SABYASACHI MUKHERJEE 1

CHAPTER 7
SECURITISATION
 This chapter encloses…
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 Know the emergence of securitisation

 Understand the technical terms
 Highlight the benefits and problems
 Provide an overview of the securitisation industry.

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 Introduction…
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 Innovative financing mode emerged in 1970s in US &

1990s in India
 According to Leon T. Kendall, ‘Securitisation is one of the
most important and abiding innovations to emerge in the
financial markets since the 1930s’.
 Outcome of financial engineering.
 Started with the housing loan mortgages & later auto loan
receivables, credit card receivables, trade receivables, etc.

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 Concepts & Definition…
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 Securitisation is something special to those companies

which extend loans to its customers.
 The securities created in the process of securitisation or
what is called ‘securitised papers’ have the backing of the
assets, they are described as ‘Asset-Backed Securities
(ABS)’.

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 Securitisation of residential mortgage loan accounts, the

securities are called as ‘Mortgage-Backed Securities
(MBS)’.
 Report of the In-house Working Group on Asset
Securitisation of the RBI(1999), which defines
securitisatiion as “ the process of pooling and
repackaging of homogenous illiquid loans into
marketable securities that can be sold to investors”.

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 Securitisable Asset Pools…
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Securities
 Mortgage-Backed Securities ((MBS)
 Asset-Backed Securities (ABS)
Asset Pools
 Residential mortgage loans
 Commercial mortgage loans
 Credit card receivables

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 Mortgage-Backed Securities ((MBS)

 Auto loan receivables
 Personal loan receivables
 Lease receivables
 Trade receivables
 Toll receivables
 Export receivables
 Off-shore remittances

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 Securitisation: How It Works…
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E.g., Securitisation Process in a Housing Finance Company

(HFC)
1. HFC lends to borrowers for buying/constructing residential
houses
2. Mortgage is created on the property in favour of the HFC
3. HFC collects a pool of mortgages with similar maturity period
and interest rates

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4. HFC sells the mortgage pool to the Special Purpose Vehicle

(SPV)
5. SPV converts the mortgage pool into securities
6. SPV sells the securities to the investors
7. SPV pays the HFC with the proceeds from the sale of
securities

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 Need for securitisation…
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 Additional funds for their operations

 Transform credit assets into marketable securities
 Can sell the securities – investors – raise capital
 Securitisation leads to “capital relief”
 To increase liquidity, long-term assets are converted into
marketable securities.
 Avoids long wait & provides immediate funds
 Provides way for smaller investors.

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 Parties to an issue
The initial owner of the loans.
Originator Sells them to the SPV

SPV Set up specifically for transaction.

Purchases assets from Originator.
Special purpose
Company/Trust/ Mutual Fund
Vehicle

The loan customers.

Obligors Pay cashflows that are securitised

Subscribe to securities
Investors issued by SPV
 Parties to an issue (contd.)
Collects money from Obligors,
Collection monitors and maintains assets.
Agent Usually the originator

Provides a rating for the deal

Credit Rating based on structure, rating of parties
Agency & portfolio, legal and tax opinion etc

Credit Provides credit enhancement

by way of swaps, hedges,
Enhancement
guarantees, insurance etc.
Provider
As structurer for designing &
Merchant executing the transaction and
Banker as arranger for the securities
 Historical perspective…
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 Started in US, since 1970

 The development of MBS market in the US was by,
 Government National Mortgage Association
 The Federal National Mortgage Association
 Federal Home Loan Mortgage Corporation
 1983- trend of securitisation of receivables

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 1985- trend of securitisation of auto loans

 In India, the transaction took place between Citibank &
GIC Mutual
 Later, emerged as a viable fund raising option for NBFCs,
HFCs, manufacturing companies & service sector

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 Securitisation Structure….
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 Participants in securitisation process…
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Involves 3 primary parties:

1. The Originator
 Securitiser, initiator of the deal
 Wants to securitise their assets to genenrate capital
 E.g., NBFCs, HFCs, FIs, Banks, etc.,

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2. The Special Purpose Vehicle (SPV)

 An entity created for the purpose of
 Executing the deal
 Originator – SPV – Investors
 Issuer of ABS or MBS
 Legal structure of SPV, is in the form of company, firm, society,
or trust.

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3. The Investor
 Individual investors / instructional investors (FIs,mutual funds,
etc.,)
 Receive the interest & principal as per the agreement

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 Other parties…
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1. The Obligors – who are the borrowers from the originator

2. The Rating Agency – plays an important role
3. The receiving & paying agency – receives the installments
from the obligors & pays it to the SPV
4. Credit enhancer – credit enhancer may be the originator or
3rd party such as banks & provides credit enhancement

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5. Structurer – investment banker acts as a strucutrer or

arranger of the deal & brings together the other
parties
6. Trustee – appointed to look after the interest of the
investors

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 Mechanisms of securitisation..
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 Deal begins from the originator

 Rating takes place, which involves “cherry picking” &
“seasoning”
 Cherry picking – selection of assets
 Seasoning – monitors the performance of the selected
assets over a period of time
 Credit enhancement & investors comes into the deal

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 Deal begins from the originator

 Issues of ABS to the investors, involves 2 types of structure
1. Pass Through Certificate (PTC) – longer maturity period,
E.g., car loans
2. Pay Through Structure (PTS) – loans with shorter maturity
period, E.g., credit card receivables

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 Benefits of securitisation…
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A. For Originator
 Off-balance sheet financing
 Concentrate on core business
 Up-front booking of profits
 Improves capital requirements
 Recycling of funds
 Leverage effect
 Reduction in borrowing costs
 Best practices

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B. For Investors
 Securities are issued in capital market
 Cash flows are generated
 Securities are rated
 Risk can be ascertained ( e.g., Triple ‘A’, Double ‘A’)

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C. For economy
 Makes the market efficient by risk sharing & risk pooling
 Wider distribution of financial products
 Fulfill the various risk-return preference of investors
 Increases the asset turnover

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 Problems…
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 Stamp duty
 Transfer of loan accounts is heavy in some states
 Under the Transfer of Property Act 1882, mortgage debt
constitutes an immovable property & can transfer by an
instrument in writing – attracts stamp duty
 Taxation
 Transfer on income without transfer of assets attracts income
tax for originator

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 Accounting treatment
 Stated to be an off – balance sheet financing
 Unclear accounting guidelines
 Lack of standardization
 Format of documentation & administration differs from each
originator
 Foreclosure laws
 Existing foreclosure laws are not adequately supportive

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 Regulatory framework…
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 No specific regulatory framework

 In 2002, the enactment of SARFAESI Act, 1st legislative
step that enabled the securitisation of the Non- Performing
Assets
 In 2005, development in the financial system was made by
“The High Level Committee On Corporate Debt &
Securitisation (Patil committee)

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 In 2006 Feb, RBI guidelines for securitisation of standard

assets by banks was issued
 In 2007, SCRA was amended to include the securitised
instruments in the definition of the term ‘ securities’
 In 2007 June, SEBI draft a regulation for public offering
& listing of securitised debt instruments

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 Risk assessment in securitisation…
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 Complete transaction
 Credit rating plays a key role
 Rating for securitisation is different from conventional credit
rating exercise
 Look after the credit enhancement
 Credit rating agency evaluated 3 issues
1. Transaction structure
2. Asset pools
3. Cash flows

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 Types of risk…
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 Collateral risk
 Primary risk
 Extent to which the obligors of underlying assets will default
or delay of payment
 Structural risk
 Involved in passing on the cash from the asset pools & credit
enhancement to the investors

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 Legal risk
 Extent to which the regulatory action can delay or prevent the
payment to investors
 Third party risk
 Failure of performance of third parties

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 Documentation…
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Involves the following process,

1. Deed of Assignment to transfer the receivables as per the
terms and conditions of the transaction.
2. Trust Deed to create the SPV.
3. Credit Support Agreement or Cash Collateral Agreement
for the purpose of credit enhancement for the transaction.

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4. Power of Attorney by the Issuer in favour of the

Administrator/Successor.
5. The RPA agreement.
6. The Aministrator Agreement.

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 Securitisation in India…
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1. First securitisation deal in India between Citibank

and GIC Mutual Fund in 1991 for Rs 160 mn.
2. L&T raised Rs 4090 mn through the securitisation of
future lease rentals to raise capital for its power plant in
1999.
3. India’s first securitisation of personal loan by
Citibank in 1999 for Rs 2841 mn.

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4. India’s first Mortgage-Backed Securities Issue

(MBS) of Rs 597 mn by NHB and HDFC in 2001.
5. Securitisation of aircraft receivables by Jet Airways
for Rs 16,000 mn in 2001 through offshore SPV.
6. India’s first sales tax deferrals securitisation by Govt of
Maharashtra in 2001 for Rs 1500 mn.

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7. India’s first deal in the power sector by Karnataka

Electricity Board for receivables worth Rs 1940 mn and
placed them with HUDCO.
8. India’s first Collateralised Debt Obligation (CDO) deal
by ICICI bank in 2002.

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9. India’s first floating rate securitisation issuance by

Citigroup ofRs2810 mn in 2003. The fixed rate auto
loan receivables of Citibank and Citicorp Finance India
included in the securitisation.
10. India’s first securitisation of sovereign lease receivables
by Indian Railway Finance Corporation (IRFC) of Rs
1960 mn in 2005. The receivables consist of lease
amounts payable by the ministry of railways to IRFC.

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11. India’s largest securitisation deal by ICICI bank of Rs

19,299 mn in 2007. The underlying asset pool was auto
loan receivables.

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 Conclusion…
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 Thus Securitisation plays a major role in the emerging

market
 Initially, it was meant for residential mortgage loan with
longer time horizon
 Later, securitisation takes place for shorter tenor securities
 In India, securitisation has taken a stronger roots.

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