Securitization in India

By, Prashant Sharma Kaushal Patel Yagesh Rathi

What is securitization
It is a technique by which identified receivables and other financial assets can be packaged into transferable securities and sold to investors

Benefits: The process can turn ordinary liquid assets into reasonable liquid instruments It creates instruments of high credit quality out of debt of low quality.

Risks involved

Characteristics of Indian Securitized markets

The investor base is limited, comprising mutual funds ,insurance companies and a few private sector banks Most investments in securitized paper are made on a hold to maturity basis. Pass/Pay though certificates (PTCs) are still not classified as securities and hence are not tradable on the stock exchange No transaction has defaulted to date.

Types of securitization
Collateralized Loan/Bond Obligations Housing Mortgage Loans-HDFC MBS Credit Card Receivables Two Wheeler Receivables- Citi bank ABS Consumer Durable Receivables Trade Receivables- RIICO Aircraft Hire Purchase/Lease ReceivableRailways

Why to Securitize?
Primary Reason: liquidity/alternate sources of funding. India has serious infrastructure problems. Therefore, need for capital. Securitization makes it possible. MBS helps housing finance companies (HFCs) in churning their portfolios and focus on fresh asset origination. Secondary Reason: until February 2006, upfront booking of profits Priority Sector Lending Structured transactions can help premier corporate to obtain a superior pricing.

Direct Assignment
The direct assignment route facilitates the transfer of pool of loans qualifying as advances to priority sector directly from the Originators loan book to the Investors loan book instead of investment book. Banks fulfill their priority sector lending norms stipulated by Reserve Bank of India (RBI) by directly acquiring the pool of priority sector loan from Non Banking Finance Companies(NBFC),Housing Finance Companies (HFCs) through this route.

Direct Assignments
In general securitization structures, stamp duty is levied when the assets are sold to an SPV. With direct assignments, however, the transfer of the tangible security is only effected upon the breach of certain predefined performance triggers, thus avoiding this cost.

Financial products used in Securitization

PTC CMO MBS/ABS CDO: a) CLO b) CBO c) CSO CDS d) CDO^2 e) CDO^n

Current developments

Insurance v/s CDS

Insurance: - need to have reference entity - law of large no. -benefit: loss suffered CDS: - no need to reference entity -hedging -benefit: Agreed value

CDS in India
Required to be reported to a centralized trade reporting platform Need to have reference entity Only plain vanilla CDS is allowed

 Indian structured finance market in FY 2010 is Rs. 426 billion.

Issues facing Indian Securitized Market

Regulatory Issues: Stamp Duty: Payable on any security which seeks transfer of rights (Pay through securities). So transfer of receivables from Originator to SPV, Stamp Duty to be paid; And if securitized instrument is issued as debt instrument (Bond, debentures), Stamp duty applicable. Stamp charges in various states:
Gujarat, Maharashtra, Tamil Nadu, Karnataka reduced there rates from 4-10% to 0.1%. Other states still charge between 4-10%.

If Pass Through Securities; No stamp duties.

Issues (Contd)
Foreclosure laws:
Lack of effective foreclosure laws in India Existing law not lender friendly.
Therefore, increases risk of MBS by making it difficult to transfer property incase of default.

Taxation related issues:

Tax treatment on SPV (trust) unclear.
Currently, the investors (PTC and SR holders) pay tax on the income distributed by the SPV Trusts and on that basis the trustees make income pay outs to the PTC holders without any payment or withholding of tax.

Issues (Contd)
Legal Issues: Listing of PTCs over stock exchange. Difficult since PTC not considered as a security under the Securities Contract Regulation Act, 1956. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) allows QIBs to hold SRs but not to NBFCs unless they are notified by either by the central government as financial institutions.

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