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INTRODUCTION OF SECURITIZATION

A lot has been written and spoken about securitization in recent times. Indeed, one has

been hearing about it in India since the early 1990s, but with increasing regularity in

recent times. This concept note is intended to place the concept of securitization in the

right perspective, and importantly, set aside some myths and misconceptions associated

with it.

The ‘deals’ that have been talked about are Citibank’s sale of its car loan portfolio,

among others. With only this much information provided on this deal, it may be

concluded that such transactions are only in the nature of refinancing arrangements,

since no new marketable securitization, in our meaning, is explained in the following

paragraph.

Consider the case of a limited company and its financing advantages over a partnership

firm. A partnership firm is based on relationships, which cumbersome to handle, and

whose changes in composition could affect the firm’s liquidity. In the case of limited

company, share is issued to each ‘partner’ and the company’s capital structure does not

change with a change in the composition of its ‘partner’. Shareholder come and goes as

they please. This is because the shareholder’s stake is concurrent with their holdings of

share certificates, which are transferable pieces of paper, called securities. Securitization

therefore is the process of converting relationship into transactions. The trend of

debentures and bonds replacing illiquid loans by a bank is also a step in the direction of

converting relationship into transactions.

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Securitization is an innovation of the home loan financing segment of banking, called

residential mortgage financiers. These organizations typically lend over a 20-year

period, and need to raise finance of sufficiently long tenors. A major asset they hold are

the receivables in respect of loans already granted. Thus, these receivables are sold in

order to garner receivable

for a whole new round of fresh loans. Therefore, the advantages of securitization are in

the forms of.

1) making illiquid receivable liquid

2) getting loans of long tenors, thereby withstanding the shocks that could come

from short term funding (asset-liability management or ALM) and

3) Lock on to a long-term, low-cost source of finance, enhancing their credit

planning efforts.

Apart from the stated advantages, securitization also in enhancing the Capital Reserve

Adequacy Ratio (CRAR) and reduces the overall cost of capital due to transfer of risk

off its balance sheet, as explained later. Thus, securitization involves financial

engineering with several associated credit derivatives.

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HISTORY OF SECURITIZATION

Securitization may be said to have originated in Denmark. Loans were granted when

bonds of an equal amount and tenor were sold. This is form of asset-liability matching,

resource management, and even the interest margins are protected. Therefore seems to

be sound policy. In Prussia, bonds backed by mortgage loan were issued by some banks,

the instrument, and a bond symbolizing the underlying cash flows called pfandbrief.

Interestingly, over its 200 years history, no pfandbriefs has ever been defaulted upon.

However, standardization and liquidity seem to pose a problem, otherwise tradability of

such instrument will be only in restricted markets.

Securitization in its modern form really took off in Chicago. Chicago is also a home to

many seminal developments in finance. Mortgage bankers would deploy their initial

capital in creating mortgages. Fresh borrowers would have to turn away. Chicago

mortgages banker struck upon the idea of selling the loan portfolios to larger mortgages

banker. The largest mortgage bankers carved of the stream of underlying receivables

into tradable denominations as in equity and bonds in order to attract investors and

facilitate trading in these bonds. Other innovation followed. First, the interest and

principle portions were separately traded. These are called STRIPS, the acronym for

Separately Traded Interest Only (IO) and principal only (PO) Segments. Other

innovation included the splitting up of the bonds to sort investors having an appetite for

varied lengths of time. The details are explained elsewhere in this paper. To sum up, the

underlying receivables were carved in a process known as slicing and dicing, analogous

to the beef cuts that were sold as a marketable commodity, as opposed to trading in the

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whole animal itself. Securitization instruments shorn of such innovations are known as

plain vanilla securitization instruments.

The concept of securitization is rapidly spreading in several countries in various stages

of development. From the Danish origins and the pfandbriefs, securitization has spread

and evolved in the US. Policy makers in several developing countries are keen that

securitization takes off, since these are capital deficit countries. Securitization in these

markets will strengthen lending agencies and improve their linkages with the capita

markets.

SECURITIZATION TRANSACTION PROCESS

The successful execution of a securitization depends on the investor’s uncontested right

to securitized cash flows. Hence, securitized loan need to be separated from the

originator of the loan. In order to achieve this separation, a securitization is structured as

a three-step frame work:

1. A pool of loan is sold to an intermediary by the originator of the loans. This

intermediary (called a special purpose vehicle or SPV) is usually incorporated

as trust. The SPV is an entity formed for the specific purpose of transferring the

securitized loans out of the originator’s balance sheet, and does not carry out

any other business.

2. The SPV issues securities, backed by the loan, and by the payment streams

associated with these loans. These securities are purchase by investors. The

proceeds from the sale of the securitized are paid to the originator as a purchase

consideration for the loan receivables.

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3. The cash flows generated by the loans over a period of time are used to repay

investors. There could also be some credit support built into the transaction to

protest investors against possible losses in the pool. However, the investors will

typically have no recourse to the originator.

Diagrammatic representation of a securitization transaction

Borrowers Credit Support(Given by the originator or

third party)

SPV(Trust managed by

the trust)

InvestorsOriginator

(Owner of the assets)

Collection account(Operated by the trusty)

InstallmentPayment

Payment from borrower deposit from originator

Transfer/sellsloans

Issues PTC

Consideration

Payment made to investors

Loans(Assets)

Consideration

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PARTIES INVOLVED IN SECURITIZATION TRANSACTION

Originator: The originator is the original lender and the seller of the

receivables. Typically, the originator is a Bank, a Non Banking Finance

Company (NBFC), or a Housing Finance Company (HFC). Some of the

larger originator in India includes ICICI Bank, HDFC Bank and

Citigroup.

Seller: The seller pools the assets in order to securitize them. Usually,

the originator and the seller are the same but in some cases originator sell

their loans to the other companies that securities them.

Obligors/borrowers: The borrower is the counter party to whom the

originator makes the loan. The payments made by borrowers are the

sources of cash flows used for making investor payments.

Issuer: The issuer in a securitization deal is the special purpose vehicle

(SPV) which is typical set up as a trust. The trust issues securities which

investors subscribe to.

Investors: Investors are the purchase of the securities. Banks, Financial

Institution, NBFC and Mutual Fund are the main investors in securitized

paper.

Service: The service collects the periodic installments due from

individual borrowers in the pool, make s payouts to investors, and

follows up on delinquent accounts. The service also furnishes periodic

information to the rating agency and the trustee on pool performance.

There is a service fee payable to the service. In most cases, the originator

acts as the service.

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Trustee: Trustees are normally reputed Banks, Financial Institutions or

independent trust companies set up for the purpose of settling trusts.

Trustees oversee the performance of the transaction till maturity and are

vested with necessary powers to protest investor’s interests.

Arrangers: These are Investment banks responsible for structuring the

securities to be issued, and liasoning with other parties such as investors,

credit enhancers and rating agencies to successfully execute the

securitization transaction.

Rating agencies: Independent rating agencies analyze the risks

associated with a securitization transaction and assign a credit rating to

the instrument issued.

VARIOUS STAGES INVOLVED IN WORKING OF SECURITIZATION

Identification Process: The lending financial institution either a bank or any

other institution for that matter which decides to go in for securitization of its

assets is called the ‘originator’. The originator might have got assets comprising

of a variety of receivables like commercial mortgages, lease receivables, hire

purchase receivables etc. The originator has to pick up a pool of assets of

homogeneous nature, considering the maturities, interest rates involved frequency

of repayments and marketability. This process of selecting a pool of loans and

receivable from the asset portfolios for securitization is called ‘identification

processes.

Transfer Process: After the identification process is over the selected pool of

assets are then ‘passed through’ to another institution which is ready to help the

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originator to convert those pools of assets onto securities. This institution is called

special purpose vehicle (SPV) or the trust. The pass through transaction between

the originator and the SPV is either by way of outright sale basis. This process of

passing through the selected pool of assets by the originator to a SPV is called

transfer process and once this transfer process is over the assets are removed from

the balance sheet of the originator.

Issue Process: After this process is over the SPV takes up the onerous task of

converting these assets to various type of different maturities. On this basis SPV

will issue securities to investors. The SPV actually splits the packages into

individual securities of smaller values and they are sold to the investing public.

The SPV gets itself reimbursed out of the sale proceeds. The securities issued by

the SPV are called by different names like ‘Pay through Certificates’, ‘Pass

through Certificates’. Interest only Certificate, Principal only Certificate. The

securities are structured in such a way that the maturity of these securities may

synchronies with the maturity of the securitized loans or receivables.

Redemption Process: The redemption and payments of interest on these

securities are facilitated by the collections by the SPV from the securitized assets.

The task of collection of dues is generally entrusted to the originator or a special

service agent can be appointed for this purpose. This agency paid certain

commission for the collection service rendered. The servicing agent is responsible

for collecting the principal and interest payments on assets pooled when due and

he must pay a special attention to delinquent accounts. Usually the originator is

appointed as the service. Thus under securitization the role of the originator gets

reduced to that of the collection agent on behalf of SPV in case he is appointed as

a collection agent. A pass through certificate may be either ‘with recourse’ to the

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originator or ‘without recourse’. The usual practice is to make it ‘without

recourse’. Hence the holder of a pass through certificate has to look the SPV for

payment of the principal and interest on the certificate held by him. Thus the main

task of the SPV is to structure the deal raise proceeds by issuing pass through

certificates and arrange for payment of interest and principal to the investors.

Credit Rating Process: The passed through certificate have to be publicly

issued, they required credit rating by a good credit rating agency so that they

become more attractive and easily acceptable. Hence these certificates are rated at

least by one credit rating agency eve of the securitization. The issues could also

be guaranteed by external guarantor institutions like merchant bankers which

would enhance the credit worthiness of the certificates and would be readily

acceptable to investors. Of course this rating guarantee provides to the investor

with regard to the timely payment of principal and interest by the SPV.

VARIOUS CATEGORIES OF SECURITIZATION INSTRUMENT:

Asset Backed Securities (ABS) are instruments backed by receivable from financial

assets like vehicle loans, credit cards, personal loans and other consumer loan but

excluding receivables from housing loans. Mortgage Backed Securities (MBS) are the

instruments backed by receivables from housing loans. Collateralised Debt obligation

(CDO) is instruments backed by various types of debt including corporate loans or

bonds.

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Different types of securities:

1. Pass through and pay through certificates: In case of pass through

certificates payments to investors depend upon the cash flow from the assets

backing such certificates. In other words as and when cash (principal and interest)

is received from the original borrower by the SPV it is passed on to the holders of

certificates at regular intervals and the entire principal is returned with the

retirement of the assets packed in the pool. Thus, pass through have a single

maturity structure and the tenure of these certificates is matched with the life of

the securitized assets.

On the other hand pay through certificates has a

multiple maturity structure depending upon the maturity pattern of underlying

assets. Thus, two or three different types of securities with different maturity

patterns like short term, medium term and long term can be issued. The greatest

advantage is that they can be issued depending upon the investor’s demand for

varying maturity pattern. This type of is more attractive from the investor’s point

of view because the yield is often inbuilt in the price of the securities themselves

i.e. they are offer at a discount to face value as in the casa of deep-discount bonds

2. .Preferred stock certificate: Preferred stocks are instruments issued by a

subsidiary company against the trade debts and consumer receivables of its

parent company. In other words subsidiary companies buy the trade debts and

receivables of parent companies to enjoy liquidity. Thus trade debts can also

be securitized through the issue of preferred stocks. Generally these stocks are

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backed by guarantees given by highly rated merchant banks and hence they

are also attractive from the investor’s point of view. These instruments are

mostly short term in nature.

3. Asset-based commercial papers: This type of structure is mostly prevalent

in mortgage backed securities. Under this the SPV purchases portfolio of

mortgages from different sources (various lending institution) and they are

combined into a single group on the basis of interest rate, maturity dates and

underlying collaterals. They are then transferred to a Trust which in turn

issued mortgage backed certificate to the investors. These certificates are

issued against the combined principal value of the mortgages and they are also

short term instrument. Each certificate is entitled to participate in the cash

flow from underlying mortgages to his investments in the certificates.

Other type

Apart from the above there is also other type of certificate namely

i. Interest only certificates

ii. Principal only certificate.

In the case of interest holding certificate payments are made to investors only

from the interest incomes earned from the assets securitized. As the very name

suggest payment are made to the investors only from the repayment of

principal by the original borrower. In the case of principal only certificates

these certificate enables speculative dealings since the speculators know well

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that the interest rate movements would affect the bond value immediately. For

instance the principal only certificate would increase the value when interest

rate go down and because of these it becomes advantageous to repay the

existing debts and resort to fresh borrowing at lower cost. This early

redemption of securities would benefit the investors to a greater extent.

Similarly when the interest rate goes up, interest holding certificate holders

stand to gain since more interest is available from the underlying assets. One

cannot exactly predict the future movements of interest and hence these

certificates give much scope for speculators to play the game.

Need of Special Purpose Vehicle (SPV) in securitization:

The investor’s return in securitization transaction should depend purely on the

securitized cash flows and should be insulated from the financial risks

associated with the originator. Hence, it is necessary to have legal separation of

these assets from the estate of the originator. This is achieved by means of sale

of the assets to SPV. The SPV is set up solely for the purpose of the

securitization transaction and does not engage in any other business activity.

The SPV does not borrow or lend any money and hence cannot go bankrupt.

Most SPV follow a set of pre-determined activities clearly identified by the

securitization documents. Without the flexibility of taking any management

decision. This mode of structuring the transaction ensures that securitized assets

become bankruptcy remote from the originator.

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Securitized instruments v/s Debentures v/s factoring

An investor in a debenture issued by a bank or a loan originator will be on official

liquidator’s list in the event of its winding up. However, a PTC holder has access to the

obligor’s asset, and is hence saved from winding up. Liquidation or bankruptcy

proceedings. PTC therefore, is understood to be bankruptcy-remote.

Secondly, credit perception of PTC is based on the strength of the obligor and not the

balance sheet of the originator. This is the feature that enhances the credit rating of the

PTC, which is not the case in Debentures, which is based on the originator’s own

balance sheet.

For the above reasons, coupon rates on securitized instruments are lower than coupon

rates on plain vanilla bonds.

Thirdly, securitization can result in the return of a fraction of principal loan along with

interest, as part of each installment. In the case of debentures and other bonds, the initial

stream of payments is in respect of interest only, with entire repayment in bullet form on

a specified maturity date. At period intervals, say monthly installments, every rupee of

the installment amount is adjusted against a fraction of principal and balance against

interest.

There have also been interesting comparisons between securitization and factoring

services. The similarities are in the refinancing aspect, as both the processes result in

exchange of receivables for cash inflows. There are however, significant differences.

Factoring is predominantly a service, collection mechanism. With financing (in the case

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of advance factoring). Securitization is essentially a financing mechanism, with several

other powerful financial engineering implications. Additionally, in factoring, no

marketable financial instrument comes into existence. To sum up, it may be stated that

an organization engaged in advance factoring may resort to securitization as a source of

finance!

Securitization different from traditional debt instruments:

Securitized instrument have some distinct features which distinguish them from

traditional debt:

Isolation of pool of assets: In the securitization the securitized assets are

separated from the original lender through a sale to a separated legal entity

called as a Special Purpose Vehicle (SPV) which acts as an intermediary.

Claims against a pool of assets: Traditional debt instrument represent claim

against the company that issue the debt. Investors rely entirely on the borrower

company’s credit quality for repayment of their debt. In securitization

transaction, investor payout is made from collection of securitized assets and

the instruments are thus claims on the assets securitized. Investor does not

typically recourse to the originator.

Credit enhancement: Credit enhancement is an additional source of funds

that can be used if collections on the assets are insufficient to pay investors

their dues in full. Credit enhancement thus support the credit quality of the

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securitized instrument and enable it to achieve a higher credit rating than the

pool of assets on its own, in many cases the rating would also be higher than

that of the originator. This is not possible in conventional debt.

Payment Mechanisms: securitized instrument typically incorporate structural

features to ensure that scheduled payment reach investor in a timely manner.

Operational and administrative requirements: as the SPV is the only shell

entity the administration of the pools of securitized loans involves multiple

parties performing various functions. These functions include collection,

accounting, and loan servicing, legal compliances etc which need to be

performed through out the life of transaction.

Economic benefit of securitization:

Securitization creates tangible economic benefits. These benefits are more visible

in US and other developed countries where securitization markets have matured

over the past two decades.

Market Efficiency: Through securitization process the companies holding

financial assets like loans have ready access to low cost sources of fund and can

reduce their dependence on financial intermediaries for their capital requirement.

This translates into lower interest cost the benefits of which are also passed to the

end consumers.

Specialisation: The classic bank/financial institution model of Origination-

Funding-Credit administration of loans has led to an unbundling of roles and

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greater specialization as various player can now concentrate on their core

function, be it origination, funding or credit administration.

Streamlined system and process: Securitization demand high levels of data

transparency and requires robust system. This enhances the overall monitoring

and control of asset portfolios.

Why securitize? An originator’s perspective.

Efficient Financing: In securitization it is possible to achieve much higher

target rating for instrument than the originator’s credit raring by providing

credit rating enhancements for the transaction. Thus the borrower can

obtain fund at lower interest rates applicable to highly rated instrument and

gain a pricing advantage.

Off balance sheet funding: For accounting purposes securitization is

treated as a sale of assets and not as financing. Therefore the originator

does not record the transaction as a liability on its balance sheet. Such off

balance sheet raise funds without increasing the originator’s or debt equity

ratio.

Lower capital requirement: Securitization enables banks and financial

institutions to meet regulatory capital adequacy norms by transferring

assets and their associated risks off the balance sheet. The capital support

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the assets is released and the proceeds from securitization can be used for

further growth and investment.

Liquidity management: Tenor mismatch due to long term assets funded

by short term liabilities can be rectified by securitization as long term

assets are converted into cash. Thus securitization is a tool of asset liability

management.

Improvement in financial ratios: Since securitization help in undertaking

larger transaction volumes with the same capital profitability and return on

investment ratios increase post securitization.

Profit on sale: Securitization helps in up-fronting profits. This would

otherwise accrue over the tenor of the loans. Profits arise from the spread is

booked as profit leading to increased earnings in the year of securitization.

Why invest? An investor’s perspective.

Securitization instrument offer investors an attractive investment proposition

since they combine above average yields with a strong credit performance.

Potential investors in this instrument in India should consider the following

factors:

Size of investment opportunity: The securitization market in India is

growing leap and bound. In the financial year 2004-05, securitization

volumes are expected to reach Rs 250billion with 15% of retail loans

(excluding MBS) currently funded through securitization.

Safety Features: Securitization offers investors a diversification of

risks, since the exposure is to a pool of assets. Most issuances are

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highly rated by independent credit rating agency and have credit

support built into the transactions. Investors get the benefit of the

payment structure closely monitored by an independent trustee which

may not always be in the case of traditional debt instruments.

Performance track record: Securitization instruments have

demonstrated consistently good performance with no downgrades or

defaults on any instrument in India.

Yields: Yields of ABS/MBS/CDO are higher than those of other debt

instrument with comparable rating. Spreads of securitized instrument

are typically in the range of 50-100 basis points over comparable AAA

corporate bonds.

Flexibility: An important advantage of securitization is the flexibility

to tailor the instrument to meet the investor’s risk and tenor appetite.

o Durations can range from few months to many years.

o Repayment are usually made on monthly basis but can be

structured on a quarterly or semi annually basis.

o Interest rate can be fixed or floating depending upon investor

preferences.

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UNDERSTANDING RISKS IN SECURITIZATION

Risk investors face in securitization:

Investors in securitized instruments can take advantage of the benefits that these

instrument offer, however they also need to be aware of the inherent risks in these

transaction. These risks classified into:

Asset pool risks which arise due to the unpredictable behavior of the

underlying borrowers. The payment behavior of underlying borrowers can

be estimated with a reasonable degree of accuracy based on historical

data.

Legal risks due to lack of judicial precedence on securitization legislation

and regulation.

Counter party risk arise as a securitization transaction involved multiple

parties throughout the tenure of the instrument. The investor’s returns can

be impacted by non-performance or bankruptcy of any of these

counterparties.

Investment risks like all other investment securitized instruments are

subject to market related risks.

Investors are protected against these risks by means of structural features and

credit enhancement which enable the instrument to achieve high credit ratings.

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Assets pool risk in a securitization and mitigation:

Assets pool risks are classified into credit risks and prepayment risks.

Credit risks: Investors have a direct exposure to the repayment ability of the

underlying borrowers whose loans have been securitized. If borrower default on

payment of installments or make delay payment collection will be inadequate to

scheduled investors payouts. Thus timely investor payments will depend on the

credit quality of the pool borrower.

Mitigation: Credit enhancement provide for PTC is sizes to cover the expected

levels of payment default and delays. In case there is short falls in the collection

the credit enhancement is used to make timely payment to the investors.

However, in the event of short falls over and above credit enhancement levels

investors will incur losses on their investment.

Risk of prepayment: Investors face the risks that underlying borrowers may

prepay all or part of the principal outstanding of their loans. When prepayment

occurs they are passed on to the investor (unless the instrument structure

provides for a separate class of PTC to absorb prepayments). This can affect

investor in two ways:

o Reinvestment risk: If there are heavy prepayment in the pool the average

tenure of the instrument reduces resulting in reinvestment risk for the

investor.

o Prepayment loss: If the investor has paid an additional consideration to

receive excess interest spreads generated by the pool the investor principal

outstanding is greater than the pool principal outstanding. Hence when the

contract is prepaid this excess interest spread payable to the investor from

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that contract is lost. Hence prepayments can result in the shortfalls in

payments.

Mitigation: Reinvestment risks can be mitigated by carving out a separate class

of PTC from pool cash flows to absorb prepayments occurring in the pool. This

class of PTC is called a ‘prepayment strip’ and commonly found in securitized

instruments. Prepayment loss is mitigated as the credit enhancement is sized to

cover such losses. However in case of excessive prepayment losses greater than

the credit enhancement amount will be borne by the investor.

Property/asset price risk: Assets backing securitized instruments may be

prepossessed and sold post securitization. The proceeds and loss on sale depends

upon market values of the assets, which fluctuate.

LEGAL ISSUES WITH SECURITIZATION

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Documents that are used in securitization transaction:

Following document is part of the securitization transaction and represents current

practice in the securitization market. Some or all of these would be used in any

securitization transaction.

Trust deed: This document settles a trust for the purpose of purchasing the

receivables. The right and duties of the trustee are spelt in this document.

Deed of assignment of receivables: This document evidences the transfer of

receivables to the trust for the consideration. It is made by the originator in the

favors of SPV.

Declaration of trust: The unilateral document prepaid by the originator,

where the originator acts as the SPV/trustee, declaring that it holds the

receivables in trust for the investors.

Information memorandum: The offer document that provides details of the

proposed securitization of receivables to the potential investors.

Service agreement: Outlines the terms and conditions of the securitization

transaction and the right and the duties involved. It also lays down the right

and duties of servicing agents.

Cash collateral agreement: Spells out the termed and conditions under which

the cash collateral and yield reserve can be utilized/released. This agreement is

executed between the seller/service and a designated bank where the cash

collateral will be maintained.

Power of attorney: This authorizes the trustee to execute acts and deeds with

regards to the securitization contracts, including the enforcement of security.

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Collection and payout account agreement: This document spells out the

operational details of the collection account.

Stamp duty impact securitization transaction:

Stamp duty can be described as a tax levied on all documents of a commercial

nature. Stamp duty is an important issue for securitization transaction executed in

India due to:

Serious consequences of stamp duty evasion: Inadequately stamp

documents attract an enormous penalty, sometimes as much as ten times

the deficiency in stamp duty paid. Documents that are inadequately

stamped are also not recognized in court as evidence and are therefore

unenforceable.

Bearing the cost of stamp duty: The general is that the person claiming

the benefit of a document should bear the stamp duty or any penalties/fines

levied on that document.

Differential role of stamp duty: All states in India are empowered to

determine their own stamp duties and these vary from state to state.

In most of the states sale of asset attracts high stamp duty, sometimes up to

12% of the value of the assets transferred. This result in prohibitive transaction

costs. Only the states of Maharashtra, Gujarat, Tamil Nadu, West Bengal,

Andhra Pradesh and Karnataka have enacted stamp duty law favorable to the

transfer of assets. Legal expert believe that a consequence of the differential

stamp duty is that if document executed in one state is taken into another state,

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the document is liable to be stamped in the second state if the stamp duty in

the latter is higher.

True sale of assets relevant in securitization:

True sale ensures that the sale of assets in a securitization is absolute and binding and

effectively removes the financial assets from the balance sheet of the originator. It is

relevant since the investor’s return in asset securitization depends purely on cash flows

from the securitized assets. A ‘true sale’ will ensure that the investor’s rights and

entitlements in respect of these cash flows are not affected in case of bankruptcy or

liquidity of the originator.

There is no statutory definition or judicial interpretation of true sale as yet in India.

However, the following issues are pertinent in evaluating a transaction for ‘true sale’:

Extent of recourse to and risk retained by the originator in the securitized

assets: Generally company is of the opinion that in cases where the originator

retains a high level of risk in the assets, the courts are likely to recognize the

transaction as a secured borrowing.

Options and obligations to repurchase assets: The presence of an option to

repurchase does not by itself negate true sale. However, company treats an

originator’s obligation to repurchase assets on account of deteriorating asset

quality as inconsistent with true sale.

Extent of control retained by the originator over the assets: Company will

acknowledge a transfer as a true sale only if the transferee gains unrestricted

rights to the assets.

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Company like CRISIL, CARE also bases its analysis of a securitization transaction

on professional opinion from an independent legal counsel, confirming that the

transfer of assets is consistent with a true sale.

NHB role in Mortgage Backed Securitization (MBS):

The National Housing Bank (NHB) is a regulatory body to promote and support

Indian housing finance companies (HFC and the housing portfolios of banks). NHB

has played a lead role in starting up MBS and developing a secondary mortgage in

India by:

Setting up Special Purpose Vehicle (SPV) for MBS and acting as a trustee to

the issuance on behalf of investors.

Acting as a guarantor and facilitating MBS transactions.

Acting as a refinancing arm for HFC by making loans and advances as well

as rendering financial assistance to scheduled banks and HFC.

Making continual efforts to generate awareness about residential MBS

among market participants.

Risk applicable on MBS investments for Banks:

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SECURITIZATION

To improve the flow of credit housing sector, RBI has liberalized the

prudential requirement on risk weight for housing finance by Banks.

Accordingly, Banks extending housing loan to individual against the mortgage

of residential housing properties will be permitted to assign risk weight of

75% instead of the earlier requirement of 100% provided certain condition are

met. However,

Loans against the security of commercial real estate will continue to attract

100% risk weight. Moreover, bank investments in MBS of residential assets of

HFC will also be eligible for risk of 75% for the purpose of capital adequacy,

subject to certain terms and condition.

The loans should be securitized under the ‘true sale’ of assets to the

SPV.

The loans to be securitized should be loans advanced to individuals for

acquiring/constructing residential houses, which should have been

mortgaged to HFC by way of exclusive first charge.

The loans to be securitized should be accorded an investment grade

credit rating by a credit rating agency at the time of the assignment of

SPV.

The securitized loans should be originated from housing finance

company/banks.

Can banks investment in PTC:

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SECURITIZATION

Banks can invest in PTC. The Reserve Bank of India (RBI) issued guidelines

in November 2003 prescribing prudential limits for banks on all non-SLR

investment, specifically for investments in unlisted securities. In December

2003, RBI clarified that investment in either security receipts issued by

securitization companies/reconstruction Company registered with RBI, or

Assets Backed Securities (ABS) and Mortgage Backed Security (MBS) which

are rated at or above the minimum investment grade will not be reckoned as

unlisted non-SLR securities for computing compliance with the prudential

limits prescribed in the above guidelines. Therefore there is no impact on the

ability of the banks to invest in PTC as issued currently in transaction. It is

expected that the PTC would soon be specifically notified as securities under

SCRA and hence get listed.

RATING PROCESS IN SECURITIZATION

27

SECURITIZATION

Rating scale employed by credit rating agency in securitization transaction:

Credit rating agency has developed a framework for rating the debt obligation of Indian

corporate supported credit enhancements. For example CRISIL ratings of structured

obligation (SO) factor the credit enhancement extended by an entity, which could be in

the form of guarantees, over collateral, cash etc. (SO) rating are based on the same scale

as CRISIL other rating (AAA through D for long term debt, and P1 through P5 for short

term debt). The rating indicates the degree of certainty regarding timely payment of

financial obligation on the instrument.

Provisional rating:

When any credit rating agency rates a securitized pool of assets, it initially assigns a

‘provisional rating’. The provisional rating assigned is valid for a period of 90 days,

before which the originator must comply with the following:

Submit copies of all executed transaction documents to credit rating agency.

Submit a letter from the trustee confirming that the transaction documents have

been executed to the trustee’s satisfaction.

Furnish representation and warranties as stipulated by credit rating agency.

Submit an auditor’s certificate where required.

Submit the required legal opinion from an independent counsel.

Upon receipt of the above documents, credit rating agency examines if the

documents are in line with the transaction structure as envisaged at the time of

assigning provisional rating. If the documentation and the other compliances are to

28

SECURITIZATION

credit rating agency satisfactions than agency issues a letter of compliance for the

transaction formalizing rating.

Rating process for securitization:

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SECURITIZATION

Mandate letter received from the client

Transaction details and structure communicated to rating company.

Company send its information requirement to the client specifying details of the information needed for the analysis. Based on information

made available, the rating team has detail managed meetings to understand the originator business, process, assets quality parameters,

pool characteristics etc.

Team put together a rating report based on its interactions and presents its report and recommendations to the rating committee.

A provisional rating is assigned to the transaction. If the client accepts this, Company issues a rating letter with the rationale for the rating

assigned

A compliance letter for the rating is issued once the final transaction documents, legal opinion and other compliance documents have been

received by Company legal analyst and compliance team.

Company does not end with the issue of the initial rating. Company has a dedicated surveillance team, which monitors the performance of the

securitized pool every month to ensure that it is line with the outstanding rating

Initial

Rating

Process

Post issue

Monitoring

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SECURITIZATION

Typical due diligence done at the time of rating:

Credit rating agency carries out a through due diligence for all rating, before and

after the provisional rating.

Originator due diligence: The due diligence of originator MIS and the risks

control mechanism give a fairly good idea of the originator assets portfolio

vis-à-vis industry benchmarks, and forms critical inputs in the stipulation of

the credit enhancement levels for transaction.

Pool due diligence: Agency check if all pool contracts adhere to stipulated

selection criteria. Auditor’s statement are obtained to ensures that all

information furnished to rating agency relating to the pool has been verified

and found to be correct and true.

Transaction structure: Rating agency analyses the structure for each

transaction to adequately assess any risks which investors might face. This is

extremely important as the structure is becoming more complex.

Legal due diligence: The legal team also checks the draft transaction

documents, to identify any legal issues pr legally untenable clauses. The basic

documentation examined is the trust deed, assignment agreement/deed of

assignment, service agreement and cash collateral agreement. The corporate

undertaking or guarantee is also examined where relevant.

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SECURITIZATION

32

Due diligence structure

Origination system

Credit appraisal and underwriting

Disbursement and post disbursal documentation

Collection and recovery mechanism

ManagementInformation

System(MIS)

RiskControl

Mechanism

SECURITIZATION

Surveillance process adopted by rating agency:

Rating agency believes it is of vital importance to monitor pool performance so

that it is in line with the outstanding rating. Surveillance is necessary because the

receivables from the pool of assets are used to service investors payouts. The

investor’s recourse is thus limited to these receivable, and to credit

enhancements, if any provided by the originator.

Additionally, complex structures have been introduced recent times in the

securitization market, with issuances incorporating staggered payouts

mechanisms, floating rate instruments and trigger based structures. These

complexities require close monitoring by the trustee and the rating agency to

ensures that the instruments adhere to the originally stipulated and appropriate

action is initiated at the right time in case of any deviation.

Rating agency has set up a dedicated surveillance team to monitor the

performance of rated pools. Transaction is monitored on a monthly basis and the

key parameter is tracked. This is done on the basis of monthly servicer reports

provided by servicer/trustees. The reports are checked for accuracy and

performance analysed. Thereafter, the team interacts with the concerned parties

to understand the reasons behind the trends, and the likely steps have been or

need to be undertaken to arrest adverse fluctuations in the pools performance.

A comprehensive review is under taken at least once a year, unless warranted

more frequently by deviations in the monitorables from rating agency estimates.

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SECURITIZATION

Key monitorables of rating agency surveillance process:

Collective performance: The collection performance is analysed in terms

of monthly collection ratio (MCR) and cumulative collection ratio

(CCR).The MCR gives the flow element of the pool collection

performance and acts as an early warning indicator. The CCR reflects the

stock element of the pool collection performance.

Delinquency level: Credit rating agency analysis the overdue levels in

terms of various delinquency buckets. This analysis provides an estimate

of the credit losses in the pool to date and gives an indicator of future

losses.

Counter party credit quality: Rating agency also monitors the credit

quality of the counter parties involved in the transaction. These include the

servicer, the trust, the retention account bank, the cash collateral bank or

guarantor and the swap counter party.

Credit support: The credit enhancement available indicates the level of

cushion in the transaction. This cushion is required to withstand relevant

stress levels for the corresponding rating category. This parameter rounds

off the overall analysis and ensures that the outstanding rating is current.

In addition the credit rating agency monitors other parameters such as

prepayment, collection efficiencies and collateral utilization.

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SECURITIZATION

Indian experience with securitization:

Securitization commenced in India with a car loan transaction originated by

Citibank in 1992. Since then, the market has grown rapidly, with India become

the third largest securitization market in Asia, after Japan and Korea. Proceeds

from Asset Backed Securitization (ABS) transaction account for close to 15% of

incremental disbursements in the Indian consumer finance market, underlining

the importance of securitization as a financing tool. Market sophistication has

also increased rapidly in 2004-05 with the advent of new asset classes and

structures.

Breaking new ground:

1992: First auto loan securitization was done by Citibank.

2000: First MBS was done by National Housing Bank.

2001: First offshore transaction backed by aircraft purchase receivable.

2004: First successful multi asset was done by ICICI Bank.

Size of the market: Rating agency estimates that over 330 transactions,

involving a cumulative volume of Rs 530 billion, have been placed in the market.

Issuance has grown exponentially with ABS volumes growing at a CAGR of

51% and MBS volumes growing at a CAGR of 65% since 2000.

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SECURITIZATION

Originator and investor in securitization market:

Securitization has gained popularity over the years as reflected in the increasing

number of originator entering in the market. Some key originator in the market

includes ICICI Bank, HDFC Bank, Citigroup, and Tata group.

The predominant investors in securitized instrument are mutual funds,

public sector bank, foreign bank, private sector banks and insurance company.

Asset classes securitized in India:

Assets Backed Securities Collateralized Loan Obligation

Cars Corporate bonds

Commercial vehicles Municipal bonds

Two wheelers W.C. & term loan facilities

Construction equipment Sales tax loan receivable

Aircraft purchase receivable Corporate loans

Personal loans Oil receivable

Utility vehicles Lease receivable

Used cars

Three vehicles Mortgage Backed Securities

Office equipment receivable Residential loans

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SECURITIZATION

Forms of Special Purpose Vehicle used in India market:

In India, an SPV is typically in the nature of trust. The trust is usually settled by

the third party who is appointed as the trustee, to manage the trust properties (the

securitized assets) and distribute the income from the same. The trustee is the

legal owner of the assets, whereas investor is entitled to all the benefit arising

from the trust properties. An SPV can also be formed by declaring trust over the

assets. In such cases, the originator holds the assets are transferred to the

investors, while the legal ownership of the assets continues to vest with the

originator in its capacity as the trustee.

Common structure used in the Indian market to securitise assets:

Structures have evolved in India based on investor risk, tenor preferences, and

issuer requirement.

Fully amortising structure: In India, we see fully amortising

instrument (i.e. principal is repaid to the investors along with the interest

over the tenor of the PTC). This is different from bullet structure, where

the entire principal is repaid at maturity. Fully amortising structure is

designed to closely reflect the full repayment of the underlying loans

through the interest and principal payment.

Par and premium structure: In par structure, the investor pays a

consideration equal to the principal outstanding (par value) of future

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SECURITIZATION

cash flows. In return the investor is entitled to receive scheduled

principal repayment from the pool of receivable along with a pre decide

rate of interest. Par structure also has an element of Excess Interest

Spread (EIS) generated if the yield on the pool is higher than the yield

on the PTC. The originator has the right to receive the EIS amount.

A premium structure is one where the investor pays a consideration greater than the

principal outstanding of future cash flows, for the additional right to receive EIS

arising from the securitized assets. Predominantly, par structure is used in MBS and

premium structure is used in ABS.

Senior subordinate structure: Cash flows from the securitized assets can be

carved into multiple classes of securities having different tenors and risk profiles.

The senior class is accorded the first claim on the cash flows from the pool,

whereas the subordinate class has a lower claim. Thus, the subordinate class is

‘first loss price’ and the support payment to the senior classes. Typically in India,

senior classes are highly rated instruments while subordinate classes are unrated

and retained by the originator.

Fixed and floating rate structures: PTC is issued at both fixed and floating

rates of interest. The motivation for fixed or floating rates depends on interest

rate trends in the economy. Investor preferences and other such parameters.

Recently there have been many issuances at floating rates, where the rates are

benchmarked to a designated index like the NSE, MIBOR. If underlying assets

are fixed rate loans, floating coupon rates introduce the element of interest rate

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SECURITIZATION

risk in the transaction. This risk can be mitigated by using an interest rate swap

with a swap provider who exchange rate payouts made by the trust for floating

rate payout to the investors.

Credit enhancement found in India:

The most common forms of credit enhancement found in the Indian market are listed

below. They are not mutually exclusive a combination of two or more forms of credit

support is often used.

Cash collateral: This is an external form of credit support. The originator or the

third party provides a predetermined amount of cash, which is put into the reserve

account. Withdrawals can be made from this account to off set losses on the

securitized assets. The cash collateral is held by the trustee in the favor of

investors.

Excess interest spread: This is an internal form of credit enhancement available

in transactions where the interest rate received on underlying loans is higher than

the interest rate paid on the PTC backed by those loans. This give rise to excess

margin or spread that can be applied to offset in the pool collection.

Subordinate tranches: One of the common methods of credit enhancement is

senior subordinate tranches structure, where the subordinate tranches acts as a

credit enhance for the senior tranches.

Over collateralization: This is the form of credit enhancement where the

principal outstanding of securitized assets is greater then the principal

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SECURITIZATION

outstanding of the PTC. For example, if Rs 150 million of assets backs Rs

100 million of PTC, then Rs 50 million is the over collateral in the

transaction. After the PTC redeemed, the over collateral assets belong to

the residual beneficiary in the transaction.

Guarantees: A legally valid and enforceable guarantee from the higher rated

entity for funding shortfalls in collections is external form of credit

enhancement. Such guarantee if present are usually limited to

predetermined amount.

Waterfall mechanism structured:

The term ‘waterfall’ is used to describe the order of priority in which proceeds

realized from securitized assets will be utilized. Payments to stake holders in the

securitization will be made as per the term and conditions laid out in the ‘waterfall’.

Statutory or regulatory dues pertaining to the securitized receivable.

Expenses incurred by service provider like the trustee agent, rating agency,

auditor and legal advisors.

Senior PTC holder’s payment.

Top up cash collateral.

The residential amount. If any is paid to subordinate PTC holders, if there are no

subordinate PTC, the residual amount flows back to the residual beneficiary in the

transaction, usually the originator.

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Innovation in Securitization

Strips

STRIPS are the acronym for Separately Traded Interest and Principal Segments. The

interest and principal steam of cash flow are deterministic and are known in advance.

These are sold at their present values as deep discount bonds. The principal only (PO)

and interest only (IO) segments represent two synthetic instruments that are excellent

hedging instruments. By investing in various combinations, investors can create their

own risk-return profile, something not enabled by holding plain-vanilla puts. The strip

reacts differently to changes in interest rate behavior. To understand this better, think of

strips to be the present values of a stream of cash flows, denoted by

Where C represents the cash flow from the underlying receivables

T Represents the timing of the cash flow,

R Represents the current rate discounting, the market yield

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SECURITIZATION

The price movements of strips are impacted the repayment effect, discounting effect and

their combined effect.

In the case of PO, a fall in market interest rates would induce mortgage borrowers to

prepay existing loans and borrow a fresh at lower rates. This will accelerate the cash

flows appearing in the numerator, and reduce the discounting factor in the denominator;

both effect together leading to a value appreciation and hence price of a PO. Reserve is

the case for a rise in the interest rates where borrowers would stay put and tend to

prepay, and the denominator rising, leading to a fall in the price of a PO.

In the case of the IO, a fall in the markets interest rates would reduce the denominator to

lift the price. However, due to repayment, large section of outstanding would be bereft

of future interest inflows. This represent losses in the interest income to service the IO.

The magnitude of interest rates shift and prepayments would determine the combined

effect and final value of the IO. A rise in the interest rates would protect the numerator,

but there will also be a rise in the denominator. Here again, the combined effect and the

impact on the final valuation depends on the magnitudes of the rate shift.

Hedging instruments, bank investing in the long end of the market would like interest

rates to be high. They therefore would buy Pos to protect their losses. Bank wanting

interest rates to fall to increase their lending volumes would be interested in getting

hedge protection by investing in Ions. Thus, it is to be understood that PO and IO strip

moves in opposite directions in relation to interest rates shift in order to devise hedging

strategies.

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SECURITIZATION

Tranched transactions

Tranched transactions are Collateralized Mortgage Obligation (Comes). The normal

pass through mechanism is altered here to mean pay through. In other words, under the

pay through structure, the SPV merely acts as a payment gateway. Under the pay

through structure, the SPV plays an active role in determining which class of securitized

instruments gets a priority in the principal repayment, meaning that the other classes of

instrument get only the interest for the time being. The sequence goes on until, in a

phased manner, all classes of instruments are fully redeemed with interest. This pattern

facilitates the attraction of investors with varying appetites of loan tenors and interest

rates.

As an illustration, consider the following tranches:

Type Amount raised

(Rs. Lakhs)

Coupon %

p.a.

Repayment

Years

A 50.00 8.00 1 to 5

B 50.00 8.25 6 to 10

CAT 50.00 8.50 11 to 15

The A, B and C classes of securities represent different classes of investors. The

tranches are shown as fixed interest bearing securities. The interest rates are

hypothetical and illustrative in nature.

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SECURITIZATION

There could be a variation, where tranches C assume the name Z, where the entire

interest is re-appropriated to the repayments of A, and the amounted temporarily

foregone is added back to the outstanding principal Z. these Z tranches are wildcards

and are hedging instruments as well as catering to the appetite of risk friendly investors.

Note that the presence of B, C and Z tranches serves as cushions to safeguard A. the

presence of such cushions raises the credit rating of A class securities and hence lower

there coupons obligation in the risk return matrix.

It is possible to switch from an existing fixed-interest security like A, B or C into a

floating rate mechanism, using financial techniques. The instruments so designed would

be called Floaters and Inverse Floaters. A brief description is provided below.

Floaters

A coupon-bearing bond where the coupon rates is linked to a reference rate. The

investors gains when the reference rates rises. The floating rates are equal to or above

the reference rates, the difference between the two rates being the quality spread (i.e. the

risk element embedded in the interest rate). Floaters are issued on a stand-alone basis or

complementary to Inverse Floaters.

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SECURITIZATION

Inverse floaters

These are issued complementary to floaters. The coupons rates are pegged at a fixed

ceiling rate minus floating rate. For example, if the floating rate is say 7%, and the

ceiling rate is at roughly double, say, 155 the coupon on the inverse will yield (15-7)%

= 8%. When floating rates rise to say 9%, the inverse will yield less, i.e. (15-9) % = 6%

and vise versa. A set of floaters and inverse floaters can be used to replace fixed coupon

bearing bonds. In such situations, class securities would be split in the ratio 1:1, via Rs.

25 lakhs floaters and other Rs. 25 lakhs inverse floaters. In many cases the investment

bankers assist in designing such instruments.

Variations of this theme are supper-floaters and super –inverse floaters. For example,

Rs. 50 lakhs interest at 8.50 could be split in the ratio 2:1, into Rs. 34.5 lakhs floating at

say 8% at a point in time, or say, reference rate of 7% + 1%, at a point in time. This

comes with a co-existing inverse-floating rates of (ceiling of 24% - 2 times the floating

rate of say 8%) = 44% at a given point in time. The inverse-floaters are issued for an

amount of Rs. 17.5 lakhs, half the amount of the floating securities. Considering the

magnitude of the amount and the ceiling interest rate, the inverse floaters assume the

name ‘super-inverse’ floaters.

A close perusal the two schemes outlined will reveals the interest rate hedging

mechanism of the floating rate securitized instruments.

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SECURITIZATION

CAT Bonds

Until now, the applicability of the securitization was assumed to be in the banking

sector. However, Catastrophe Bonds as they are called is also an effective risk transfer

and risk financing device in the insurance sector. The mechanism of CAT bonds is

explained in the paragraph below.

Let us assume that there is an insurance company, and it has done well in extending its

business in say, Gujarat. The premium incomes are with the company. It could so

happen that a catastrophe in Gujarat could lead to claim amounts that could wipe out

this insurance company. The conventional method of dealing with such risk would be

elements of re-insurance, where part of the premium would be ceded by the insurer to

the reinsurers, taking a proportionate amount of risk also off its balance sheet. However,

it must be appreciated that there could be some catastrophic events which make even so-

called normally anticipated losses are exceeded. To avail of contingent financing for

contingent events, the device of CAT Bonds has been innovated. Here, CAT Bonds are

issued at a high coupon rate for the contingent amount, to cover the perceived under-

financed claim-losses. Catastrophic losses beyond the threshold level trigger the

appropriation of CAT Bonds principal proceeds to settle claims, the principal now not

being repayable to the CAT Bonds investor. If no claim arises on CAT Bonds, the entire

proceeds are refund on expiry of the term of the risk insured against, in which case the

interest is a clean profit for the investors. The redemption amount is secured against

stream of premium payments, as insurance companies gain credibility (hence business

and premium inflows) when they successfully settle claims over a period of time. Thus,

CAT Bonds represents the conversion of risk, packaging them into a tradable

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SECURITIZATION

commodity and garnering capital markets solutions to safeguard against losses from

natural calamities.

Notably, all that is an SPV acceptable to the potential investors, the SPV essentially is a

trust that can be wound up once the objectives of the trust are achieved. Its role is only

in appropriating payments in a diligent manner to safeguard the investor’s interest, it is

the collective representation of the investors. Thus reinsurance-type protection as

reinsurance can be offered through the mode of securitization, obviating the need for

incorporation as a reinsurance company and the requisite minimum capital requirement

of Rs.200 cores.

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SECURITIZATION

CASE STUDIES ON SECURITIZATION

CASE STUDY 1:

CITIGROUP – DIRECT ASSIGNMENT OF RECEIVABLES

DEAL SUMMARY

Originator, Seller & Servicer: Citicorp Finance (India) Ltd.

Trustee: IDBI Trusteeship Services

Instrument: Direct assignment of Receivables from the Originator to

Banks

Issue Size : Gross value of receivables – Rest 79.5 cores; Purchase

Consideration (discount value) of Rest 72.4 Cores

Rating : AAA(so) from ICRA

Nature of Receivables : Arising from loan contracts for commercial

vehicles entered into between Originator and borrowers who are Small

Road Transport Operators (Strops)

Credit Enhancement:

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Corporate Undertaking of 9.36% of assigned receivables

CFIL shall assign right that it has under the Franchisee Agreement

specific to the Loss sharing undertaking (varies between 0% to 30% of

the amount financed) Provided by Franchisee and on the Earnest

Money Deposit (EMD) Provided by each Franchisee against loan

Agreements originated by the Franchisee acting as an Agents for

CFIL.

Maturity : Door to Door of 47 Months; Average of 18 months

SELECTION CRITERIA

The Pool has selected by CFIL from the loan contracts currently on its books

using the following criteria as on December 31st 2004, which is referred to as

the cut-off-Date:

No Over dues of greater than 60 days as on the cut- off date.

CFIL should not have initiated legal / repossession action against any

borrowers

Minimum Seasoning on cut-off date of 2months

Contracts for financing intermediaries who then onward finance the

vehicle to the final customer should not be included

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When both body and chassis is funded then both or none should be

included in the pool. If only body is funded then such cases should not be

included

The Receivables were generated in the ordinary course of its business by

CFLD either directly or through its franchisees.

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SECURITIZATION

POOL CHARACTERISTICS

Weight Average Seasoning of 4.5 months

Delayed payments are common in the CV financing market hence some over dues

SEASONING

8%6%

0%

54%

31%

0%

1%

Overdue Ageing

CURRENT, 52%1 - 30 DAYS, 39%

31 - 60 DAYS, 9%

ASSET WISE DISTRIBUTION

MCV46%

HCV15%

LCV39%

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SECURITIZATION

EFFECTIVE LOAN TO VALUE

65%-70%25%

70%-75%21%

60%-65%28%

< 50%1%

50%-55%1%

55%-60%6%

80%-85%4%

75%-80%14%

Geographical distribution

U.P.5%

Karnataka11%

Maharashtra19%

Orrisa3%

A.P19%

Kerala4%

H.P.1%

Goa0%

Delhi0%

Gujarat6%

Harayana2%

Jharkhand3%

M.P.4%

Punjab1%

Rajasthan5%

Tamil Nadu4%Uttaranchal

0%

W.B.9%

Chhattisgarh3%

Amount Financed

1 to 2 lacs, 0%

2 to 3 lacs, 6%

4 to 5 lacss, 14%

3 to 4 lacs, 17%

9 to 10 lacs, 0%

8 to 9 lacs, 5%

7 to 8 lacs, 15%

6 to 7 lacs, 23%5 to 6 lacs, 20%

Weight Average LTV of 68% (after imputing body cost of 25%)

Geographically well diversified across 19 states.

Weight Average Amount financed is Rs. 5.5%

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SECURITIZATION

CASESTUDY2

MMFSL – Securitization under floating rate Structure with swap

Deal Summary

Originator, seller & servicer: Marinara & Marinara Financial Service Ltd.

SPV: VE Trust; Trustee: UTI Bank Ltd.

Instrument: Pass Through Certificates

Maturity Coupon Issue Size Payment

Frequency

Strips A1 to

A3

Door to door

of 12

months;

average of 6-

7 months

NSE MIBOR

+ spread

Rest 45 cores Quarterly

Strip A4 to

A6

Door to door

of 28

months;

average of

16-17

months

NSE MIBOR

+ spread

Rest 45 cores Quarterly

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SECURITIZATION

Strip A7-

prepayment

strip

Door to door

of 35

months;

average of 22

months

Fixed Rate Rest 21 cores Monthly

Rating: P1+/AAA(so) from CRISIL

Nature of Receivable: Arising from loan contracts for utility vehicles

and cars entered into between originator and borrowers

Credit Enhancement:

Subordinate PTC of 9.8%

Cash Collateral of 5.75%

Opening over dues subordination

Selection Criteria:

The pool has been selected by MMFSL from the loan contracts currently on its

books using the following criteria as on October 2003, which is referred to as the

Cut-off-Date:

The pool comprises of only utility vehicles and cars.

The pool contracts have a minimum seasoning of three months.

The over dues on the contracts do not exceed a period of one month.

Only contracts directly originated by the seller and whose collection is

directly undertaken by the seller have been included.

The maximum balance tenor as on February 1, 2004 is 35 months.

The original LTV of the contracts is restricted to a maximum of 90%.

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SECURITIZATION

Asset class Utility Vehicles and

Passenger Cars

Number of contracts 6,130

Total Receivables from Feb, 1 2004 (Rest.) 1,245,092,239.00

Average contract balance (Rest.) 203,115

Minimum contract balance (Rest.) 6,385

Maximum contract balance (Rest.) 529,000

Weighted average seasoning (monthly) (as on

January 31, 2004)

11.35

Minimum seasoning (months) (as on January 31,

2004)

7.00

Weighted average balance maturity (months) 24.24

Maximum balance maturity 35.00

Weighted average LTV 73.31%

% of pool with nil over dues (as on cut-off date) 74.74%

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SECURITIZATION

Pool Characteristics:

Asset w ise classification of the pool

Utility Vehicle,

66%

Car, 34%C

Overdue analysis

Nil, 75%

30 Days, 25%

Seasoning as on Januray 31,2004

7 to 9, 29.77%

10 to 12, 52.80%

13 to 14, 17.43%

Weight Average Seasoning 11.35 months

75% of the pool had nil over dues and balance had 1 EMI over dues

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Loan to value ratio

LTV 70% to 80%, 48%

LTV<30%, 0%

LTV 30% to 50%, 5%

LTV>=95%, 3%LTV 80% to 90%, 21%

LTV 90% to 95%, 1%

LTV 50% to 60%, 8%

LTV 60% to 70%, 14%

Geographical distribution

Gujarat, 10.54%

Maharashtra, 9.74%

West Bengal, 6.50%

Haryana, 6.80%

Karnatka, 4.83%

Delhi, 2.54%

Assam, 2.29%Others, 2.50%

Orrisa, 2.12%

Jharkhand, 2.15%

Kerala, 6.43%

Himachal Pradesh, 3.57%

Andhra Pradesh, 4.10%Chhattisgarh,

3.65%Punjab, 6.65%

Rajasthan, 2.28%

M.P., 4.40%

Tamil Nadu, 6.68%

Uttar Pradesh, 12.23%

Weighted Average LTV 73%

Pool is geographically well diversified across 19 states

57

SECURITIZATION

Structure Diagram

Liquidity Reserve

Originator/Seller(MMFSL)

Investors Agent

SPV

Obligors

Servicer

Trustee

Citibank

Investors

Collection Account

MonthlyCollection

Payout on PTC

Issue of floating rate & fixed rate PTC

Interest rate Swaps

Issue of subordinate PTC Sale of receivables

& purchase consideration for receivable

Interest rate swaps have been entered into between the Investors agent and Citibank to convert fixed pool to a floating rate coupon to investors.

Collection Efficiency

5456586062646668707274

Jan-

02

Mar

-02

May

-02

Jul-0

2

Sep

-02

Nov

-02

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep

-03

Nov

-03

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep

-04

Nov

-04

Months

Co

llec

tio

n %

58

SECURITIZATION

Performance of previous issuances

CFIL & CAN

Issuance

April 02 June 02 July 02 Oct 02

Issue size (Rest.

Cores)

66.92 74.57 115.38 109.5

Total number of

PTC

69 77 117 111

Issue rating AAA (so) P1 (so)

+PSCE&

AAA (so)

P1 (so)

+PSCE&

AAA (so)

LAAA (so)&

MAAA (so)

CE stipulated 8.00% 8.50% 8.50% 4.50%+PSCE

O/s level of CE as

% future investor

cash flows

39.68% 13.51% 60.94% 41.73%

Cum. Principal

prepaid as a % of

the original

principal

outstanding on the

issuance

8.50% 3.97% 10.32% 3.43%

Peak usage of CE

(as a % of O/S

CE)

16.52% 12.26% 6.42% 16.70%

First 3 months 86.70% 76.80% 77.53% 93.42%

First 6 months 92.27% 87.21% 86.68% 95.95%

As on date 98.95% 119.29% 97.23% 97.93%

59

SECURITIZATION

ANALYSIS OF THE SURVEY

Analysis for the better understanding about Securitization. Questionnaire method was

used to carry out the survey. A set of 5 question was used in the questionnaire, which

varied from objective type of question. Questionnaire was framed and designed in such a

manner that it could be filled up with in 5minutes by the person thus saving time of

interviewee. The sample size of the survey was taken to be 50, of this 50 people 18

questioned were to business person, 20 people were servicemen and professional, 12

were student. Question Ranged from getting information about securities, securitization,

credit rating etc.

1. Do you invest in securities?

21

29

0

5

10

15

20

25

30

Yes No

60

SECURITIZATION

2. Are you aware of securitization?

27

23

21

22

23

24

25

26

27

Yes No

3. Before you invest in company do you check credit rating?

YesNo

29

19

0

5

10

15

20

25

30

4. Do you think securitization is important?

61

SECURITIZATION

25 25

0

5

10

15

20

25

Yes No

5. For securitization which one is better?

10

15

25

0

5

10

15

20

25

ABS MBS BOTH

Summary

62

SECURITIZATION

Securitization is the process of converting relationships into transactions. These

transaction must lead to the creation of tradable instruments. Incomplete securitization is

the non-existence of tradable securities, where the essential feature of relationship

continues to prevail. Securitization enables financial institutions to raise from existing

receivable streams. These resources are essentially stable and long-term, with protection

to interest spreads. In the case of well-designed securitization structures, the cost of funds

for financial instruments can be substantially reduced in comparison to plain

conventional borrowing.

The advantage for the investor are liquid investment for a range of tenors and

risks profiles.

The various forms of securitization include Asset Backed Securities, which includes

receivables from loans for tangible assets, such as mortgages, automobiles and

equipment. Securitization of credit card receivables, student loans and infrastructure and

utilities receivables is also feasible, bit here the asset is stream of future cash flows and

physical assets. The securitization process involves several players such as originator, the

obligor, merchant banker, SPV, underwriters, investors, escrow bankers, rating agencies

and credit insurance agencies.

Innovation in securitized instruments are in the forms of STRIPS, where the

interest and the principal components of receivable, in the pass through mode, are sold

off separately. These can be used as hedging instruments. Another innovation is in term

of carving up receivables and designing debt instruments for potential investors such as

short-medium and long-term investors. Such structure are known as pat through

structures or Collateralized Mortgage Obligation (CMO). Further add-on innovations in

CMO are converting fixed rate coupon cash streams into variable rate cash streams using

floaters and inverse floaters. Thus, securitization process involve financial engineering.

63

SECURITIZATION

The success of securitization is very important in the development of the economy.

Possible area for the application of securitization is residential and commercial

mortgages, infrastructure receivables, custom bile and equipment loans, student loans and

credit card loans. The advent of Catastrophe Bonds (CAT) is the interface between the

capital markets and the insurance sector.

64

SECURITIZATION

Conclusion:

Securitization in is at the crossroads. A lot has been heard about it since 1990, very little done. We are familiar with the sad Indian story of minor irritants playing a major role in stalling major development. But just as the revolution in India was out come of import liberalization for computers, so also, it is only a matter of time before high quality securitization forms the backbone of housing, infrastructure and trade finance in India. Perhaps what we also need is Ginnie Mae and Fannie Mae type origination in India.

65

SECURITIZATION

Bibliography:

www.goggle.com

www.wikipedia.com

www.vinodkothari.com

www.crisil.com

Vipul prakashan

66