funds are currently not active due to regulatory constraints. Foreign institutional investors are also missing due to regulatory ambiguity. As per guidelines, mutual funds are required to declare their NAVs on a daily basis due to which they prefer the structure/asset classes which involve low pre-payment rates. The lack of domestic non-traditional hedge fund style investors to participate in equity and mezzanine tranches has led to originators holding them.

Some examples of securitisation in the Indian context are:

First securitisation deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160 mn L&T raised Rs 4,090 mn through the securitisation of future lease rentals to raise capital for its power plant in 1999. Indias first securitisation of personal loan by Citibank in 1999 for Rs 2,841 mn. Indias first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in 2001. Securitisation of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through offshore SPV. Indias first sales tax deferrals securitisation by Govt of Maharashtra in 2001 for Rs 1,500 mn.

Current Securitization activity in India

To analyze the potential of securitization India, we split the securitization market into the following four broad areas: Asset Backed Securities (ABS) Asset backed Securities are the most general class of securitization transactions. The asset in question could vary from Auto Loan/Lease/Hire Purchase, Credit Card, Consumer Loan, student loan, healthcare receivables and ticket receivables to even uture asset receivables. In the Indian context, there has been moderate amount of activity on the Auto Loan securitization front. Companies like TELCO, Ashok Leyland Finance, Kotak Mahindra and Magma Leasing have been securitizing their portfolio of auto loans to buyers like ICICI and Citibank over the past 2-3 years, with several of the recent transactions rated by rating agencies like CRISIL and ICRA. While many of the deals are bilateral portfolio buyouts, ICICI has used the SPV structure and placed the issuance privately to corporate investors and banks. Thus, the key features of asset securitisation that distinguish it from traditional methods of buy certain assets, and not at an obligation on the part of the originator to pay. These assets are of

course specific and ascertained assets of the originator, because investing in the general assets of the originator is no different from buying a security of the originator. The nature of the assets - the assets which are "securitised" or thus converted into securities are mostly financial assets, that is, claim to a certain stream of cashflows. This is obvious because investors pay upfront to buy such asset and they need a certainty as to their payback - which is ensured by the assets representing cashflows, better than any physical asset. Transfer of assets by the originator - since the investors need to invest into the specific assets of the originator, the originator needs to accomplish a legal transfer of such assets. This is done both to ensure investors' full and supreme legal control over these assets, as also a legal isolation of the assets from the originator -such that neither the originator nor any of his creditors can ever have any claim against those assets.

Marketable securities - with the objective of creating a capital market instrument, the assets of the investor are transformed into capital market securities, such that the investors buying these securities are in fact buying a fractional claim on the originator's specific assets. Use of special purpose vehicles - special purpose vehicles are the transformation devices employed to convert the specific assets of the originator into securities. The securities may either be equity-type or pass-through securities, or may be debt-type securities, but in either case, since the special purpose vehicle has no more, and no less than the assets transferred by the originator, the securities of the SPV are essentially fractional, though re-arranged, interests in the assets transferred by the originator.

Mortgage Backed Securities (MBS, RMBS, CMBS) The MBS market in India is nascent - National Housing Bank (NHB), in partnership with HDFC and LIC Housing Finance, issued Indias first MBS issuance in August 2000. The potential of MBS in India, however, is huge. With NHB actively looking towards the development of a Secondary Mortgage Market (SMM) in the country, the MBS market in India could soon overtake the other securitization transactions in the country. An MBS market can help small HFCs with good origination capabilities and limited balance sheet strength in staying profitable and concentrate on the housing loan origination. The most important roadblocks for MBS in India are lack of mortgage foreclosure norms and the high incidence of stamp duty for assignment of mortgage necessary for securitization. Collateralized Debt Obligations (CDO, CLO, CBO) In this era of bank consolidations, CDOs can help banks to proactively manage their portfolio. CDOs can also help banks in restructuring their stressed assets. ICICI made an aborted attempt to

do a CBO issuance in August 2000. The CDO market in India is, however, likely to grow slowly owing to its complexities. The taxation and accounting treatment for CDOs needs to be clarified. Asset Backed Commercial Paper (ABCP) Asset Backed Commercial Paper (ABCP) is usually issued by Special Purpose Entities (ABCP Conduits) set up and administered by banks to raise cheaper finances for their clients. ABCP conduits are usually ongoing concerns with new CP issuances taking out the previous ones. Apart from legal requirements, an active ABCP market requires a large number of investors who understand the instrument and have appetite. Indias securitization market may not be mature currently for instruments like ABCPs.

Need for Securitization in India

In the Indian context, securitization is the only ray of hope for funding resource starved infrastructure sectors like Power3. For power utilities burdened with delinquent receivables from state electricity boards (SEBs), securitization seems to be the only hope of meeting resource requirements. Securitization can help Indian borrowers with international assets in piercing the sovereign rating and placing an investment grade structure. An example, albeit failed, is that of Air Indias aborted attempt to securitize its North American ticket receivables. Such structured transactions can help premier corporates to obtain a superior pricing than a borrowing based on their non-investment grade corporate rating. A market for Mortgage backed Securities (MBS) in India can help large Indian housing finance companies (HFCs) in churning their portfolios and focus on what they know best fresh asset origination. Indian HFCs have traditionally relied on bond finance and loans from the National Housing Bank (NHB). MBS can provide a vital source of funds for the HFCs. After the merger of Indias largest financial institution ICICI with ICICI Bank, ICICI, faced with SLR and other requirements, is actively seeking to launch a CLO to reduce its overall asset exposure [6]. It appears to be only a matter of time before other Public Financial Institutions merge with other banks. Such mergers would result in the need for more CDOs in the foreseeable future.