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Bankers Training College

Asset Securitisation

03/09/2005
Reserve Bank of India

P. Vasudevan, MoF

Bankers Training College

Securitisation has grown at a


scorching pace internationally
2002 issuance of asset backed paper worldwide was close
to $ 700 billion
Compounded growth of more than 20% p.a. over the
last 3 years
The list of assets securitised is growing daily
E.g. diamonds, intellectual property, school fees, etc.
The number of participants is constantly increasing
Pension funds, insurance companies, mutual funds,
banks, FIs are some of the largest investors
The sophistication of products has increased e.g. credit
derivatives
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Securitisation Some latest facts


Last year, German Govt. securitised its Russian loan
dues
UK Chancellor of Exchequer has proposed securitising
future aid flows to developing countries
From traditional receivables securitisation (on balance
sheet items), future flow securitisation (of cash flows to
be generated in future) has been gaining momentum
In India, during 2004-05, Rs. 25,000 crore is the
aggregate amount of assets securitised.
Volumes are bound to increase as growing asset classes
like HLs, car / vehicle loans are ideally suited for
securitisation
CRISIL estimates Rs. 60000 crore securitisation
potential in 2003
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Retail Portfolio of Banks


(As at end-March 2004)
Amount
Outstanding (Rs.
crore)

Impaired Credit
as % of
outstanding loans

Net NPAs as % of
outstanding Loans

85436

1.9

1.4

(ii) Consumer
Durables

6256

6.6

4.0

(iii) Credit Card


Receivables

6167

6.3

2.4

89537

2.6

1.6

(v) Total Retail Loans


[(i) + (ii) + (iii) + (iv)]

189041

2.5

1.6

(vi) Total Loans &


Advances

880312

7.4

2.8

Items
(i) Housing Loan

(iv) Personal Loans

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Worldwide Growth of the ABS market


Global Structured Finance Issuance by Year
($ Billions)

1200

$1,137

US Public
1000

US Private

Europe

Asia

$ Bn

$792

800

$710
$580
$455

600

$414
$347
$355
$287

400
$216
$124

200

$88

Sources: JPMS, MCM CorporateWatch, and Bloomberg.

0
1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005 YTD
3

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Bankers Training College

Securitisation The Concept


Is a process through which illiquid assets are transferred
into a more liquid form of assets and distributed to a
broad range of investors through capital markets
In other words, securitisation deals with the conversion of
assets which are not marketable into marketable ones
Is the process of conversion of existing assets or future
cash flows into marketable securities
The conversion of existing assets into marketable
securities is known as asset-backed securitisation (ABS)
and the conversion of future cash flows into marketable
securities is known as future-flows securitisation (FFS)

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ABS / CDOs / MBS


Some of the assets that can be securitised are loans like
car loans, housing loans (MBS), etc., and future cash
flows like ticket sales, credit card payments, car rentals
or any other form of future receivables
Asset Backed Securities All assets are of a uniform
nature (like car loans or housing loans)
Collateralised Debt Obligations Assets from a
diversified pool
Mortgage Backed Securities Refers to housing loans

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Securitisation The Process


The lender (or originator) segregates loans / lease / receivables into
pools which are relatively homogenous in regard to types of credit,
maturity and interest rate risk
The assets are transferred by the originator to a special purpose vehicle
(SPV) usually constituted as a Trust / Subsidiary / Limited Company /
Joint Venture with other banks / FIs, etc.
The SPV is a separate entity formed exclusively for the facilitation of the
securitisation process and providing funds to the originator
The SPV will act as an intermediary which divides the assets of the
originator into asset-backed marketable securities. This could be with or
without recourse
These securities issued by the SPV to the investors and are known as
pass-through-certificates (PTCs)

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Securitisation The Process

(Contd.)

Interest and principal payments on the loans, leases and


receivables in the underlying pool of assets are collected
by the servicer (who could also be the originator) and
transmitted to the investors
The difference between rate of interest payable by the
obligor and return promised to the investor investing in
PTCs is the servicing fee for the SPV
Credit enhancement can add features to boost investor
confidence. This could be in the form of a provision of
recourse, a guarantee requiring the originator to cover
losses, a letter of credit from a bank, or over
collateralisation
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Typical transaction structure


Investor

Originator

Sale
Consideration

Sale of Debt
service receivables

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Servicing of notes

Loan/ Receivable

Obligor

SPV

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Whats the utility of the SPV


Helps in Credit tranching
Addresses different investor classes
ABS enables SPVs to get a superior credit rating than the
loan-originating firm could earn on its own
Enables various credit enhancement mechanisms
Over-collateral
Excess spread
Liquidity lines
Arms length relationship with the originator
Addresses bankruptcy issues

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Steps in securitisation
Identification
of assets

Resolving
asset related
legal issues

Transaction
structuring

SPV
structuring

System due
diligence and
upgradation

Transaction
rating

Legal vetting
and
documentation
SPV formation
and document
execution

Syndication

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Traditional commercial banking system


Underwrite

Originate

Book

Fund

New system
Originate

Structure

Thrift
Commercial
bank
Retail
securities
firm

Investment
bank
Retail
securities
firm

Credit
Enhance

Insurance
company

Place

Pension fund
Thrift
Insurance
company
Individual

*This diagram taken from


Breaking Up the Bank, by Lowell L. Bryan
Reserve Bank of India

Trade

Investment
bank
Commercial
bank

Service

Investment
bank
Commercial
bank
Specialist
payments
processor

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Generic deal diagram


Credit
Enhancement
Providers

Obligors
Collections
Original
Loan

Credit enhancement
Issue of securities

Cash flows

Servicer

SPV
Sale of
asset

Servicing
of securities

Rating

Originator

Purchase
consideration

Rating Agency

Structurer

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Investors

Subscription to securities

Arranger
Contracts
Ongoing cash flows
Initial cash flows

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Why Securitisation
The Issuer / Originator
Ability to raise cheaper / longer / more finance
Receivables being replaced by cash thereby improving the liquidity
position
Ability to finance structures which would not get financed through
normal banking products
Freeing of capital capital relief
Enables a trim (manageable level of assets) and transparent
(identification of assets) balance sheet Manage ALM mismatches & reduces market risk (by reducing
interest rate mismatches)
Enables off-balance sheet financing
Strategic / Tax reasons
Concentration / Exposure related issues
Improve RoA / RoE by recycling of assets / funds
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Why Securitisation
The Investor

Access an asset class which is normally not available


Well structured assets show more resilience as compared to
plain vanilla assets
Usually available at a relatively higher yield to plain vanilla asset
of similar credit rating
Avenue for relatively risk-free investment
Credit enhancement provides an opportunity to acquire good
quality assets and to diversify their portfolios
Opportunity for matching cash flows and managing ALM since a
securitised instrument carries regular monthly cash flows and
has varying maturities
Prevalence of secondary markets would offer liquidity
Enables isolation of risks
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Why Securitisation
The financial system
Increases the number of debt instruments in the
market
Provides additional liquidity in the market
Facilitates unbundling, better allocation and
management of project risks
Widens the market by attracting new players
Removes dullness in the markets
Can usher in tailor-made products
Removes burden of bad / problem loans
Risk diversification across various players

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Securitisation The Risks


The way the PTCs are structured, the cash flows are unpredictable as
there will always be a certain percentage of obligors who won't pay up
and this cannot be known in advance. Though various steps are taken to
take care of this, some amount of risk still remains
In order to facilitate a wide distribution of securitised instruments,
evaluation of their quality is of utmost importance. Thus rating the
securitised instrument which will acquaint the investor with the degree
of risk involved is absolutely necessary
Greater legal and operational risks to the originator if all concerns are
not addressed
If true sale has not been achieved, the selling bank might be forced to
recognise some or all of the losses if the assets subsequently cease to
perform
Funding risks and constraints on liquidity may arise if assets designed
to be securitised have been originated, but because of disturbances in
the market, the securities cannot be placed
Potential conflict of interest if a bank originates, sells, services and
underwrites the same issue of securities
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SARFAESI Act, 2002


Enacted in December 2002
Guidelines issued by RBI to SC / RCs along with
guidance notes based on the recommendations of the
two Working Groups set up by RBI Monitored by
DNBS
Guidelines to banks / FIs on sale of assets to SC / RCs
registered under the Act and related issues Issued by
DBOD

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Securitisation as per SARFAESI Act


Acquisition of financial assets by any SC / RC from
any originator, whether by raising of funds by such
SC /RC from qualified institutional buyers by issue of
security receipts representing undivided interest in
such financial assets or otherwise

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Asset Reconstruction as per SARFAESI

Acquisition by any SC / RC of any right or

interest of any bank or financial institution


in any financial assistance for the purpose
of realisation of such financial assistance

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Registration of SCs / RCs under SARFAESI


SC / RC cannot commence or carry on without
(a) obtaining a CoR from RBI
(b) having owned fund (OF) of not less than two crore rupees

Requirement of Rs 2 crore for Registration purpose but for


Commencement or Carrying on Business enhanced OF to 15% of
assets acquired or to be acquired or Rs.100 crore, whichever is
less

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Conditions for Registration


(a) SC / RC has not incurred losses in any of the three preceding financial years
(b) SC / RC has made adequate arrangements for realisation of the financial
assets and shall be able to pay periodical returns and redeem investments
made by QIBs on respective due date
(c) The directors of SC / RC have adequate professional experience in matters
related to finance, securitisation and reconstruction
(d) The BoD of SC / RC does not consist of more than half as nominees of any
sponsor or associated in any manner with the sponsor or any of its
subsidiaries
(e) Any of its directors has not been convicted of any offence involving moral
turpitude
(f) A sponsor, is not a holding company of the SC / RC, or, does not otherwise
hold any controlling interest in the SC / RC
(g) SC / RC is in a position to comply with prudential norms
(h) SC / RC has complied with one or more conditions specified in the guidelines
issued by RBI
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Registration related matters


Registered SC / RC can undertake both securitisation
and asset reconstruction activities
SC / RC cannot accept deposits
SC / RC not to undertake any activity other than
securitisation and asset reconstruction
An entity not registered may conduct the business of
securitisation or asset reconstruction outside the purview
of the Act

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Asset Acquisition Policy


SC / RC with the approval of BoD to frame a Financial
Asset Acquisition Policy within 90 days of grant of CoR
which should cover
Norms and procedures for acquisition
Types and the desirable profile of assets
Valuation procedure assets acquired to have
realisable value
In the case of financial assets acquired for asset
reconstruction, the broad parameters for formulation
of plans for their realisation
BoD may delegate powers to a Committee
Deviation from policy to be made with the approval of
BoD
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Asset Acquisition Guidelines


Transactions to take place in a transparent manner and
at a fair price in a well informed market
Transactions are executed at arms length in exercise of
due diligence
Financial assets due from a single debtor to various
banks / FIs to be considered
Acquisition not to include takeover of outstanding
commitments of the originator
Valuation to be done in scientific and objective
manner, by internal or independent agencies

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Asset Reconstruction
SC / RC acquires assets from banks and FIs by issue of
debenture or bond or any other security or by an
agreement
SC / RC may undertake the following measures for the
purpose of reconstruction :

* Change in or take over of management


* Sale or lease of part or whole of the business
Rescheduling of payment of debts
Enforcement of security interest
Settlement of dues payable

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Plan for realisation


(i) A period not exceeding 12 months is allowed for
formulating a plan for realisation of NPAs acquired for the
purpose of reconstruction
(ii) Within the planning period, SC / RC to formulate a
plan for realisation of assets, which may provide for
measures for reconstruction
(iii) The plan for realisation shall clearly spell out the steps
proposed to reconstruct the assets and realise the same
within a specified timeframe, which shall not in any case
exceed five years from the date of acquisition

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Asset Classification
Assets to be treated as standard asset during the
planning period.
On expiry of plan period, after taking into account the
degree of well-defined credit weaknesses and extent
of dependence on collateral security for realisation,
classify the assets into :

(a) Standard assets


(b) Non-Performing Assets

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Disclosures in the Balance Sheet


SC / RC in addition to the requirements of schedule VI of the Companies Act,
1956, to prepare the following schedules and annex them to its balance sheet The names and addresses of the banks / FIs from whom financial assets were
acquired and the value at which such assets were acquired from each such bank
/ FI
Dispersion of various financial assets industry-wise and sponsor-wise
Details of related parties and the amounts due to and from them
A statement clearly charting therein the migration of financial assets from
standard to non-performing
Accounting policies if not in conformity with the Directions, the particulars of
departures together with the reasons therefor and the financial impact on
account thereof shall be disclosed
An inappropriate treatment of an item in B/S or P&L A/c cannot be deemed to
have been rectified by disclosure B/S and P&L A/c

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Trusts
SC / RC to transfer assets acquired to the Trust at the
price at which acquired from the originator
The trusteeship vests with SC / RC only
SC / RC to formulate a policy for issue of SRs, to be
approved by BOD
SRs transferable only in favour of QIBs
Disclosures to be made in the offer document relating
to issuer of SRs, terms of offer, rating

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Issues - Retail Assets


Difficult to sell on account of peculiar features
Numerous loans
Servicing issues
Collection issues
Diversification
Use historical behaviour, Cherry picking

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Issues in Securitisation

Offshore securitisation
Permit FIIs to invest in SRs ?
True Sale ?
Originating institution investing in SRs / PTCs
Sale of PAs to SCs / RCs
Securitisation outside the Act

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Guidelines on Purchase / Sale of NPAs


Issued on July 13, 2005
Applicable to banks / FIs / NBFCs
Includes accounts under multiple / consortium arrangement if classified
as NPA by selling bank
Purchase / Sale
As per Board mandated policy
Only on without Recourse basis
Should not enjoy any credit enhancements / liquidity facilities in any
manner from the seller
Only on cash basis
The estimated cash flows are normally expected to be realised within
3 years and not less than 5% of the cash flows in each half year
Should be NPA for atleast 2 years in the books of the selling bank
Purchasing bank should hold the asset for atleast 15 months before sale

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Guidelines.(Contd.)
Staff Accountability should continue to be examined
Standard Asset for 90 days in the books of the purchaser. Existing
classification of the same obligor need not be re-examined
If guidelines not completely adhered to, the asset status would be
carried forward to the books of the purchaser
Any restructuring / rescheduling / rephasing of repayment schedule
/ cash flow of the NPFA by the purchaser will render the account as
NPA
Sale below NBV Debit to P&L A/c.
Sale more than NBV Excess provisions not to be reversed
Recoveries adjusted first against acquisition cost and then to profit
Compliance with exposure norms required.
100% RW for Capital Adequacy
Sufficient disclosure required in the Notes to Accounts
Submit all relevant reports to RBI and CIBIL
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The China Experience


Huarong AMC sold NPLs worth USD 1.3 bn in
Nov 2001 purchased from the Industrial and
Commercial Bank of China (total assets USD 500
bn)
International investors Morgan Stanley,
Lehman Brothers, Salmon Smith Barney and
KTH Capital Management
Innovative structuring : Initial investment of
USD 120 mn (9% of asset value); recoveries in
excess of initial Investment would be shared
equally between Huarong and investors
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Draft Guidelines on Securitisation of


Standard Assets
Issued on April 4, 2005 Yet to be finalised
2 stage approach
Pooling & transferring of assets to a bankruptcy
remote SPV
Repackaging & selling the security interests to third
party investors
Sale to be true sale illustrative criteria included
Arms length relationship between originator & SPV
PTCs to be independently rated by an ECAI updated
atleast every 6 months
Includes banks, FIs and NBFCs

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Draft Guidelines . (Contd.)


No recourse to originator.
Originator cannot repurchase except where
residual value falls to less than 10% of original
amount sold to the SPV
Originator can provide certain services (like credit
enhancement, underwriting, hedging, liquidity support,
asset-servicing, etc.) would not violate true sale
SPV can pass on surplus income to originator would
not violate true sale
Legal opinion to be obtained by originating banks /
service providers signifying true sale
SPV not to have any formal recourse to the originator
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Draft Guidelines . (Contd.)


Originator should not purchase the PTCs issued by the SPV which are
backed by its own assets sold. However, originator can purchase
senior-most tranche of the securities at market value, for
investment purposes
such purchases should not exceed 5% of the original amount of
issue or 10% of total investment in non-SLR securities, whichever is
lower
the issue should be atleast investment grade
Any reschedulement / renegotiation / restructuring effected after sale
to SPV should be with express consent of investors / service providers /
credit enhancement providers
Originating banks not to hold substantial interest in the SPV (Rs. 5
lakh in equity or 10% of capital of the trustee coy., whichever is less)
Trustee coy. not to resemble in name or indicate any relationship with
the originator
Trustee coy. can perform only trusteeship functions in relation to SPV
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Draft Guidelines . (Contd.)


PTCs should be compulsorily rated by a rating agency
registered with SEBI updated atleast every 6 months
SPV should provide sufficient disclosures
Credit enhancement in the form of guarantees off B/S item
with 100% conversion factor
First Loss Facility reduced from the capital
Second Loss Facility reduced from the capital
Liquidity facility repaid within 90 days, else to be fully
provided. To the extent drawn, 100% RW and to the extent
not drawn, 100% conversion factor
Capital charge for credit & market risk for banks / FIs
investing in PTCs governed by extant RBI guidelines
Valuation of PTCs As applicable to non-SLR securities
Exposure norms to be adhered to by investors if individual
obligors constitute 5% or Rs. 5 crore, whichever is lower
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Any Questions ??

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Thank you

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