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Amity Business School

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Securitization of debt

1.What is Securitization

It is a technique by which a long term,non-negotiable and high valued

financial assets like hire purchase is converted into securities of small

values which can be tradable in the market just like shares.

It is a process of removing long term assets from the balance sheet of a

leading financial institution and replacing them with liquid cash through

the issue of securities against them.


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Under securitization , a financial institution pools its liquid,non-negotiable

and long term assets, creates securities against them, gets them rated and sells

them to investors. It is an ongoing process in the sense that assets are

converted into securities, securities into cash, cash into assets and assets into

securities and so on.

Structural Securities Vs Conventional Securities

Securitization is basically a structural financial transaction.At this stage, one

should not confuse such structural securities with conventional securities like

bonds, debentures etc. They differ from each other in the following respects.

Source Of repayment: In the case of conventional securities, the primary

source of repayment is the earning power and cash flow of the issuing

company. But, under securitization, the issuing company is completely free

from the botheration since the burden of repayment is shifted to a pool of

assets or to a third part


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Structure: Under securitization, the securities may be structured in such a way soas to achieve a desired level of risk and a desired level of rating depending upon the

type and the amount of assets pooled. Such a choice is not available in the case of

conventional securities.

Nature : In fact , these structured securities are basically derivates of the traditional

debt instruments.Of course, the credit standing of these securities is well supported

by a pool of assets or by a guarantee or by both.

Securitization Vs Factoring

The main differences are:

(1)Factoring is mainly associated with the assets(both debts and receivables) of

manufacturing and trading companies whereas securitization is mainly associatedwith the assets of financial companies.

(2)Factoring mainly deals with trade debts and trade receivables of clients.On the other

hand, securitization deals with loans and receivables arising out of loans like hire

purchase finance receivables, receivables from government departments etc.


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(3)In the case of factoring, the trade debt and receivables in question are short-

term in nature whereas they are medium term or long-term in nature in

the case of securitization.

(4)The question of issuing securities against debts does not arise at all in the

case of factoring whereas it forms the very basis of securitization.

(5)The factor himself takes up the collective work whereas it can be done

either by the originator or by a separate servicing agency under

securitization.

(6)Under factoring , the entire credit risk is passed on to the factor. But under

securitization , a part of the credit risk can be absorbed by the originator

by transferring the assets at a discount.


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Modus Operandi

For the operational mechanics of securitization , the following parties arerequired:

The originator

A special purpose vehicle(SPV) or a trust

A merchant or investment banker

A credit rating Agency

A servicing agent- receiving and paying agent (RPA) The original borrowers or obligators

The prospective investors , i.e. the buyers of securities

The various stages involved in the working of securitization are as follows:

(1)Identification stage/process

(2)Transfer stage/process(3)Issue stage/process

(4)Redemption stage/process

(5)Credit Rating stage/process


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Structure for securitization / type of securities

(1)Pass through and pay through certificates.(2)Preferred stock certificates

(3)Asset based commercial papers

Other types

(i) Interest only certificates

(ii) Principal only certificates

SECURITIZABLE ASSETS

(i)Term loans to financially reputed companies

(ii)Receivables from government departments and companies

(iii)Credit card receivables(iv)Hire purchase loans like vehicle loans

(v)Lease finance

(vii)Mortgage loans etc


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BENEFITS OF SECURITIZATION

(i)Additional source of fund

(ii)Greater profitability

(iii)Enhancement of capital adequacy ratio

(iv)Spreading of credit risk

(v)Lower cost of funding(vi)Provision of multiple instruments

(vii)Higher rate of return

(viii)Prevention of idle capital

(ix)Better than traditional instruments

(x)Other Benefits


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Securitization and banks

(i) Innovative and low cost of source of fund

(ii) Better capital adequacy norms

(iii) Creation of more credit

(iv) Increased profitability

(v) Tool for Asset-liability management and risk management

Conditions for Successful Securitization

(i) Selection of assets to be securitized requires utmost care,The assetsshould be ranked and selected on the basis of least losses and to providefor maximum protection to the investor

(ii) The credit rating is an integral part of securitzation. Hence, credit ratingmust be done by credit rating agencies on a scientific basis and theratings should be unquestionable. Credit rating agencies should take intoaccount the various types of risk such as credit risk, interst risk, liquidityrisk etc along with other usual factors


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(iii) The SPV should be a separate organization from the originator.It should

be completely insulated from the parent corporate entity so that SPV couldbe protected from the danger of bankruptcy.

(iv)The pass through certificates of any other similar instruments arising out ofsecuritization must be listed in stock exchanges so that they may be readilyacceptable to investors. It would provide instant liquidity and moreover, itsprice could also be easily ascertained.

(v)Alternatively , it is also advisable to provide two way quotations forfacilitating the buying and selling of the pass through certificates in themarket as in the case of mutual fund units.

(vi)There must be standardized loan documentation for similar loans so thatthere may be uniformity between different financial institutions. It mustcarry a right to assign debts to third parties , so that , it could be sold ortransferred to the SPV.


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(vii)There should be a proper accounting treatment for the various transactions

involved in asset securitization . Suitable accounting norms for therecognition of the trust created for securitized debt should be evolved. Theaccounting system should provide for the removal of the securitized assetsfrom the balance sheet of the originator. Only then, the real benefit will goto the originator

(viii)Above all, there should be proper and adequate guidelines given by theregulatory authorities dealing with the various aspects of the process ofsecuritization

New Guidelines on Securitization

RBI has issued guidelines allowing commercial banks to finance special

purpose vehicles (SPVs) which have been forward to transfer securitizedassets separated from them

(i)All banks, term lending institutions and NBFCs have to securitize onlystandard assets.

(ii)Banks can finance SPVs which are engaged in transferring seuritized assets


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(iii)While financing SPVs, an independent party, other than the originators (banks)

group entities, should provide 25% of the liquidating facility. It means that everybank should locate a third party for financing SPVs.

(iv)The liquidity facility provided by banks should not be available for :

(a)Meeting recurring expenses of securitization

(b)Funding acquisition of additional assets by SPVs

(c)Funding the financial scheduled repayment of investors

(d)Funding breach of warranties

Causes for the unpopularity of securitization in India

(i)New concept

(ii)Heavy stamp duty and registration fees

(iii)Cumbersome transfer procedures

(iv)Difficulty in assignment of debts

(v)Absence of standardized loan documentation

(vi)Inadequate credit rating facilities

(vii)Absence of proper accounting procedures

(viii)Absence of proper guidelines


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Future for Securitization in India

(i) With the liberalization of financial markets, there is bound to be moredemand for capital

(ii) There has been an explosive growth of capital market and a vastincrease in the investor base in recent times

(iii) The entry of newer financial intermediaries like mutual funds, money

market , pension funds etc. has paved the way for floating debtinstruments easily in the market

(iv) Debt instruments have become popular in recent times since corporatecustomers are not willing to take recourse to the equity route as a majorsource of financing their projects

(v) There is a proposal to establish Asset Reconstruction Fund as per the

Narsimhan Committee recommendations for the purpose ofsecuritization of non-performing assets

(vi) Since the financial institutions and banks have to follow the capitaladequacy norms as recommended by the Narsimhan Committee, theyhave to necessarily go for securitization.


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There is much scope for securitization in respect of loans lender:

Mortgage

Housing loans

Other term loans

Credit and Receivables

In the case of non-banking financial companies also, lease receivables andvehicle loans could easily be securitized .With nearly Rs 70,000 crore

outstanding corporate debts of financial institutions , at least Rs 50,000

crore could be securitized and thereby financial institutions could raise their

liquidity for greater profitability.

On the whole the economy would be developed at a faster rate them what it

is, if securitization becomes a popular technique of financing.


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The securitization and reconstruction of financial assets

and enforcement of security interest (SARFAESI)

Chronology of action points/check list

1. Proper scrutiny and identification of eligible NPA accounts

2. Permission of competent authority to issue notice (Format A)

3. Issue of demand notice (60 days period)- Format B or C+D

4. Disposal of reply/objections of the party to the demand notice bypreparing suitable reply by applying mind. Approval of draft replyby law officer/retainer advocate

5. Taking possession and issue of possession notice Format M(for immovable). Incase of movable secured assets, panchnama(format K) shall be drawn and signed by witnesses followed bypreparing inventory (format L) of movable assets taken

possession(a) Approach district magistrate/Chief Metropolitan Magistrate if

resistance from borrower /owner of property is anticipated (FormatJ)

(b) Safe custody and insurance of secured assets taken possession


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(c) Valuation by the approved valuer under the Actif sale of securities is affected through publicauction/inviting tenders

(d) If patty approaches DRT within 45 days oftaking possession, steps shall be taken to getthe appeal disposed off by DRT. Incase ofadverse orders of DRT move to DRAT

(e) If party moves High court, banker may requestHigh court for vacation of stay or to direct thearty for settlement


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6. Issue of 30 days sale Notice (after 15 days of issuing possession notice)-Format N

(a) Actual sale after 30 days of issuing sale notice

(b) Mode of sale anyone of the four modes permitted under the Act, viz,Public auction/inviting sealed tenders/private treaty/by obtainingquotations from the parties dealing in secured assets.

(c) Sale of properties may be effected by inviting sealed tenders or by publicauction (format O). If sale is by private treaty or by obtaining quotationsfrom the parties dealing in secured assets or otherwise interested inbuying such assets, consent of the borrower/owner of the property shallbe obtained

(d) Issue sale certificate (format P&Q)1

1. Approved valuers

2. Graded panel of enforcement agencies for different sized assets

3. Enforcement agencies

4. Segregation of assignments for valuation of assets and enforcement ofsecurity interest

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