asset securitisation - irm
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Securitisation has grown at ascorching pace internationally
2002 issuance of asset backed paper worldwide was closeto $ 700 billion
Compounded growth of more than 20% p.a. over thelast 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. creditderivatives
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Securitisation Some latest facts
Last year, German Govt. securitised its Russian loandues
UK Chancellor of Exchequer has proposed securitisingfuture aid flows to developing countries
From traditional receivables securitisation (on balancesheet items), future flow securitisation (of cash flows tobe generated in future) has been gaining momentum
In India, during 2004-05, Rs. 25,000 crore is theaggregate amount of assets securitised.
Volumes are bound to increase as growing asset classeslike HLs, car / vehicle loans are ideally suited forsecuritisation
CRISIL estimates Rs. 60000 crore securitisationpotential in 2003
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Retail Portfolio of Banks(As at end-March 2004)
Items AmountOutstanding (Rs.
crore)
Impaired Credit
as % of
outstanding loans
Net NPAs as % of
outstanding Loans
(i) Housing Loan 85436 1.9 1.4
(ii) Consumer
Durables6256 6.6 4.0
(iii) Credit Card
Receivables6167 6.3 2.4
(iv) Personal Loans
89537 2.6 1.6(v) Total Retail Loans
[(i) + (ii) + (iii) + (iv)]189041 2.5 1.6
(vi) Total Loans &
Advances880312 7.4 2.8
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Global Structured Finance Issuance by Year
($ Billions)
Worldwide Growth of the ABS market
Sources: JPMS, MCM CorporateWatch, and Bloomberg.
0
200
400
600
800
1000
1200
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 YTD
US Public US Private Europe Asia
$88
$124
$216
$287
$347
$414
$455
$580
$710
$792
$355
$1,137
3
$ Bn
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Securitisation The Concept
Is a process through which illiquid assets are transferredinto a more liquid form of assets and distributed to abroad 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 marketablesecurities is known as future-flows securitisation (FFS)
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ABS / CDOs / MBS
Some of the assets that can be securitised are loans likecar loans, housing loans (MBS), etc., and future cashflows like ticket sales, credit card payments, car rentalsor any other form of future receivables
Asset Backed Securities All assets are of a uniformnature (like car loans or housing loans)
Collateralised Debt Obligations Assets from adiversified pool
Mortgage Backed Securities Refers to housing loans
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Securitisation The Process
The lender (or originator) segregates loans / lease / receivables intopools 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 thesecuritisation process and providing funds to the originator
The SPV will act as an intermediary which divides the assets of theoriginator into asset-backed marketable securities. This could be with orwithout recourse
These securities issued by the SPV to the investors and are known aspass-through-certificates (PTCs)
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Securitisation The Process (Contd.)
Interest and principal payments on the loans, leases andreceivables in the underlying pool of assets are collectedby the servicer (who could also be the originator) andtransmitted to the investors
The difference between rate of interest payable by theobligor and return promised to the investor investing inPTCs 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 ofrecourse, a guarantee requiring the originator to coverlosses, a letter of credit from a bank, or overcollateralisation
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Typical transaction structure
Sale
Consideration
Sale of Debt
service receivables
Originator
Obligor
SPV
Investor
Loan/Receiv
able
Servicingofno
tes
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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 relatedlegal issues
Transaction
structuring
SPV
structuring
System due
diligence and
upgradation
Legal vetting
anddocumentation
Transaction
rating
SPV formation
and document
execution
Syndication
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Traditional commercial banking system
New system
Originate Underwrite Book Fund
Originate StructureCredit
EnhancePlace Trade Service
Thrift
Commercial
bank
Retail
securities
firm
Investment
bank
Retail
securities
firm
Insurance
company
Pension fund
Thrift
Insurance
company
Individual
Investment
bank
Commercial
bank
Investment
bankCommercial
bank
Specialist
payments
processor*This diagram taken from
Breaking Up the Bank, by Lowell L. Bryan
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Generic deal diagram
SPV Investors
Originator
Obligors
Credit
EnhancementProviders
Rating Agency
Structurer
Issue of securities
Collections Credit enhancement
Rating Subscription to securities
Cash flows
Servicing
of securities
Contracts
Ongoing cash flows
Initial cash flows
Servicer
Original
Loan
Sale of
asset
Purchase
consideration Arranger
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Why Securitisation
The Issuer / Originator
Ability to raise cheaper / longer / more finance
Receivables being replaced by cash thereby improving the liquidityposition
Ability to finance structures which would not get financed throughnormal 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 reducinginterest 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 toplain vanilla assets
Usually available at a relatively higher yield to plain vanilla assetof similar credit rating
Avenue for relatively risk-free investment
Credit enhancement provides an opportunity to acquire goodquality assets and to diversify their portfolios
Opportunity for matching cash flows and managing ALM since asecuritised instrument carries regular monthly cash flows andhas 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 themarket
Provides additional liquidity in the market
Facilitates unbundling, better allocation andmanagement 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 asthere will always be a certain percentage of obligors who won't pay upand this cannot be known in advance. Though various steps are taken totake 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 thesecuritised 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 toperform
Funding risks and constraints on liquidity may arise if assets designedto be securitised have been originated, but because of disturbances inthe market, the securities cannot be placed
Potential conflict of interest if a bank originates, sells, services andunderwrites the same issue of securities
B k T i i C ll
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Enacted in December 2002
Guidelines issued by RBI to SC / RCs along withguidance notes based on the recommendations of thetwo Working Groups set up by RBI Monitored byDNBS
Guidelines to banks / FIs on sale of assets to SC / RCsregistered under the Act and related issues Issued byDBOD
SARFAESI Act, 2002
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Securitisation as per SARFAESI Act
Acquisition of financial assets by any SC / RC fromany originator, whether by raising of funds by suchSC /RC from qualified institutional buyers by issue ofsecurity receipts representing undivided interest in
such financial assets or otherwise
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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 forCommencement or Carrying on Business enhanced OF to 15% ofassets acquired or to be acquired or Rs.100 crore, whichever is
less
B k T i i C ll
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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 financialassets and shall be able to pay periodical returns and redeem investmentsmade by QIBs on respective due date
(c) The directors of SC / RC have adequate professional experience in mattersrelated to finance, securitisation and reconstruction
(d) The BoD of SC / RC does not consist of more than half as nominees of anysponsor or associated in any manner with the sponsor or any of itssubsidiaries
(e) Any of its directors has not been convicted of any offence involving moralturpitude
(f) A sponsor, is not a holding company of the SC / RC, or, does not otherwisehold 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 guidelinesissued by RBI
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Registration related matters
Registered SC / RC can undertake both securitisationand 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 ofsecuritisation 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 FinancialAsset Acquisition Policy within 90 days of grant of CoRwhich 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 formulationof 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 andat a fair price in a well informed market
Transactions are executed at arms length in exercise ofdue diligence
Financial assets due from a single debtor to variousbanks / FIs to be considered
Acquisition not to include takeover of outstandingcommitments of the originator
Valuation to be done in scientific and objectivemanner, by internal or independent agencies
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Asset Reconstruction
SC / RC acquires assets from banks and FIs by issue ofdebenture or bond or any other security or by anagreement
SC / RC may undertake the following measures for thepurpose 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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Asset Classification
Assets to be treated as standard asset during theplanning period.
On expiry of plan period, after taking into account thedegree 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 wereacquired 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 ofdepartures 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 beapproved by BOD
SRs transferable only in favour of QIBs
Disclosures to be made in the offer document relatingto 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 classifiedas 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 anymanner from the seller
Only on cash basis
The estimated cash flows are normally expected to be realised within3 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. Existingclassification of the same obligor need not be re-examined
If guidelines not completely adhered to, the asset status would becarried 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 asNPA
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 inNov 2001 purchased from the Industrial andCommercial Bank of China (total assets USD 500bn)
International investors Morgan Stanley,Lehman Brothers, Salmon Smith Barney andKTH Capital Management
Innovative structuring : Initial investment ofUSD 120 mn (9% of asset value); recoveries inexcess of initial Investment would be sharedequally between Huarong and investors
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Draft Guidelines on Securitisation ofStandard Assets
Issued on April 4, 2005 Yet to be finalised
2 stage approach
Pooling & transferring of assets to a bankruptcyremote SPV
Repackaging & selling the security interests to thirdparty investors
Sale to be true sale illustrative criteria included
Arms length relationship between originator & SPV
PTCs to be independently rated by an ECAI updatedatleast 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 originalamount sold to the SPV
Originator can provide certain services (like creditenhancement, 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 arebacked by its own assets sold. However, originator can purchase
senior-most tranche of the securities at market value, forinvestment purposes
such purchases should not exceed 5% of the original amount ofissue 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 saleto SPV should be with express consent of investors / service providers /credit enhancement providers
Originating banks not to hold substantial interest in the SPV (Rs. 5lakh in equity or 10% of capital of the trustee coy., whichever is less)
Trustee coy. not to resemble in name or indicate any relationship withthe 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 extentnot drawn, 100% conversion factor
Capital charge for credit & market risk for banks / FIsinvesting 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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a e s a g Co ege
Thank you