S.

K SOMAIYA COLLEGE OF ARTS, SCIENCE & COMMERCE

VIDYAVIHAR (EAST), MUMBAI - 400077

PROJECT ON:
STUDY

OF SECURITIZATION.

MASTERS OF COMMERCE
(BANKING & FINANCE)

PART 2 (SEM III)

(2016-2017)

Submitted:
In Partial Fulfillment of the requirements
For the Award of the Degree of
MASTERS OF COMMERCE
( BANKING & FINANCE )
BY
KUNJAL M SHAH
ROLL NO : 48

DECLARATION

I KUNJAL M SHAH student of class Mcom (BANKING & FINANCE) PART 2

(SEM-III), ROLL NO. 48, academic year 2016-2017 Studying at S.K. SOMAIYA
COLLEGE OF ARTS, SCIENCE AND COMMERCE, hereby declare that the work
done on the project Entitled STUDY OF SECURITIZATION . is true and
original and any Reference used in this project is duly acknowledged.

DATE:

PLACE: MUMBAI
SIGNATURE OF STUDENT
( KUNJAL M SHAH )

CERTIFICATE
This is to certify that MISS KUNJAL SHAH, studying in Mcom (BANKING &
FINANCE) PART 2 (SEM-III), ROLL NO. 48, academic year 2016-2017 at
S.K.SOMAIYA COLLEGE OF ARTS, SCIENCE & COMMERCE has completed
the project on STUDY OF SECURITIZATION under the guidance of Proff.
PRAVIN MALU
The information submitted herein is true and original to the best of my knowledge.

____________________

___________________

Proff. PRAVIN MALU

DR. SANGEETA KOHLI

[PROJECT GUIDE]

[PRINCIPAL]

____________________

___________________

EXTERNAL EXAMINER

MR. RAVIKANT
[CO-ORDINATOR]

DECLARATION BY GUIDE

I, the undersigned Prof. has guided MISS KUNJAL SHAH ROLL NO. 48 for her
project. She has completed the project on STUDY OF SECURITIZATION.
successfully.
I, hereby declare that information provided in this project is true as per the best
of my knowledge.

Prof.
Project Guide

ACKNOWLEDGEMENT
It

gives

me

immense

pleasure

to

present

project

on

STUDY

OF

SECURITIZATION . As a Mcom student it is a great honour to undergo a project

work at an graduate level and I would like to thank the University of Mumbai for giving
me such a golden opportunity.
I am eternally grateful to almighty god for giving me the spirit to put in my best effort
towards my project. I owe my sincere gratitude to DR. SANGEETA KOHLI, the
principal of our college. I am also thankful to my project guide MR. PRAVIN MALU
for his valuable guidance and for providing an insight to the subject.
I am also obliged to the library staff of S.K..Somaiya College for the numerous books
made me available for the handy reference.
Although, I have taken every care to check mistake and misprint yet it is difficult to claim
perfection. Any error, omission and suggestion brought to my notice, will be thankfully
acknowledged by me.

INDEX
SR
NO.

PAGE
NO.

TITLE

1 INTRODUCTION OF SECURITIZATION

2 VARIOUS STAGES INVOLVED IN SECURITIZATION

11

3 ECONOMIC BENEFITS OF SECURITIZATION

17

4 UNDERSTANDING RISKS IN SECURITIZATION

20

5 LEGAL ISSUES WITH SECURITIZATION

22

6 RATING PROCESS IN SECURITIZATION

26

7 INDIAN EXPERIENCE WITH SECURITIZATION

31

8 US SUB-PRIME MORTGAGE CRISIS

35

CONCLUSION

44

BIBLOGRAPHY

45

CHAPTER 1
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 Citibanks 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 firms liquidity. In the case of limited company, share is issued to each
partner and the companys 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 shareholders 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.
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.

SECURITIZATION TRANSACTION PROCESS

The successful execution of a securitization depends on the investors 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 originators
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.
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

Issues PTC

Transfer/sells
Originator

SPV

loans

(Owner of the assets)

Investors

(Trust managed by the trust)

Consideration
Consideration

Payment from borrower deposit from originator

Payment made to investors

Collection account
(Operated by the trusty)

Loans
(Assets)

Installment
Payment
Borrowers

Credit Support
(Given by the originator or third party)

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.
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 investors 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.

CHAPTER 2
VARIOUS STAGES INVOLVED IN WORKING OF SECURITIZATION

10

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 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
11

may be either with recourse to the 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.
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

12

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 investors demand
for varying maturity pattern. This type of is more attractive from the investors 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 backed by guarantees given by highly rated merchant banks and
hence they are also attractive from the investors 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.

13

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 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 investors 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.

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 liquidators list in the
event of its winding up. However, a PTC holder has access to the obligors asset, and is hence saved

14

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 originators 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 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:

15

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 companys 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 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.

CHAPTER 3
16

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 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 originators perspective.

Efficient Financing: In securitization it is possible to achieve much higher target rating for instrument
than the originators 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 originators 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

17

support 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 investors 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 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.

18

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
investors risk and tenor appetite.

Durations can range from few months to many years.

Repayment are usually made on monthly basis but can be structured on a quarterly or semi
annually basis.

Interest rate can be fixed or floating depending upon investor preferences.

19

CHAPTER 4
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 investors 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.

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.

20

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 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.

21

CHAPTER 5
LEGAL ISSUES WITH SECURITIZATION

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.

Collection and payout account agreement: This document spells out the operational details
of the collection account.

22

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, 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 investors
return in asset securitization depends purely on cash flows from the securitized assets. A true sale will
ensure that the investors 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:

23

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 originators 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.

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.

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Risk applicable on MBS investments for Banks:

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:

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.

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CHAPTER 6
RATING PROCESS IN 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 trustees satisfaction.

Furnish representation and warranties as stipulated by credit rating agency.

Submit an auditors 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 credit rating agency satisfactions than agency issues
a letter of compliance for the transaction formalizing rating.

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Rating process for securitization:

27

Company send its information requirement to the client specifying details of the information ne

Team put

A provisional rating

A compliance letter for the rating is issued o

Company does not end with the issue of the initial rating

28

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--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.
Auditors 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.

Due diligence structure

Origination s

Management

Credit appraisal and

Information
System

Disbursement and post dis

(MIS)

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Collection and recov

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 investors 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.

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.
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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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CHAPTER 7
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.
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.

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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 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.

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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
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 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.

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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 holders 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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CHAPTER 8
SUB-PRIME MORTGAGE CRISIS
The Intention of this assignment is to understand the currently going major economic issue Sub-prime
Mortgage crisis problem which was started in 2006 in the US. This crisis has now become global issue
as it has affected major economies of the world and it is continuously growing.
This Crisis was started with the US housing sectors Boom and bust which had thrown US economy in
to recession.
In 2005, The US housing sector was on boom as the value of the houses has gone up to 140% due to
large demand of the houses. The financial institution started providing loan to the Sub prime candidates
who are not eligible to applying for Conventional loan. Overbuilding of the houses during the boom
period eventually leads to decline house price. Due to which many homeowners and sub prime loan
borrowers become default and Bank started foreclosure activity which leads to more downfall in housing
price. Now, there were more houses and fewer buyers which create illiquidity in to the housing sector.
Finally it landed banks in to the financial crunch.
This report has been prepared to understand the major causes of this crisis and its impact on the
International debt and equity market.

1 Sub Prime Mortgage Crisis

It is a kind of mortgage that financial institutions provide to the borrowers who have lower credit rating
(often below 600) or who do not have credit history. The borrowers with poor credit history are not
eligible to have conventional mortgage loan so, the financial institution provide them sub prime
mortgage loan and charge them with higher interest rate as compared to conventional loan in order to
compensate themselves for bearing higher risk.

36

There are several different kinds of subprime mortgage structures available. The most common is
the adjustable rate mortgage (ARM), which initially charges a fixed interest rate, and then converts to a
floating rate based on an index such as LIBOR, plus a margin. The better known types of ARMs include
3/27 and 2/28 ARMs.
There are several terms and condition which are hidden in the agreement of Subprime Mortgage loan of
which a borrower is not aware off.
In fact some people calls it NINJA loans which means granting loan to people with no Job, no Income
and with no Assets.

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Background Of Sub Prime Mortgage Crisis

US housing Bubble
The Subprime Mortgage Crisis threatens to throw the U.S. economy into a recession. The Sub Prime
mortgage crisis is an ongoing financial crisis which is characterized by the contracted liquidity in global
credit market. This crisis had become more apparent in year 2007 and 2008. The Subprime Mortgage
crisis was started approximately in 2005-2006 began with the bursting of the United States housing
bubble and high default interest rate on subprime loan and on ARM. What exactly happens is that in
2005-2006, at the height of the US property boom, when lenders started adopting creative methods to
make home ownership more accessible for a population demographic which was previously unable to
own their own home. The lending industry offered very flexible products like easy initial terms, no
documents, honeymoon period etc in order to make monthly repayments affordable for these credit
impaired clients and as a result:

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 Low start, honeymoon period was introduced with very low interest rate which is as low as 1% or
2%. It becomes easy to make repayments for borrowers having lower income which is going to
further fuelling the US property boom. However this low interest rate was just under honeymoon
period which was reset to standard variable rate of about 7%. This Rollover made many subprime
borrowers incapable of repaying.

Unscrupulous brokers and some lenders take the undue advantage of relaxation of credit policies to
sign up clients who are unable to make necessary payments. These clients sign high income
declaration which later called NINJA loans. Financial institution paid commission to the broker for
every single NINJA loan.

The Subprime loans (NINJA loan) become very popular in the US which is evident by the fact that more
than 7 million property owner of the US took out these types of loan. The whole new generation of new
real estate investors caught up in this sub prime lending market.
The crunch time come for many of the American investors when the validity of the honeymoon low
interest period expires and the interest rate reset to standard variable rate which make many borrowers
incapable for repayment.
As the initial term expired the default and foreclosure activity increased dramatically in the US. During
2007, nearly 1.3 billion housing properties were subjected to foreclosure.

39

To handle the situation some finance experts packaged these loans with the US investment bank and sold
them as AAA rated security to Institutions and lenders around the world with the promise of high net
return through the process of securitization. But the number of default continues to grow in the US
market which finally bring the value of the property down and also created illiquidity in the Credit
market. The Institutions finally lost their money invested in these securities. All this finally leads to
global financial crisis.
Major Banks and other financial institutions around the world have reported losses of approximately
US$435 billion as of 17 July 2008.

Factors responsible for Sub Prime Mortgage crisis

Unfair lending of Loan
Betting on collateral rather than borrower
Overbuilding of Houses during the boom period
Liquidity in the Housing market
Poor Anticipation of borrowers and lenders
High personal and corporate debt level

2 Impact of Sub Prime Mortgage Crisis

Lack of liquidity: Overbuilding during the boom period eventually led to a surplus inventory of homes,
causing home prices to decline. Easy credit with the assumption that housing price would continue to
appreciate had forced many subprime borrowers to obtain Adjustable Rate mortgage which they could
not bear after the expiry of the initial terms. The increasing construction of the houses and fewer buyers
create a housing glut. As a result, U.S has recorded nearly a four million unsold existing homes were for
sale, including nearly 2.9 million that were vacant. More houses and less buyers create illiquidity in the
housing market and real estate prices began to fall in many part of the US due to which refinancing
become more difficult and the subprime mortgage borrowers were unable to refinance and began to
default on loans as their loans reset to higher interest rates and payment amounts. This increases number
of default and foreclosure rate provide the additional supply of inventory house. This excess supply of

40

home inventory placed significant downward pressure on prices. As prices declined, more homeowners
were at risk of default and foreclosure.

The house plunge leads to more delinquencies and foreclosures generating a vicious cycle
The Value of the AAA rated Mortgage back security which was purchased by the Institutions and lenders
also become less and they had suffered a huge loss in this. The Investors loose their confidence and they
are not willing to purchase any Mortgage backed securities anymore. Finally it leads to Lack of
Liquidity into the credit market because banks are not able to make payments of policies on maturity
date due to lack of funds. This inability of Bankers of lack of funds in the credit market slowly leads
global financial crisis. Moreover, the size of the crisis can not be determined with any degree of
certainty. The uncertainty has eroded market confidence raised the volatility of financial markets.
Credit crunch: The U.S sub-prime crisis has resulted in multi billion $ loss to international banks like
Citibank etc and investors world wide who have invested in the MBS.
There is a severe credit crunch in the sub-prime segment of the mortgage market. Till now 30 sub-prime
lenders is out of the market. New Century was the last one to get out of the business who is known to be
the second largest sub-prime lender. Many more lenders are losing massively on their sub-prime
operations.
Investor fears have been exacerbated by uncertainty about the full scale of losses and distribution
associated with sub-prime exposures. The Housing price going down continuously and the number of
default and foreclosure are increasing are the reason for investors fear. The lending standards have been

41

sharply tightened by many lenders and regulation around the world. Economists at Goldman Sachs in
New York said in a report this week that the tightening of subprime credit could cut annual demand
for new homes by 200,000 units, or about a fifth of new-home sales last year.
Australian has also affected from the U.S sub-prime mortgage crisis.
The issuance of residential mortgage backed securities (RMBS) as an important long-term funding
source has reduced significantly. Since July 2007, new issuance only accounted for less than AU$5
billions compared with AU$25 billions in the first half of 2007.

Source: RBA, Sept 2008, page no. 30

Asset-backed commercial paper market (ABCP), which provides securitized short-term funding for
vehicles holding a variety of financial assets, has also shrunk with falling outstanding. As at July 2008,
the outstanding value of offshore ABCP issued by the Australian entities was just over $ 7 billion,
around 80% lower than its peak in May 2007.
Finally global credit crunch has squeezed economic growth.
Stock market down: The US sub-prime crisis has triggered the sharp decline of stock market
worldwide. Trillions of dollars have been wiped off global share markets as investors panic in the face of
an economic slowdown. The Investors are not willing to invest in Bond, Treasury note etc. And they

42

started withdrawing their investments due to which stock market goes down and interest rate gone up.
Report publishes on February 2008 by the Bank of America estimated a global loss of US$ 7.7 trillion in
the stock market since October 2007.

3 Effect on the International Debt and equity market

This Crisis will have some negative affects on the international debt and equity market. The U.S
financial crisis, which has sent tremors around the world, is likely to slow down foreign institutional
investors' investment in India's equity markets. The risk of economic fallout from the US subprime
housing crisis has decreased following the recent 0.5 percent cut in the US Federal Funds rates.
Although Investment banks have aggressively reduced their underwriting of new debt issues to cover
their own anticipated and unanticipated funding needs. Investors mainly banks, institutions and high-networth individuals who have long positions in the global markets, will incur losses on their exposure to
the collateralized debt obligations, hedge funds and leveraged-buyout activities. While banks from the
Middle East region face little or no risk from the subprime crisis, some private equity firms operating in
this part of the world will be affected. Private equity firms operating in Middle East region are less
dependent on leverage finance compared with those in the West. The debt markets worldwide and in the
Middle East region will be affected more than the stock markets. The Sub prime mortgage in the U.S
and Europe has choked off funding for private equity teams, Bloomberg reports the funding squeeze
resulted in 63% drop in global buyout in the second half 2007. Global equities are in a bear market.
Equity markets continued to rise until mid-May. After that, though, they tumbled back, so that the MSCI
world index is now below that March low. Indeed, global equities are now down 12% year to date and
around 20% from the high of October 2007. The global index is now at its lowest level since October
2006. The equity bear market is confirmed. To date, banks and financial houses have written off more
than $425 billion of their assets. The cost of capital, as expressed in corporate bond yields and mortgage
rates, has moved higher. Corporate earnings are now in negative territory in the US and Europe. Above
all, real GDP figures are heading south everywhere, while inflation rates are heading north. That is a
deadly combination. From here, the credit cycle is moving from big percentage losses incurred in subprime mortgage debt to the more typical small percentage losses in the general mortgage, consumer and
corporate sectors that are incurred in an economic recession. Liquidity contraction will ricochet through
more pools of debt, causing leverage to contract for the real economy. That will hit financial market
prices further. The global economy is heading into a recession, as the economic data are beginning to

43

reveal. This will be expressed in falling profit margins and negative earnings growth. That's bad news
for equities.
Assets are yet to be hit in the credit crisis and, as leverage continues to fall out of play, liquidity will
keep on drying up. Equity prices are bound to fall still further too.
To Conclude, There will be some degree of negative affect on the International debt and equity market
which may differ from region to region. Like the Sub-prime mortgage crisis is likely to have only a
limited effect on the equity and debt market of Middle East region due to their support of huge
investments in infrastructure and a confident private sector positioning itself for growth and expansion.
The impact of the crisis will be more visible if the world economic growth will further decline.

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Conclusion:
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 longterm, 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.
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.
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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.

46

Bibliography:

www.google.com

www.wikipedia.com

www.vinodkothari.com

www.crisil.com

Vipul prakashan