Chapter: 1.

Introduction
Background: Securitisation in India
Securitisation, also termed as structured finance, is the creation and issuance of debt
securities, or bonds, whose payments of principal and interest derive from cash flows
generated by separate pool of assets. Simply stated, it is a form of secured funding
through issuance of bonds in a specific pool of assets. Credit performance is directly
linked to the cash flow generation of the pool of these assets. This financial tool, that
was almost non-existent till the 1970s, is used by financial institutions and businesses to
immediately realise the value of cash-producing assets like loans, or leases or trade
receivables. It allows originators to unlock the value of upfront assets.

The idea of Securitisation was born in the 1970s when government mortgage agencies in
the United States Freddie Mac, Fannie Mae, and Ginnie Mae issued mortgage based
pass-through securities to investors; thus fostering a secondary market in home
mortgages. This idea evolved as an outcome of the financial institutions’ inability to
keep pace with the growing demand for housing finance. Traditionally, these were
funded either by way of bank deposits and other financial institutions or by debt.
Financial innovations towards increasing the availability of mortgage finance led to
investment bankers coming up with an investment vehicle, which isolated the mortgage
pools, segmented the credit risk, and structured the cash flows from underlying loans.

Subsequently, this vehicle caught the eye of the investors and the concept of asset
securitisation came into existence. What developed as a technique for the mortgage
market was applied for the first time in 1985 to auto loans which proved to be a better
match for structured finance as their maturities were shorter compared to mortgage
loans that made these pods of assets more ammendable to the structured products.

1
The major players in the asset securitisation market in India are expected to be
commercial FIs, PSUs, Corporates, Government bodies, Mutual Funds, Pension Funds,
etc. Securitisation generally pre-supposes that the Originator has a bulk of its assets in
the form of selfamortising financial assets, either with or without underlying security. It
is also imperative that these assets should have a clearly established repayment
schedule. Moreover, since capital market instruments have a minimum marketable
tenure, the receivables underlying the securities should themselves have a sufficiently
long tenure, so as not to frustrate the securitisation exercise.

While securitisation started off in the housing loan sector, the development of the
securitisation market as a standard funding option across most industries has been the
result of a constantly expanding universe of securitisable non-mortgage asset types.
Securitisation is a relatively new concept in India but is gaining ground-quite rapidly.
CRISIL rated the first securitisation program in India in 1991 when Citibank securitised
a pool from its auto loan portfolio and placed the paper with GIC Mutual Fund. Since
then, securitisation of assets has begun to emerge as a clear option of fund raising by
corporate and a few transactions of well-rated companies have taken place in the
country.

Initiating securitisation requires the creation of a Special Purpose Vehicle (SPV), which
is legally separate from the original holder of the assets. The SPV can either be a trust,
corporation or a partnership firm set up specifically to purchase the originators assets
which also acts as a conduit for the payment flows. In a typical transaction, the owner
sells its assets to the SPV. The payment streams generated by the assets can then be
repackaged to back an issue of bonds. In some cases, the SPV serves only to collect the
assets, which are then transferred to a trust. The trust in turn becomes the nominal
issuer of the bonds/securities. In both cases, the bonds are exchanged with an
underwriter for cash. The underwriter then sells the securities to investors.

2
The final outcome of a securtitisation transaction is upfront funding of the originator via
selling a stream of cash flows that was otherwise to accrue to a entity over a period of
time. Alternatively, the financial asset is completely taken off from the balance sheet of
the originator, thus not only providing immediate liquidity but also mitigate the strain
on capital adequacy. In the United States, the success of securitisation allowed many
individuals with sub-prime credit histories to access credit.
It allowed more sub-prime loans to be made because it provided lenders an efficient
way to manage credit risk. Securitisation in recent years has also emerged as a new
means of financing bad debts.

What is securitization:
Securitisation is the process of pooling and repackaging of homogenous illiquid
financial assets into marketable securities that can be sold to investors. In other words
Securitization is the transformation of an illiquid asset into a security. For example, a
group of consumer loans can be transformed into a publically - issued debt security.
security is tradable, and therefore more liquid than the underlying loan or receivables.
Securitization of assets can lower risk, add liquidity, and improve economic efficiency.
Sometimes, assets are worth more off the balance sheet than on it.

3
Structured Finance and Securitisation
One of the crucial features of securitisation is the creation of different grades of
securities with different ratings assigned to them. The term “structured finance” refers
broadly to such rated products that are structured to meet specific needs. The senior
most class of securities is often rated triple A, the highest rating given based on largely
two factors: isolation of the assets from the bankruptcy risks of the originator, as in
being originator independent; and the creation of a credit risk mitigation device by
subordination of classes B and C, such that those lower classes provide credit support to
class A. It is possible that the size of classes B and C is so computed as to meet the rating
objective for class A and similarly, the size of class C is so computed as to have class B
accorded the desired rating. In other words, the entire transaction could be engineered
or structured, to meet specific investor needs. Thus, use of structured finance principles
allows the originator company to create securities that meet investor needs. Rating is
not the only basis for structuring of securities though. There are several other features
with respect to which securities may differ like interest sensitivity (i.e., duration and
convexity), maturity or average life, cash flow pattern and prepayment.

The transfer of assets in turn is also a transfer of risk. There is an element of credit risk,
interest rate risk or similar risks for most financial assets and securitisation transactions
transfer these risks in a structured fashion. The one who takes the first loss risk is a
junior holder, and the one who takes subsequent risk is the senior. There could also be
mezzanine security holders if there are more than three classes of A, B and C securities.

4
1.1. Need of the Study:

 Growth of Non-performing Assets: The Challenge to all Banks Indian Banking

Industry set up its pillar on piles of NPA. Several reformatory measures were
adopted time to time, but the effort for NPA identification was either sluggish or
remained undetected.
 NPA has been the greatest complication for the Indian banking sector. The
problem was predominantly acute in India with NPAs accounting to thousands
of crores.
 The effect of large NPAs was devastating as it reduced interest income,
additional provisioning, and erosion in capital and reduction in competitiveness.
 The government and the banks have put in a lot of effort to address the serious
problem posed by the NPAs.
 Debt Recovery Tribunals (DRTs) were set up to recover the bad loans. The banks
have also come up with One Time Settlement systems to settle the problems once
and for all with the defaulting borrowers. Though these tribunals and schemes
were partly successful, they did not go to the extent of solving the problem.
 Consolidation, therefore, seemed to be the only way to transform the existing
banking sector into a commercially viable organization.
 NPA issue in the financial sector has been the cause of concern for all economies
and India is not an exception to it. Reduction in NPA has become synonymous
with the functional efficiency of financial intermediaries. Although the value of
NPA is reflected in the Balance Sheet and affects the financial position of the
organisation, yet it had huge macroeconomic impact.
 If these assets are not recovered on time, the values will decline with the efflux of
time and gradually the banks could only recover a negligible value. This in the
long-run will affect the financial sector growth.

5
  Keeping all above aspects in consideration the securitization is only way out for
management of NPA and recovering debt amount from defaulters. There is need
of using securitization technique as strategic tool for competitiveness.

1.2. Scope of the Study:

This report talks about emergence of securitization in Indian context and importance of
securitization for economic development and also provides recommendations for
measure problems.

1.3. Objective of the Study

Primary Objective:

 To understand the concept of securitization

 To Study in detail regarding the scope, present situation, problems faced and the
future of Securitization in India
 To understand the different types of risk involved in securitization.
 Impact of securitization in India

Secondary Objective:

 To understand the Importance of Securitization mechanism in Emerging India.

 To study the different parameters that is influenced as a result of introduction of
the securitization mechanism

6
Chapter: 2. Literature Review

Over the years, various attempts have been made by the researchers to evaluate the
different aspects of securitized instruments and examine the justifiability of its
introduction in the financial markets.

 Lipkin (1992) stated that as real estate values continue to deteriorate and
liquidity evaporates, the crisis in thrift institutions, banks, and insurance
companies worsens. Consequently, there arises an unquestioned need for
creative products to serve as non-traditional sources of financing, which has been
very well solved by securitisation of real estates.

 Frost (1997) has specified that asset securitization is a financial innovation in

which corporations sell financial assets to a specially formed entity that in turn
taps financial markets for the purchase price. The device provides firms an
alternative to raising capital through traditional debt and equity markets.
Practitioners of the approach tout securitization as a means through which a firm
can lower its overall cost of capital by limiting the risk facing investors in the
securitized assets. Commentators have described asset securitization as “one of
the most important financing vehicles in the United States.” Interest in the device
is increasing dramatically as more companies see it as a way to decrease their
cost of capital. In his article he examined the reasons for which asset
securitization has become such a popular financing device. He developed an
analytical model that focuses on the market failures which explain the reasons
firms use asset securitization.

7
 Loutskina (2004) conducted an extensive study to show that by allowing banks
to substitute cash and securities for loans, securitisation reduces the sensitivity of
bank lending to the availability of the external sources of funds and thus reduces
the need for the monetary authority to affect bank lending through open market
operations.

 In Indian context, Ketkar and Ratha (2001) suggested that developing countries
cannot obtain lowcost, long-term loans during financial crises. Thus,
securitisation of future flow receivables can help investment-grade public and
private sector entities in these countries obtain credit ratings higher than those of
their governments and raise funds in international capital markets.

 Kothari and Gupta (2004) studied the development of mortgage-backed

securities market in India and examined the relevance of securitisation, both
agency-backed Volume-I, No.-2, July -December 2011 Business Spectrum
ISSN- 2249-4804

 Securitisation (i.e. MBSs issued by government sponsored agencies which

promote mortgage secondary markets) and private label securitisation (i.e.
mortgage backed issues securitised by non-agency financial institutions) over the
development of housing refinance market in India. The research conducted till
date in India has focused on theoretical aspects mostly with little emphasis on
empirical research. Also, none of the empirical studies conducted so far focused
on the impact of securitisation on the Indian Banking Industry, the sector
affected most by securitisation. Hence, in view of this research gap the present
study assumes significance in Indian context.

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Chapter: 3.Research Methodology

3.1. Types of Research Design

 The type of research design is used for this study is Exploratory research design

3.2. Method of Data Collection

 The Data for the Study was collected from the Secondary Resources.

 The Secondary Data was gathered from various sources like Newspaper Articles,
Journals, Reports and websites

3.3. Duration of the Study

 Duration provided for this study was 2 months that is from 15th December, 2013
to 15th February, 2014

3.4. Scope of the Study:

 This report talks about emergence of securitization in Indian context and

importance of securitization for economic development and also provides
recommendations for measure problems.

3.5. Limitation
 The time duration given to complete the report was not sufficient, it was only
two months.

9
Chapter: 4.Need for Securitisation
The generic need for securitisation is as old as that for organised financial markets.
Financial markets developed in response to the need of involving a large number of
investors in the market place. As the number of investors increases, the average size per
investors comes down. As the small investor is not a professional investor, he needs a
liquid instrument, which is easier to understand. This sets the stage for evolution of
financial instruments which would convert financial claims into liquid, easy to
understand and homogenous products, at times carrying certified quality labels (credit-
ratings or security), which would be available in small denominations to suit everyone's
wallets. Thus, securitisation generically is basic to the world of finance.

Following are the reasons as to why the world of finance prefers a securitised
financial instrument to the underlying financial claim in its original form:
1). Financial claims often involve sizeable sums of money, beyond the reach of the small
investor. The initial response to this was the development of financial intermediation:
an intermediary such as a bank would pool the resources of small investors and use the
same for the larger investment need of the user. However, then came the following
difficulty.
2). As small investors are typically not in the business of investments, liquidity of
investments is most critical for them.
3). Generally, instruments are easier understood than financial transactions. An
instrument is homogenous, usually made in a standard form, and containing standard
issuer obligations. Besides, an important part of investor information is the quality and
price of the instrument, and both are easier known in case of instruments than in case of
financial transactions.
In short, the need for securitisation was almost inescapable, and present day's financial
markets would not have been what they are, unless some standard thing that market
players could buy and sell, that is, financial securities, were available.

10
Chapter: 5.Process of Securitisation:

If an entity having receivables as one of its major assets (leasing co.) has already created
these receivables, it means the company's working capital is tied in the receivables.
Securitisation will unlock this working capital, and make it free for further asset
creation. In this sense, securitisation is a mode of financing, or rather, a mode of
disinvesting.

According to John Henderson & Jonathon Scott, it is a process which takes

place when a lending institution’s assets are removed in one way or the other
from its balance sheet and are funded instead by the investors who purchase
a negotiable financial instrument evidencing this indebtedness, without
recourse to the original lender. The process of securitization primarily involves
three parties namely, the originator, the special purpose vehicle (SPV) and the
investor. The originator is the one who owns the financial asset and who wants to
offload the same in the market. The originator could be a banking, industrial or
finance company. The SPV or in other words the issuer is the one who issues
mortgage-backed securities to investor in the market. Generally merchant
bankers function as SPV’s.

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Following is the three stages involved in the process of securitization:

Stage 1: Asset Identification:

The ‘originator’, first identifies the asset or a pool of assets that have to be securitized.
There must be some basic conditions that must be satisfied by an asset, which is to be
securitized. For instance, the cash flows from the reference asset should be reliable and
payments should be periodically obtained. This means that the asset portfolio should
have a documented history showing default and delinquency experience. The assets
have to be of good quality that in turn facilitates the marketability to be quick and easy.
This is to ensure that default risks are brought down considerably. The pool of assets
should carry identical dates of interest payment and maturities. Assets that stand a
chance of being sold to investors ideally should have the features like:
a) Be well diversified;
b) Have a statistical history of loss experience;
c) Be homogenous in nature;
d) Be broadly similar in repayment and final maturity structures; e) be to some extent
liquid
Stage 2: Structuring the Asset Backed Securities (ABS):

In a typical securitization deal, the asset originator creates a SPV and sells reference
assets to the same. The SPV can either be a trust, corporation or form of partnership set
up specifically to purchase the originator’s assets and act as a conduit for the payment
flows. Payments advanced by the originators are forwarded to investors according to
the terms of the specific securities. The SPV then structures the ABS based on the
preferences of the originator and the investors. To make the ABS attractive to the
investors, issuers follow some credit enhancement procedures. Credit enhancement in
securitization is a way of increasing the credit quality of the security above the
original loan pool to increase the likelihood of buyers receiving payment. After

12
structuring the ABS, they are offered to the investor public through a merchant banker.
The issuer takes up the responsibility of creating a market in the securities that are
created. However, as per the RBI Guidelines on Securitisation issued in May 2012
prohibit stipulation of credit enhancement for assignment transactions, thus exposing
the purchasing banks to the entire credit risk on the as- signed portfolio.

Stage 3: Investor Servicing:

The investor is serviced by periodic payments depending on the nature of the ABS.
According to the terms of the issue, the investor may be paid interest periodically and
the principal at the end of the maturity as a bullet payment. Or they may be paid both
interest and principal periodically over the period of maturity. Investors buy this risk if
they see the risk as a diversifying asset, the risk premium demanded by them for
underwriting such a risk is lower than the internal funding costs of the originator who
has a concentration of such a risk

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5.1. Parties/Players involved in a Securitisation Transaction /Process:
Primarily there are three parties to a securitisation transaction:

 The Originator: The Originator is the entity that securitises its assets. He is the
original lender/supplier who sells the receivables due from its debtors (the
Obligors). Typically, the Originator is a Development Financial Institution, a
Bank, Non-Banking Financial Company, Housing Finance Company or a
Manufacturing/ Service Company. This is the entity on whose books the assets
to be securitised exist. It is the prime mover of the deal i.e. it sets up the
necessary structures to execute the deal. It sells the assets on its books and
receives the funds generated from such sale, the Originator transfers both legal
and the beneficial interest in the assets to the Special Purpose Vehicle (SPV).

 The SPV: This entity is the issuer of the bond/security paper and is typically a
low-capitalized entity with narrowly defined purposes and activities. It usually
has independent trustees / directors. The SPV buys the assets to be securitized
from the Originator, holds the assets in its books and makes upfront payment to
the Originator. Since securitisation involves a transfer of receivables from the
Originator, it would be inconvenient, to the extent of being impossible, to
transfer such receivables to the investors directly, since the receivables are as
diverse as the investors themselves. Besides, the base of investors could keep
changing, as the security is marketable. Thus, it is necessary to bring in an
intermediary that would hold the receivables on behalf of the end investors. This
entity is created solely for the purpose of the transaction: therefore, it is called a
special purpose vehicle.

14
  The Investors: The investors could be either individuals or institutions like
financial institutions (FIs), mutual funds, pension funds, insurance companies,
etc. The investors buy a participating interest in the total pool of assets and
receive their payments in the form of interest and principal as per an agreed
pattern.

Apart from these three primary players, others players involved in a securitisation
transaction include:

 The Obligor(s): The obligor is the Originator’s debtor or the borrower of the
original loan. The credit standing of the Obligor is very important in a
securitisation transaction, as the amount outstanding from the Obligor is the
asset that is transferred to the SPV.

 The Rating Agency: The rating process assesses the strength of the cash flows
and the mechanism designed to ensure full and timely payment. In this regard
the rating agency plays an important role as it assesses the process of selection of
loans of appropriate credit quality, the extent of credit and liquidity support
provided and the strength of the legal framework.

 Administrator or Servicer: Also called as the receiving and paying agent, it

collects the payment due from the Obligor(s) and passes it to the SPV. It also
follows up with delinquent borrowers and pursues legal remedies available
against defaulting borrowers.

 Agent and Trustee: It oversees that all the parties involved in the securitisation
transaction perform in accordance with the securitisation trust agreement. Its
principal role is to look after the interests of the investors.

15
 External Credit Enhancements: Underwriters sometime resort to external credit
enhancements to improve the credit profile of the instruments. There are various
types of external credit enhancements such as surety bonds, third-party
guarantees, letters of credit (LC) etc.

 Structurer (Investment Banker): Normally, an investment banker is responsible

for bringing together the Originator, credit enhancer, the investors and other
partners to a securitisation deal. He also helps in structuring the deals along with
the Originator.

 The segmentation of roles of different parties to the securitisation deal helps in

building specialisation and introducing efficiencies. The entire process is broken
into distinct parts with different parties concentrating on origination of loans,
raising funds from the capital markets, servicing of loans, etc.

16
5.2. Typical Securitization structure:

17
5.3. Basic procedure/process/steps of Securitisation of Receivables:

 The originator either has or creates the underlying assets, that is, the transaction
receivables out of which he will securitise.
 The originator selects the receivables to be assigned.
 A special purpose entity is formed.
 The special purpose company acquires the receivables at their discounted value
(or nominal value if originator's profit is to be retained).
 The special purpose vehicle issues securities to investors- either debt type
securities or beneficial interest certificates. These are publicly offered or privately
placed as found conducive.
 The servicer for the transaction is appointed, normally the originator.
 The debtors are/ are not notified depending on the legal requirements.
 The servicer collects the receivables, usually in an escrow mechanism, and pays
off the collection to the SPV.
 The SPV either passes the collections to the investors, reinvests the same to pay
off to investors at stated intervals.
 In case of any default, the servicer takes action against the debtors as the SPV's
agent.
 When only a small amount of outstanding receivables are left to be collected, the
originator usually cleans up the transaction by buying back the outstanding
receivables.
 At the end of the transaction, the originator's profit, if retained and subject to any
losses to the extent agreed by the originator, in the transaction is paid off.

18
5.4. Types of Key Risks Involved in Securitization Transaction

19
Chapter: 6.Types of Securitization:

The two most common type of securitization are:

 Mortgage Backed Securities
 Asset Backed Securities

 Mortgage Backed Securities: MBS are securities wherein mortgages are pooled
together and undivided interests or participations in the pool are sold. The
mortgage backing, a pass through security is generally of the same loan type in
terms of amortization level, payment, adjustable rate etc. Moreover they are
similar to with respect to maturity and loan interest rate to the extent where the
cash flows can be projected as if the pool were a single mortgage. The originator
services the mortgages collecting the payments and passing through the
principal and interest to the security holders after deducting the servicing,
guarantee and other fees

 Asset Backed Securities: are securities backed by financial assets. These assets
generally are receivables other than mortgage loans and may consist of credit
card receivables, auto loans, manufactured housing contracts, junk bonds,
equipment leases, small business loans guaranteed by some agency home equity
loans etc. They differ from other kind of securities offered in the sense that their
creditworthiness is derived from sources other than the paying ability of the
originator of the underlying assets. They are secured by collaterals and credit is
enhanced by internal structural features or external protections which ensure
that obligations are met.

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6.1. Types of Securitization Instrument:

 Pass through Securities: Also know as participation certificates, it represents direct

ownership interest in the underlying asset pool. All the periodic payments of principal
and interest are collected by the servicer and passed on to the investors. In this structure
there is no modification of the cash flow as it is received from the obligor(s).

 Tranched Securities: In this type of security, the cash flows from the obligors are
prioritised into tranches. The first tranche receives the first priority of payment followed
by subsequent tranches.

 Planned Amortisation (PAC) Tranches: A principal sinking fund is created that takes
care of prepayments beyond a certain band. This ensures stability of cash flows and
hence offers lower yields compared to similar tranches without a sinking fund.

 Z-Tranches or Accretion Bonds: No interest is paid during a certain period (lock out
period) during which the face value of the bond increases due to accrued interest. After
the lock out period, the tranche holders start receiving interest and principal payments.

 Principal Only (PO) Securities: The PO investors receive only the principal component
of the underlying loans. These bonds are usually issued at a deep discount to their face
value and redeemed at face value.

21
 Interest Only (IO) Securities: The IO investors receive only the interest component of
the underlying loans. These securities have no face or par value and its cash flow
diminishes as the principal is repaid or prepaid.

 Floater and Inverse Floater Securities: The floater and inverse floaters are instruments
that pay a variable interest rate linked to an index such as LIBOR. The Floater pays an
interest rate in the same direction of interest rate movements while a reverse floater pays
an interest rate in the opposite direction of the interest rate movements.

 Amortizing and Non-amortizing Securities: The principal repayment for instruments

issued could be done either by a) repaying total amount at maturity, or b) throughout
the life of the security. The latter refers to a schedule of payments called amortisation
schedule and securities issued under this are called amortizing securities. Loans having
this feature include car & home loans.

22
6.2. Types of Securitization Structure:

The SPV pre-designs the type of bonds to be issued depending on the deal structure.
The broad type of securitisation structures include:
 Cash vs. Synthetic Structures: Most transactions world over follow the cash
structure in which the originator sells assets and receives cash instead. In a
synthetic transaction, the seller keeps his title and investment on the assets
unaffected. In other words, he does not sell assets for cash but merely transfers
risks/rewards relating to the asset by entering into a derivative transaction.
When securities are issued by the SPV, they carry such embedded derivative.
Synthetic securitisation is gaining popularity in Europe and Asia.
 True Sale vs. Secured Loan Structures: The true sale structure involves sale of a
specific pool of assets where the originator tansfers both the legal and the
beneficial interest in the assets. In a secured loan structure, the originator takes a
loan similar to any secured lending. Investor rights in this case are protected by
creating a fixed and a floating charge over the undertaking of the originator in
favour of a security trustee. The assets are generic assets of the originator and the
trustee is empowered to take possession of the assets at times of certain trigger
events to prevent the assets from being burdened any further. The use of secured
loan structure depends on the legal provisions of the country concerned. The
secured loan structure is more popular in the UK.
 Pass Through vs. Collateral Structure: In a pass through structure, the SPV
issues participation certificates that enable investors to take a direct exposure on
the performance of the securitised assets. Investors are serviced as and when
cash is actually generated by the underlying assets. Risks like delay/disruptions
in cash flows are mitigated via credit enhancement. (As investors do not have
recourse to the Originator, they seek comfort through credit enhancement
methods by which risks intrinsic to the transaction are re-allocated.) Pass
through structure is the most basic and simplest way of securitisation in

23
 mortgage markets. In a collateral structure (also known as pay through
structure), the SPV retains the assets to be securitised with it and gives investors
only a charge against the securitised assets. The SPV issues debt that is
collateralised by the assets that are transferred by the originator. This is also
referred to as the Pay through structure and popularly known as collateralised
mortgage obligations (CMO).
 Discreet Trust vs. Master Trust: Discreet trust implies one SPV for a single
identified pool of assets where investors participate in the cash flow of the pool.
In the creation of a master trust, the Originator sets up a large fund in which
large pools of receivables are transferred, much larger than the size of the
funding raised by investors. Several security issuances can be created from this
fund either concurrently or consecutively. The master trust serves as a tool to
create disparities between the repayment structures and the tenure of the
securities and assets in the pool. Master trusts are increasingly becoming the
preferred mode of securitisation as a result of their flexibility.
 Conduit vs. Standalone Transactions: In conduit transactions, the purchaser or
conduit sources the assets from multiple originators and securitises the assets by
issuing asset-backed commercial paper. Since commercial papers of short term
duration, it becomes necessary for the conduit to avail of short term or bridge
financing from banks. In standalone transactions, the conduit purchases the
assets from a single originator. In this case the conduit issues securities of a
maturity matching the maturity of the underlying asset pool.

24
Chapter: 7.Features of Securitisation
A securitised instrument, as compared to a direct claim on the issuer, will generally
have the following features:

1. Marketability: The very purpose of securitisation is to ensure marketability to

financial claims. Hence, the instrument is structured to be marketable. Marketability
involves two postulates: (a) the legal and systemic possibility of marketing the
instrument (b) the existence of a market for the instrument.
In most jurisdictions of the world, well-coded laws exist to enable and regulate the
issuance of traditional forms of securitised claims, such as shares, bonds, debentures
(negotiable instruments). Most countries do not have legal systems pertaining to
securitised products, of recent or exotic origin, like securitisation of receivables. It is
imperative on part of the regulator to view any securitised instrument with the same
concern as in case of traditional instruments, for investor protection. However, where a
law does not exist to regulate such issuance, it is naïve to believe that it is not permitted.
The second issue is of having a market for the instrument. Securitisation is a fallacy
unless the securitised product is marketable. The purpose will be defeated if the
instrument is loaded on to a few professional investors without any possibility of
having a liquid market therein. Liquidity is afforded either by introducing it into an
organised market (securities exchanges) or by one or more agencies acting as market
makers, i.e., agreeing to buy and sell the instrument at pre-determined or market-
determined prices.

2. Merchantable Quality: To be market-acceptable, a securitised product has to have

merchantable quality. Merchantable quality in case of financial products, means the
financial commitments embodied in the instruments are secured to the investors'
satisfaction. “To the investors’ satisfaction” is a relative term, and therefore, the
originator of the securitised instrument secures the instrument based on the needs of

25
the investors. The general rule is: the more broad the base of the investors, the less is the
investors’ ability to absorb the risk, and hence, the more the need to securitise.
For widely distributed securitised instruments, quality evaluation, and its certification
by an independent expert, viz., rating, is common. The rating is for the benefit of the lay
investor, who is otherwise not expected to be able to appraise the degree of risk
involved.
Securitisation is a case where a claim on the debtors of the originator is being bought by
the investors. Hence, the quality of the claim of the debtors assumes significance, which
at times enables investors to rely purely on the credit-rating of debtors and so, makes
the instrument totally independent of the originators’ own rating.

3. Wide Distribution: The basic purpose of securitisation is to distribute the product.

The extent of distribution, which the originator would like to achieve, is based on a
comparative analysis of the costs and the benefits achieved thereby. Wider distribution
leads to a cost-benefit, as the issuer is able to market the product with lower financial
cost. But a wide investor-base involves costs of distribution and servicing.
In practice, securitisation issues are still difficult for retail investors to understand.
Hence, most securitisations have been privately placed with professional investors.
However, in time to come, retail investors could be attracted to securitised products.

4. Homogeneity: To serve as a marketable instrument, the instrument should be

packaged into homogenous lots. Most securitised instruments are broken into lots,
affordable to the marginal investor, and hence, the minimum denomination becomes
relative to the needs of the smallest investor. Shares in companies may be broken into
slices as small as Rs.10 each, debentures and bonds are sliced into Rs.100 to Rs.1000
each. Designed for larger investors, a commercial paper may be in denominations as
high as Rs. 5Lac. Other securitisation applications may also follow this logic.
The integration of several assets into one lump, and then their differentiation into
uniform marketable lots often invites the next feature: an intermediary for this process.

26
5. Special Purpose Vehicle (SPV): In case, the securitisation transaction involves any
asset or claim which needs to be integrated and differentiated, unless it is a direct and
unsecured claim on the issuer, the issuer will need an intermediary agency to act as a
repository of the asset or claim being securitised. Thus, the issuer will bring in an
intermediary agency to hold the security charge on behalf of the investors, and then
issue certificates to the investors of beneficial interest in the charge held by the
intermediary. So, the charge continues to be held by the intermediary, but the beneficial
interest becomes a marketable security.

7.1. Advantages of Securitisation for the Issuer

1. Lower cost
Cost reduction is one of the most important motivations in securitisation. Securitisation
seeks to break an originating company's portfolio into echelons of risks, trying to align
them to different investors' risk appetite. This alchemy supposedly works - the
weighted overall cost of a company that has securitised its assets seems to be lower than
a company that depends on generic funding. One of the most tangible effects of
securitisation is to reduce the extent of risk capital or equity required for a given
volume of asset creation. Assuming that equity is the costliest of all sources of capital,
lower equity requirements do result into lower costs.
Securitisation enables the originator to achieve a rating arbitrage - obtain a rating that a
generic funding could not have. Such a rating is possible due to the structural
enhancements in securitisation – senior/junior structures, or a Z-bond structure.
In future flows securitisation; the objective of the originator is to achieve ratings higher
than the rating of the entity or the rating of the originator’s country. As securitisation
makes such higher ratings possible, it enables the originator to borrow at lower costs.
2. Retail distribution of assets
Securitisation enables a financial intermediary to retail-market its assets to a large
section of investors. The intermediary’s role is changed from a fund-based intermediary

27
to a distributor of an asset, while maintaining its spreads. Retail distribution of
liabilities remains the aim of any financial firm. Securitisation offsets a retail liability
against a retail asset, and hence, achieves this purpose.
3. Makes the issuer-rating irrelevant
Being an asset-based financing, securitisation may make it possible even for a low-rated
borrower to seek cheap finance, purely on the strength of the asset-quality. One of the
common statements, rating companies make is: in a normal debt issuance, we rate a
product. In structured finance, the issuer dictates the rating, and the structure is worked
out accordingly. It is possible to obtain a AAA rating for securitised products,
irrespective of the originator’s rating -there should be adequate legal protection against
the originator’s bankruptcy and adequate credit enhancement.
4. Off-balance sheet financing
Financial intermediaries look at securitisation essentially as an off-balance-sheet
funding method. The off-balance sheet feature could be looked at either from the
accounting viewpoint, or from the regulatory viewpoint. The latter is relevant for
computation of regulatory capital or capital adequacy requirements. From the
accounting viewpoint: the tendency, of financial institutions and others, to prefer off-
balance sheet funding over on-balance sheet funding is because the former allows
higher returns on assets, and higher returns on equity, without affecting the debt-equity
ratio. As tools of managerial performance, these have a definite relevance.
Securitisation allows a firm to create assets, make income thereon, and yet put the assets
off the balance sheet the moment they are transferred through securitisation. Thus, the
income from the asset is accelerated and the asset disappears from the balance sheet,
leading to an improvement in both income-related ratios as also asset-related ratios.
5. Helps in capital adequacy requirement
Capital adequacy requirements are requirements relating to minimum regulatory
capital for financial intermediaries. A very strong motivation for securitisation is that it
allows the financial entity to sell some of its on-balance sheet assets, and remove them
from the balance sheet, and hence reduce the amount of capital required for regulatory

28
purposes. Alternatively, if the amount raised by selling on-balance-sheet assets is used
for creating new assets, the entity is able to increase its asset-creation without a haircut
for its capital.
Motivated by this, large commercial banks have made extensive use of securitisation.
This has led to formation of some regulations on capital requirements for securitisation
in different countries. These regulatory requirements define the conditions subject to
which securitisation will be given off-the-balance-sheet treatment, and, if off the balance
sheet, the required capital deduction for the risks retained by the originator.
In spite of these guidelines, it is a common experience that securitisation has enabled
banks either to reduce the level of their on-balance sheet assets, or to achieve a higher
amount of asset-generation with a given amount of capital.
6. Improves capital structure
By being able to market an asset outright (while not losing the stream of profits therein),
securitisation avoids the need to raise a liability, and hence, it improves the capital
structure. Alternatively, if securitisation proceeds are used to pay off existing liabilities,
the firm achieves a lower debt-equity ratio.
The improvement of capital structure as a result of lower debt-equity ratio may not be a
mere accounting gimmick - if securitisation results into either transfer of risks inherent
in assets, or capping of such risks, there is a real re-distribution of risks taking place,
leaving the firm with a healthier balance sheet and reduced risk.
7. Better opportunity of trading on equity with no increased risk
This point is a re-statement of the accounting and capital-adequacy-related benefits,
discussed earlier. The ability to create assets, as a result of off-balance-sheet treatment
and regulatory freedom, results into more profits and hence a stronger firm.
8. Extends credit pool
Securitisation keeps the other traditional lines of credit undisturbed; hence, it increases
the total financial resources available to the firm. Many firms, in addition to regular
borrowings have tried securitisation, not in place of it.

29
9. Not regulated as a loan
Most countries have laws regulating borrowing abilities of financial companies, since
they are taken as para-banking companies. Securitisation does not suffer borrowing-
related fetters, as it is not taken by regulation to be debt. E.g., a regulation relating to
borrowings from public will not be attracted, since it is not a case of borrowing.
From the point of view of law, often, the distinction between securitisation and
borrowing is based on a strict interpretation of the word "borrowing": thus,
securitisation with recourse may not qualify for off-balance sheet purposes or for capital
adequacy requirements, but when it comes to a borrowing-related legislation, the same
is not to be taken as a debt. In India, for example, securitisation will escape regulation
pertaining to raising of deposits by financial companies, as such regulation is a part of
the law not a prudential regulation.
10. Reduces credit concentration
Securitisation has also been used by many entities for reducing credit concentration.
Concentration, either sectoral or geographical, implies risk. Securitisation by
transferring on a non-recourse basis by an entity has the effect of transferring risk to the
investor.
11. Escapes taxes based on interest
For technical purposes, securitisation would not be treated as "interest" on loans. Hence,
if there are taxes based on interest earnings, they would not be applicable to investors'
earnings in securitised products. In India, interest-tax on interest income of banks/
financial institutions will not be applicable in case of investments in securitised
products. Besides, withholding taxes that apply solely to interest payments will not
apply in case of a tax-acceptable securitisation.

30
7.2. Advantages of Securitisation for the Investors
Needless to emphasise, advantages to the originator would not carry much relevance
unless securitisation was an attractive option for investors too. All over the world,
investors, particularly institutional investors, have shown active interest in investing in
securitised products. Rating agencies have helped in promoting these interest levels
since most securitised products have obtained good ratings, and in several cases, even
with the downgrading of the entity, the structured finance offerings have not been
downgraded.

Who are securitisation investors?

Securitisation has drawn in a large cross-section of investors. The mortgage pass-
throughs in the USA are actively traded in organised markets and have drawn both
institutional and retail investors. But other asset classes resulting in creation of
securities are not easy for retail investors to understand. Besides, being high- grade, low
return and fixed income securities, securitisation has basically drawn institutional
investors.
Some securitisation investors: high net worth individuals looking at diversification and
hedging, pension funds, insurance companies, bank trust departments, investment
funds, commercial banks, finance houses, mortgage banks, etc.

31
Investor Motivations
1. Good ratings
As already noted, many structured finance offerings have obtained good ratings. With
increasing institutionalisation of investment, investments are being managed by
professional managers who prefer a formally rated instrument to an unrated one.
2. Better matching with investment objectives
Securitised instruments are flexible to match with investors’ investment objectives.
Investors looking for a safe high-grade investment can pick a senior most A-type
product. Those looking for a mediocre risk with higher rate of return can opt for a B-
type option. Investors can also look at investing over a short term, medium term or long
term.
3. Yield premiums
Securitised offerings have offered good yields with adequate security. Empirical data
reveal that an investor who maintained a good balance of emerging market and
developed market offerings has been able to come out with good rates of return.
4. Lesser regulation
If there are any regulations or taxes applicable on investment products, it is unlikely
that they will apply to securitisation products. E.g., investments by non-financial
companies may be limited by a statute, such as Sec372A of the Companies Act in India:
but this limitation will not apply to a securitisation transaction.

32
7.3. Limitations of Securitisation
1. Costly source
The aggregate cost of securitising assets is theoretically expected to be lower than the
cost of mainstream funding. However, securitisation has been shown to be a costly
source, primarily in emerging markets. Being a new product, investors pay a penalty for
their own lack of understanding. Also, the costs of rating and legal fees tend to be huge.
2. Uneconomical for lower requirements
The huge upfront costs in the form of rating fees and legal costs, including stamp duties
where applicable, would add up to a heavy initial payment. Securitisation in order to be
cost effective has to be limited to large sourcing.
3. Passes on data-base to investors
One of the most important limitations of securitisation is that the entire data about the
receivables is passed on to the SPV. The SPV may technically be under the control of the
originator himself, but beneficiaries have a legal right to inspect the books of the SPV.
Hence, in a competitive environment, a competitor may corner the company's portfolio
and push the originator out of the market.
4. Leaves the entity with junk assets
If the investors prefer cherry-picked assets, securitisation will leave the originator with
junk assets. If one imagines an entity as a composite of good, medium and poor assets,
if the good assets are chipped off, what remain are junk assets. The Bank for
International Settlements in a 1992 publication, said: It is sometimes contended that
banks in seeking a good market reception for their securitised assets may tend to sell
their best quality assets and thereby increase the average risk in their remaining
portfolio. Investor and rating agency demand for high quality assets could encourage
the sale of an institution's better quality assets. Such arguments are not easy to support
with empirical evidence. Banks that have securitised large amounts of assets do not
exhibit signs of lower asset quality. Banks, which constantly securitise assets, are
necessarily interested in maintaining the quality of their loan portfolio. Any asset-

33
quality deterioration would affect their reputation and their rating and indeed the
capital adequacy requirement imposed by their supervisors.

7.4. Securitisation as a Strategic Tool of Risk Management

 Securitisation is more than just a financial tool. It is an important tool of risk
management for banks.

 It primarily works through risk removal but also permits banks to acquire
securitised assets with potential diversification benefits.

 When assets are removed from a bank's balance sheet, without recourse, all the
risks associated with the asset are eliminated.

 Credit risk is a key uncertainty that concern domestic lenders. By passing on this
risk to investors, or to third parties when credit enhancements are involved,
financial firms are better able to manage their risk exposures.

34
Chapter: 8.Securitization as a Strategic Tool for Competitiveness:
8.1. Benefits of Securitization:
 Globalisation, deregulation of financial markets and growing cross border
business transactions has reset the ambience among financial institutions,
increasing manifold opportunities for financial engineering.
 Securitisation increases the lending capacity of an FI without having to find
additional capital or deposits.
 Securitisation facilitates specialisation and is gaining wide acceptance as the most
innovative form of asset financing.
 A significant impact of securitisation is the profiling and placement of different
risks and rights of an asset with the most efficient owners.
 It provides capital relief, improves market allocation efficiency, expands
opportunities for risk sharing and risk pooling, increases liquidity, improves the
financial ratios of FIs and banks, creates multiple streams of cash flows for the
investors, is tailored to the risk profile of a number of customers and facilitates
asset-liability management.
 The requirements for capital adequacy in recent years have also motivated
financial institutions and banks to securitise.

On the demand side, investors are motivated to buy these securities as they view these
as having risk characteristics, compatible with the profile.

35
8.2. Benefit of Securitization to the FIs in different ways by:
(i) Providing strategic choices;
(ii) Reducing funding costs;
(iii) Developing core competencies in certain areas. For example, some
institutions specialise in originating and servicing, not financing at all. Other
institutions expand business volume without expanding their capital base in
the same proportion. The process helps in identifying cost pools of various
activities in the value chain. Securitisation is changing the horizons of
traditional banking significantly:
Liquidity
 Fund raising through securitisation is independent of the Originator's rating. The
market for securities is more efficient than for bulk asset sales as the latter is
illiquid. Many banks are trapped in a situation where they can't rollover their
debt due to downgrading of the ratings of the issuer below investment grade
consequent upon the changes in economic environment. This happens when long
term assets are being financed by short-term liabilities (CP. etc.) which are rolled-
over from time to time. Securitisation enables FIs to increase the rating of debt
much higher than that of the issuer through intrinsic credit of the assets
themselves. This enables the FIs to obtain funding which was not feasible earlier.
 The funds raised by some of the banks in Emerging Markets are examples in the
point. The liquidity provided by securitisation makes it an extremely powerful
tool, which can be used by management to adjust asset mix quickly and
efficiently.
 The risks in an asset portfolio can be divided and apportioned so that some risks
are transferred while others are retained. Liquidity is also increased through
fractionalised interest that is marketable to a broader range of suppliers of
capital.

36
Risk Tranching / Unbundling
 A securitised transaction is structured to reallocate certain risks inherent in the
underlying assets such as prepayment risk and concentration risk. With reduced
or reallocated risks and greater liquidity, securities are more appealing to a
wider range of purchasers and, consequently, the yield required to sell them will
be lower.
 Securitisation can modify the risk exposure of investors to various risks by
creating securities that allocate these risks according to specific rules. The
institution can then sell the securities, which have risk characteristics not suitable
to the organisation and keep those with risk profile matching the overall mission
of the organisation. An example is the practice of subordinating one tranche of a
security to another for credit enhancement. A security may be divided into two
trances, A class and B class, the former giving lower yields but having priority
over claims than B class security.

Asset- Liability Management

 Some FIs in the Emerging Markets are not in a position to raise long-term
international borrowings due to various limitations including the size of the
institution, the sovereign limitation, etc. Securitisation helps in improving the
rating for particular deal much above the institution's rating and enables the
institution to raise funds for a longer period. This facilitates in matching the
tenure of the liabilities and the assets.
 Securitisation allows flexibility in structuring the timing of cash flows to each
security tranche. In general, securitisation provides a means whereby custom or
tailor made securities can be created. For example, a typical security issuer might
wish to shorten the duration of a portfolio of mortgage loans. The liabilities
against which mortgage loans are funded may have shorter duration than the
assets. To minimise the gap mismatch, the issuer bank may create two Classes" of
securities from mortgages sequential pay securities i.e. the second security

37
 receives only interest until the principal and interest for the first security has
completely been paid. The second security receives principal and interest only
thereafter. Selling the second one and retaining the first one shortens the
duration of its asset portfolio.
 Securitisation also segments funding and interest rate risk so that it can be
tailored and placed amongst appropriate investors. The other risk in the
mortgage finances is the incidence of early payment that arises as borrowers
foreclose their loans due to various reasons. Creating multiple tranche from the
common pool of receivables and thereby providing instruments, which have
different types of early payment risks.

Systems/Reporting
 Securitisation provides the incentive to an FI to mmage its loan portfolio better
and keep better track of delinquencies and put more pressure on them to pay, in
order to keep the cost of future credit enhancement low. The portfolio has to be
made more transparent to rating agencies and the investors. This permits easier
mapping of internal risk codes with the external agency letter ratings needed to
set pool risk ratings and enhancement levels. One important operational concern
that new issuers of ABS face is that of inadequate historical data on the assets
and their performance. Data on loan payments etc. are many times not
considered important for the ongoing maintenance of asset portfolio. These
involve heavy costs for FIs in the Emerging Markets.
 The need to document the policies and procedures for originating, monitoring
and servicing the assets to meet the requirements of the rating agencies helps FIs
tone up their systems. The responsibility / accountability of FIs extend from
equity holders to the investors of securitised bonds.
 MIS improves the transparency, uniformity and judicious decision making.
Decisions can be identified and ongoing improvements in the quality of service
can be- undertaken.

38
Originator Discipline
 The discipline that securitisation provides not only in the treasury area of the
seller but throughout all other aspects of business has an increasingly positive
influence on an FI. Both the demands of adhering to strict underwriting criteria
and compliance with the asset servicing covenants provide the seller with the
necessary incentives with which to manage its business.
 Securitisation encourages best practices Client Relationship effect The sale of
loans as securities while retaining the customer contact through loan servicing
gives the Originator access to deposits and other customer service opportunities.
Ownership of customer-remains with the servicer by virtue of billing and
collection procedures; only ownership of the financial instruments is transferred
to the new investors. Thus the servicer benefits from customer relation without
the obligation to keep his loan on the balance sheet.

Pooling
 Similar debt instruments can be pooled to enhance creditworthiness and
transform illiquid loans into liquid market securities. MBSs, automobiles, credit
cards are the examples. In the case of life insurance, by pooling a large number of
similar people, uncertainty of a single person's default can be transformed into
risk that can be priced, because objectively known probabilities can be attached
to default. In the case of automobile loans, investors don't feel secure because
they can repossess an automobile if a borrower defaults, but rather because, on
average, these borrowers are unlikely to default beyond the level of credit
enhancement.

 Automobile loans are marketable because investors can place a good bet on the
pooled characteristics of people who borrow to purchase autos. Once they are
pooled, auto loans have a demonstrably low risk of default (lower than the
mandated capital requirement). As it is inefficient to hold them on bank's balance

39
 sheets, the market will find ways to release some bank capital that is tied up
because of regulations that insure risk that the market does not perceive.
 Grouping of financial assets (loans etc.) into homogeneous pool facilitates
actuarial analysis of risks. It also makes it easier for third parties such as credit
rating agencies and credit enhancers to review and reinforce the credit
underwriting decisions taken by the original lenders.

8.3. Benefits Securitization to Investors:

 Securitized assets offer a combination of attractive yields (compared with other

instruments of similar quality), increasing secondary market liquidity, and
generally more protection by way of collateral overages and/or guarantees by
entities with high and stable credit ratings.
 They also offer a measure of flexibility because their payment streams can be
structured to meet investors’ particular requirements.
 Most important, structural credit enhancements and diversified asset pools free
investors of the need to obtain a detailed understanding of the underlying loans.
This has been the single largest factor in the growth of the structured finance
market.
For Borrowers
 Borrowers benefit from the increasing availability of credit on terms that lenders
may not have provided had they kept the loans on their balance

40
Chapter: 9.Economic impact of securitisation
Securitisation is as necessary to the economy as any organised markets are. While this
single line sums up the economic significance of securitisation, the following can be
seen as the economic merits of securitisation:

1. Facilitates creation of markets in financial claims: By creating tradable securities

out of financial claims, securitisation helps to create markets in claims. It makes
financial markets more efficient by reducing transaction costs.

2. Disperses holding of financial assets: The basic intention of securitisation is to

spread financial assets amidst as many inestors as possible. Thus, the security is
designed in minimum size marketable lots. Hence, it results into dispersion of financial
assets. One should not underrate the significance of this factor just because institutional
investors have lapped up most of the recently developed securitisations. Lay investors
need a certain cooling-off period before they understand a financial innovation.

3. Promotes savings: The availability of financial claims in a marketable form, with

proper credit ratings, and with double safety nets in form of trustees, etc., securitisation
makes it possible for lay investors to invest in direct financial claims at attractive rates.
This promotes savings.

4. Reduces costs: As securitisation tends to eliminate fund-based intermediaries, and

leads to specialisation in intermediation functions, it saves the end-user company from
intermediation costs, since the specialised-intermediary costs are service-related, and
generally lower.

41
5. Diversifies risks: Financial intermediation is a case of diffusion of risk because of
accumulation by the intermediary of a portfolio of financial risks. Securitisation further
diffuses such diversified risk to a wide base of investors.

6. Focuses on use of resources, and not their ownership: Once an entity securitises its
financial claims, it ceases to be the owner of such resources and becomes merely a
trustee or custodian for the several investors who thereafter acquire such claim. In this
sense, securitisation carries Gandhi's idea of a capitalist being a trustee of resources and
not the owner. Securitisation in its logical extension will enable enterprises to use
physical assets even without owning them, and to disperse the ownership to the real
owner thereof: the society.

42
Chapter: 10.Problems with Securitization in India

Issues facing the Indian Securitisation Market

 Stamp Duty: One of the major hurdles facing the development of the
securitisation market is the stamp duty structure. In India, stamp duty is payable
on any instrument which seeks to transfer rights or receivables. Therefore, the
process of transfer of the receivables from the originator to the SPV involves an
outlay on account of stamp duty, which can make securitisation commercially
unviable in states that still have a high stamp duty. Few states have reduced their
stamp duty rates, though quite a few still maintain very high rates ranging from
5-12 per cent. To the investor, if the securitised instrument is issued as
evidencing indebtedness, it would be in the form of a debenture or bond subject
to stamp duty, and if the instrument is structured as a Pass Through Certificate
(PTC) that merely evidences title to the receivables, then such an instrument
would not attract stamp duty. Some states do not distinguish between
conveyances of real estate and that of receivables, and levy the same rate of
stamp duty.
 SEBI has suggested to the government on the need for rationalisation of stamp
duty with a view to developing the corporate debt and securitisation markets in
the country, which may going forward be made uniform across states as also
recommended by the Patil Committee.
 Foreclosure Laws: Lack of effective foreclosure laws also prohibits the growth of
securitisation in India. The existing foreclosure laws are not lender friendly and
increase the risks of MBS by making it difficult to transfer property in cases of
default.
 Taxation related issues: There is ambiguity in the tax treatment of mortgage
based securities, SPV trusts, and NPL trusts. Presently, the investors or the
buyers (PTC and SR holders) pay tax on the earnings from the SPV trust. As a
result the trustee makes income payouts to the investors without any payment of

43
 tax. The Income Tax law envisages the taxation of an unincorporated SPV either
at the trust SPV level or the investor level in order to avoid double taxation.
Therefore, any tax pass through regime merely represents a stance that the
investors in the trust will bear the tax liability instead of the Trust being held
liable to tax the investors on their respective earnings.
 Issues under the SARFAESI Act: A security receipt (SR) gives its holder a right
of title or interest in the financial assets included in securitisation. This definition
holds good for securitisation structures where the securities issued are referred
to as pass through certificates. However, the rationale fails in the case of pay
through certificates with different classes of primary and secondary rights to the
cash flow. Also, the SARFAESI Act has been structured such that SRs can be
issued and held only to Qualified Institutional Buyers (QIBs). There is a need to
expand the investor base by including NBFCs, non-NBFCs, private equity funds,
etc.
 Legal Issues: Investments in PTCs are typically held-to-maturity. As there is no
trading activity in these instruments, the yield on PTCs and the demand for
longer tenures especially from mutual funds is dampened. Till recently, Pass
through Certificates (PTC) were not explicitly covered under the Securities
Contracts (Regulation) Act, definition of securities. This was however ammended
with the Securities Contracts (Regulation) Amendment Act, 2007 passed with a
view to providing a legal framework for enabling listing and trading of
securitised debt instruments. This will bring about listing of PTCs which in turn
will support market growth.

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Other Loop holes in Securitization market in India

 In India, securitizations espouse a trust structure i.e. the assets are transferred
by way of sale to a trustee, who holds it in trust for the investors. In this
situation, a trust is not a legal entity in law but it is entitled to hold
property that is distinct from the property of the trustee. Therefore, the trust
performs the role of the special purpose vehicles (SPV). SARFAESI is quite
inadequate in commercial practice. Major shortcomings of the Act are:

 A security receipt (as defined in sub-clause 2 of SARFAESI Act) gives its holder a
right of title in the financial asset involved in securitization. This definition
holds good for structures where ‘Pay through Securities’ (PTCs) are issued.
However, there is a lack of strong provision in case of PTC.

 Secondly, the legislation does not contain effective foreclosure laws. If an SPV
wants to foreclose an asset owing to a default by a party, it has to resort to the
traditional means of litigation, which is time consuming and expensive. The
legislation also fails to define a “true sale”, thereby, leaving it to the
interpretation of the parties. During FY2012, the Indian income tax authorities
sent notices to trustees of several securitization transactions which the trustees
in turn passed on to the investors, i.e., mutual fund houses asking them to
pay tax on income generated through pass through certificates (PTCs).
Following this move, the MFs filed petitions in the Bombay HC, seeking a relief
from the tax claim. The IT department’s stance effectively challenges this premise
and thus, a resolution to this issue could be an important factor for determining
the future of securitization going forward. Most market participants are of the
view that the most immediate and severe obstacle to securitization is this
unresolved issue of taxation of the securitization SPV.

45
 The secondary market in India for debt which could offer an easy exit route to
investors is not yet developed. Public sec- tor banks which have a huge pool of
debts have so far remained far from these products. Trusts and Provident Funds
which are the major source of huge funds, have limitations on investment in
structured products. Only regulatory changes could help more funds for
investment in these products.

 The intermediaries involved in creating a securitized product have to comply

with multiple legal provisions to give shape to the product. The financial asset is
transferred from the originator to the SPV and thus attracts relevant provisions
of Stamp Act, The Transfer of Property Act 1882, The Negotiable Instruments
Act, and Registration Act. Moreover lack of clear supporting legal provisions for
the features which are integral part of the process of securitization hinders wider
acceptability of the product.

 The securitization process attracts stamp duty at various stages. The incidence
of stamp duty is one of the major concerns which make securitization transaction
financially unviable. Typically, the rate of stamp duty ranges from 0.5 per cent to
as high as 4 to 8 percent of the value of transaction. Thus, the process of
securitization becomes too expensive. Recently, there has been significant relief
since Stamp duty has been reduced to 0.1 percent in some States.

 Registration requirements on transfer of mortgage backed receivables from

immovable property which again adds to the cost of securitization transaction
and needs to be ad- dressed. Under the Registration Act, 1908 transfer requires
compulsory registration. This also imposes additional costs to the transaction.

46
 Further some provisions of the Income Tax Act, 1961 are reported to have an
impact on securitization. For instance, Section 60 of the Act contemplates transfer
of income without transfer of assets which are the source of the income. In such a
case, the income so transferred is charge- able to income tax as the income of
the transferor and is included in his total income. Similarly, there are other sec-
tions in the Act which restrain the progress of securitization. Another
important aspect which hinders the growth of secu- ritization in India is the lack
of effective foreclosure laws. The existing foreclosure laws are not lender
friendly and increase the risks of mortgage backed securities by making it
difficult to transfer property in cases of default.

 During the acquisition and sale of the assets of the borrower by the company,
issues relating to valuation of assets and fixation of realizable value of assets
have to be cleared. Value need to be arrived in transparent manner. Such values
should be fairly discounted in the opinion of the values acting on behalf of
the concerned bank or financial institution. The problem of making distinction
between willful defaulters and others is very difficult to make. Some argue that
the decision has to lie with the creditor because the misjudgment might result
in a greater loss.

47
10.1. Accounting Treatment Issues:

Accounting is a crucial issue in securitisation, since one of the prime motivations is to

put assets off the balance sheet. Accounting for securitisation is not merely a matter of
presentation: it reflects on cost, and therefore, the very viability of the securitisation
option. If it results in putting the assets of the balance sheet, a securitisation option does
not constrain the firms’ existing financial resources, and therefore, is not an alternative
to equity; it has lesser costs. If it is a liability on the balance sheet, it competes with other
funding options.

Some issues in the accounting treatment for securitisation:

 A 'sale' treatment for accounting purposes is preferred because it would enable the
originator to put the assets off the balance sheet

 And a 'loan'/ 'financial' treatment for tax purposes would be preferable because the
gain made on assignment of receivables will not be taxable immediately
 At present, in India the basic issue with regard to accounting is: whether the
securitised assets should be considered as an off-balance sheet item or not
 As per FRS 5 (UK), where the originator has transferred all significant benefits and
risks relating to the securitised assets and has no obligation to repay the proceeds
of the note issue, derecognition, i.e., removal of the securitised assets from the
balance sheet is appropriate
 Securitisation accounting is not essentially based on risk/reward approach, but
rather the "transfer of control" approach. This means the assets have gone beyond
the reach of the transferor, where he cannot re-acquire the same, except at market
price, and the transferee is free to deal with the assets and make a profit on the
assets
 Any money received for future cash flows by the Originator should be treated as a
borrowing until its treatment as a securitised asset could be decided upon. This is

48
 justified because an asset or a liability, which may arise in future, should not be
recognized. In accounting, only the past transactions or events can give rise to assets,
liabilities, income and expenses
 The Research Committee (RC) of The Institute of Chartered Accountants of India
may consider the following issues:

o Accounting treatment in case of over-collateralisation to ensure that the

investors are not affected by the bankruptcy of the Originator.
o Inflows of proceeds in the books of Originator without corresponding
transfer of assets

If the Originator provides credit enhancements, there is said to be some recourse back
to him. In the absence of clear accounting guidelines, it is difficult to classify such
transactions as a sale treatment rather than a financing treatment. RC may examine the
issue.

49
Chapter: 11.SARFAESI Act, 2002
Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest Act 2002
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (SARFAESI Act) is a mix of three different things Securitisation, Asset
management companies and enforcement of security interests on loan defaults to banks.
The basic intention behind this act is to strengthen creditor rights through foreclosure
and enforcement of securities by banks and financial institutions. By conferring on
lenders the right to seize and sell assets held as collateral in respect of overdue loans, it
SARFAESI Act 2002 came into effect from June 21, 2002 and its provisions deal
with Securitization along with asset reconstruction and enforcement of security
interest. It facilitates asset recovery and reconstruction. The act is based upon
the recommendations of the Narasimhan Committee I and II and
Andhyarujina Committee Reports for enacting a new law for enacting a new
law for regulation of securitization and reconstruction of financial assets,
enforcement of security interest and formation of asset reconstruction
companies. This would help banks and financial institutions to deal NPA in a
better way with defaulters.
Following three major aspects are dealt in SARFAESI:
(i) Providing a legal framework for securitization of assets;
(ii) Enforcement of security interest by secured creditor (such as banks
and other financial institutions);
(iii) Transfer of non- performing assets to asset reconstruction companies,
which can be dispose-off later and realize the proceeds

50
SARFAESI has made following provisions:

(a) For registration and regulation of securitization companies or

reconstruction companies by India’s federal bank, the Reserve Bank of
India (“RBI”);
(b) To facilitate s e c u r i t iz a t io n of financial assets of banks;
(c) To empower securitization companies to raise funds by issuing security
receipts to qualified institutional buyers (QIBs);
(d) To empower banks and financial institutions to take possession of
securities given for financial assistance and sell or lease them to take over
management in the event of failure to pay.

SARFAESI Act does not permit Banks and Financial Institutions to create Special
Purpose Vehicles (SPVs) for undertaking securitization transaction. The act calls
for setting up of Securitization Companies or Reconstruction Companies with its
registration with Reserve B a n k of India (RBI) to carry on the b u s i n e s s of
securitization or asset reconstruction. This company can carry out the work of
formulation of schemes and setup (schemewise) separate trusts . A
Securitization company can act as an asset reconstruction company and vice
versa. The act provides the reconstruction company the right to acquire financial
assets of any bank by issuing debentures or bonds or any other security in the
nature of the debenture. They can also acquire assets by entering into an
agreement with such banks or financial institutions. The bank or financial
institution gets the rights of the lender in relation to any financial asset acquired
by the securitization company. Such company shall on such acquisition be
deemed to be the lender and all rights of the bank or financial institution.
The securitization company cannot raise funds f r o m retail investors. It can
devise a separate scheme for each o f the financial assets taken by it and raise
funds only from Qualified Institutional Buyers (QIBs) by developing schemes to

51
acquire assets. The company will issue security receipts to QIBs which represents
undivided interest in such financial assets. The company will realize the financial
assets and redeem the investment and will make payment to returns to QIBs
under each scheme. The company should maintain separate set of accounts in
respect of every such scheme for every financial asset which has been acquired by
the QIB. The company should also ensure the realization of such financial assets
and pay returns assured on such investments. In the case of non realization of the
financial assets the QIBs of the securitization company or reconstruction
company holding security receipts of not less than 75% of the total value of the
company is entitled to call a meeting of all the QIBs and every resolution
passed in such meeting should be binding on the company. Any dispute
between QIBs and the company shall be referred for conciliation or arbitration
under the Arbitration and Conciliation Act 1996

52
Chapter: 12.Growth of securitization in India

 The landscape of securitization has changed dramatically in the last decade. No

longer is it wed to traditional assets with specific terms such as mortgages, bank
loans, or consumer loans (called self-liquidating assets).

 Improved modeling and risk quantification as well as greater data availability

have encouraged issuers to consider a wider variety of asset types, including
home equity loans, lease receivables, and small business loans, to name a few.

 Although most issuance is concentrated in mature markets, securitization has

also registered significant growth in emerging markets, where large and highly
rated corporate entities and banks have used securitization to turn future cash
flow from hard-currency export receivables or remittances in to current cash. In
the future, securitized products are likely to become simpler.

 After years of posting virtually no capital reserves against highly rated

securitized debt, issuers will soon be faced with regulatory changes that will
require higher capital charges and more comprehensive valuation.

 Reviving securitization transactions and restoring investor confidence might also

require issuers to retain interest in the performance of securitized assets at each
level of seniority, not just the junior tranche.

53
1. FY02-FY05
SARFAESI Act provided the framework to the constitution of asset
reconstruction companies specializing in securitizing assets purchased from
banks. Through the 90s, securitization of auto loans was the mainstay of the
Indian markets. But since 2000, Mortgage Backed Securities (RMBS) have fuelled
the growth of the market. Post SARFAESI Act, the securitization market in India
matured significantly with the established band of investor community and
regular issuers. Since the inception, securitization volumes have been scaling
peaks every year. The party continued till 2005. Innovative transactions with
prepayment protected tranches, etc kept emerging in the market. This growth
was due to investors’ familiarity with the underlying asset classes, relatively
shorter tenures of issuances, stability in the performance of past pools
Type FY02 FY03 FY04 FY05
ABS 12.9 36.4 80.9 222.9
MBS 0.8 14.8 29.6 33.4
CDO/LSO 19.1 24.3 28.3 25.8
Others 4.0 2.3 0.5 26
Total 36.8 77.8 139.3 308.1

Table-1: Trend in Securitization volume during FY02-FY05 (Rs. Billion)

2. FY06-FY11
In early 2006, the RBI came out with guidelines on regulatory capital
treatment for securitization which dealt a blow to the securitization market.
The RBI guidelines provided a robust regulatory and institutional framework for
the orderly development of the securitization market in the long term. At the
same time the guidelines eliminated some incentives for securitization. This led
to temporary reduction in issuance volume. However, in the medium and long
term, the securitization market witnessed reasonable growth. There were several
changes that occurred in response to these guidelines. The first change is that
several originators shifted from a securitization structure to what is termed as

54
“direct assignment” structure. A direct assignment is a bilateral portfolio sale
there is no Special Purpose Vehicle here as the buyer is an operating company or
investor. In view of the language of the RBI Guidelines, it was felt that these
transactions will not be covered by the RBI guidelines, which explicitly define
securitization to mean transfer of assets to SPVs. The second perceptible change
is that in several deals, instead of credit enhancements provided by the
originator, there is a “third party guarantee”, typically from a bank. A bank
guarantee is also a first loss support provided by the bank, and the capital
consequences that typically arise to the originator will arise to the bank in such
cases. It would be difficult to contend that such guarantee is a mezzanine
support, unless the mezzanine piece has been given an investment grade rat-
ing. After a decline in FY06, the markets grew significantly till FY08. Until the
first half of FY09, the Indian structured finance market was not severely
impacted by the global credit cri- sis, largely because of the absence of
transactions involving complex derivatives, revolving structures, and credit
default swaps. Low structural complexity and leverage levels relative to
that in typical transactions in developed markets, as well as the fairly stable
performance of the underlying assets, insulated Indian investors from the
widespread multi-notch downgrades of structured finance papers that
happened overseas. However, the tight liquidity conditions during the third
quarter of FY09 led to significant redemption pressure on Mutual Funds. In
that scenario, the relative illiquidity and lack of market depth for structured
finance paper made their impact felt. This, along with rising concern over the
underlying credit quality, caused investor interest in structured paper to
decline. On the other hand, during the second half of the fiscal year, loan
originators started to lend more cautiously due to tight liquidity conditions
and increase in the interest rates. With a slowdown in the growth of their
loan books, the originators’ need to securitize loans (to raise resources) also
declined. The dip in the overall securitization volumes in FY10-FY11 owed

55
 mainly to the substantial reduction in LSO issuances. The recommendations of
RBI regarding the mini- mum lock-in period and minimum retention
requirement, affected corporate loan sell-down transactions, which were
mostly short-term in nature.
Type FY06 FY07 FY08 FY09 FY10 FY11
ABS 178.5 234.2 313.2 135.8 209.7 218.1
MBS 50.1 16.1 5.9 32.9 62.5 50.2
CDO/LSO 21.0 119.0 318.2 364.4 145.8 44.4
Others - - 13 11.6 7.9 5.4
Total 249.6 369.3 650.3 544.7 425.9 317.1

Table-2: Trend in Securitization volume during FY06-FY11 (Rs. Billion)

3. FY12-FY13
Issuance volume in the Indian securitization market was Rs. 366.1 billions in
FY12, a growth of 15% over the previous fiscal. The increase in volume
following a continuous decline for three years was on account of a 26% rise in
securitization of retail loans (both ABS and MBS cumulatively). The number of
transactions was also 32% higher in FY12 than in the previous fiscal. The number
and volume of retail loan securitizaion (both ABS and MBS together), was the
highest in FY12 compared to previous fiscals, while the LSO issuance was the
lowest ever. RBI’s draft guidelines issued in the first quarter of FY2011, specially
the requirement of Minimum Holding Period (MHP) of 9 to 12 months, created
a potential interest rate risk for the originator and adversely affected the LSO
issuance volume. Moreover, the lackluster demand from mutual funds (MFs)
the key investor segment in LSOs in the pastowing to low secondary market
liquidity for PTCs, and the prohibition on investment by liquid funds in debt
with tenure longer than 91 days further impacted LSO issuance volume. As
per the ‘Master Circular by the RBI for Lending to Priority Sector’ released in July
2011, loans by banks to Non Banking Financial Companies (NBFCs) no longer
qualify as Priority Sector Lending (PSL); post this change in regulation there was
56
only one major way in which banks could meet their shortfall in priority
sector lending targets, viz., acquisition of compliant portfolios from NBFCs. On
the other hand, originators’ (read NBFCs’) motive in entering into these trans-
actions was a finer pricing, capital relief and tenure-matched funding, apart f r o m
keeping open an alternate fund-raising channel. This led to a rise in
transactions involving bilateral assignment of retail loan pools.
The RBI Guidelines on Securitization and Direct Assignment issued in May 2012 for
banks and in August 2012 for NBFCs prohibited originators from providing credit
enhancement for assignment transactions. Pursuant to this move by RBI there
was a significant shift from the assignment route (assignment of receivables
directly by the originator to the purchaser, with credit enhancement) to the
conventional securitization route (assignment of receivables by the originator
to an SPV, issue of Pass-Through Certificates (PTCs), with credit enhancement)

Type FY12 FY13

ABS 260.7 266.3
MBS 76.8 36.2
CDO/LSO 22.2 -
Others 6.4 -
Total 366.1 302.5

Table-3: Trend in Securitization volume during FY12-FY13 (Rs. Billion)

57
12.1. The Future Prospects of Securitisation
1. Future Expectations
Going forward, ICRA expects the market d y n a m i c s to alter again following the
clarity in the taxation regime for securitization, brought in by the Union Budget
2013-14. The new tax treatment should open the path for mutual funds to invest
in securitization transactions. Nevertheless, the same is feared to be a negative for
banks, since there could be a propor- tionate disallowance of expenses incurred in
respect of such investment—thus having a significant impact on the post-tax yield
on the transactions. Consequently, 2013-14 could wit- ness a return of direct
assignments as the chosen route for acquiring PSL assets by banks, new transaction
structures in securitization to minimize the taxation impact and MFs re- starting
investments in securitization. The issuance of final guidelines on reset of credit
enhancement in securitization transactions (likely to be issued by the RBI by end-
June 2013) is expected to be another important development in the se- curitization
space. Reset of credit enhancement should help in lowering the charge on capital
and thus, improving the economics of a securitization transaction.

1.2. In brief, securitisation will grow in future for two significant reasons:
a) securitised paper is rated more creditworthy than the FI itself
b) strict capital requirements are imposed on the FIs
Future trends in securitisation of assets will not only be influenced by those FIs who are
knowledgeable about this process, and therefore, aware of its potential but will also be
affected by the level of knowledge in the financial community as a whole as well as the
perception of the regulators. While the benefits that securitisation brings in its wake are
well documented, it may be worthwhile to examine whether the domestic financial
markets are sufficiently developed to accept the product and utilise it efficiently.

58
2). The debt market has deepened and widened in recent years in India after the
introduction of financial sector reforms. The recommendation of the committee on
financial sector reforms (Narasimhan Committee Phase II) stipulates that the minimum
shareholding by Government /Reserve Bank of India in the equity of the nationalised
banks should be brought down to 33%. The same report also emphasises financial
restructuring with the objective of, interalia, hiving off non-performing-asset portfolio
from the books of the FIs through securitisation. According to an estimate, Indian banks
may be able to raise funds at 200 basis points (BP) above US Treasury rate for an issue
of US$150 mn, with a maturity of five years, giving them a gain of 200 to 400 BP over
domestic rates after taking care of related expenses. The securitised paper can be raised
in a period of 16 weeks after signing the mandate with advisors/lead manager. The
costs involved are advisors’ fee to the tune of 1.5% of issue size, rating agency fee
US$300,000, legal expenses US$500,000 and road shows US$100,000. The guidelines of
RBI restricting the quantum of the public deposits that can be raised by an NBFC have
given them further incentive to look for alternative sources of funds. The opening of the
insurance sector for privatisation can create demand for the securitised paper.
3). The Indian financial system is sound and well developed. A number of new
financial products have arrived and been tested in the market during the brief period
since the reforms began. The past few years have also witnessed a healthy trend
towards computerisation of transaction and information management systems. The
availability of computer technology would thus permit the capture and manipulation of
large databases, which are a basic requisite in structuring, securitised products.

4). The debt market is poised for substantial growth with the development of the
sovereign yield curve across different maturities and the active participation of primary
dealers. The Indian market has well-developed institutions, specialised regulators in
banking, capital markets, rating agencies and a well-developed regime of controls and
supervision. The existence of specialised financing institutions like Housing Finance
Companies, Urban/Infrastructure development Bodies like Housing and Urban

59
Development Corporation (HUDCO), Rural Electrification Corporation (REC) etc. who
not only have existing securitisable portfolios but also have the capacity to keep
creating such assets with a view to securitising them. Since most such institutions are
facing resource constraints, securitisation will enable them to focus on their core
competency of supporting infrastructure products through the gestation stage and
securitising them later, rather than funding them till maturity.
The domestic financial institutions are fast reaching their prudential limits in various
sectors. Further lending by them to these sectors is thus dependent upon their being
able to securitise their existing portfolios.

5). The investors with long-term funds have traditionally favoured equity and
Government securities portfolio and have stayed out of debt. Also the present
illiquidity of the loan portfolios does not allow FIs to actively manage or manipulate the
related sector, interest rate or maturity risks. This places a restriction on further asset
expansion, as assets once taken on the books necessarily need to be carried till maturity.
Securitisation will provide a solution for their requirements.
6). The market is thus at a stage where debt is increasingly going to be offered in a
tradable form, whether or not secondary market trades take place in individual cases.
Securitisation, by converting debt into tradable financial instruments, provides an
opportunity for more efficient reallocation of sector specific risks among a more
diversified set of players. By offering an exit option, it channelises surpluses that have
so far remained untapped, to capital–deficient sectors of the economy.

60
Chapter: 13.News Articles on Securitization:

Securitised debt trades to be reported within 15 minutes: Sebi ET 08 Jan 2014, 00:30 IST

Sebi today said all trades in securitised debt instruments or certificates will be reported on stock
exchanges within 15 minutes of the transaction.

Securitised debt must be settled via clearing houses: SEBI ET 08 Jan 2014, 09:40 IST

Investors will have to settle over-the-counter trades in securitised debts through clearing houses,
with Sebi making it mandatory on Tuesday.

SKS Microfinance securitises fourth tranche of loans worth Rs 55 crore ET 31 Dec 2013, 02:30 IST

SKS Microfinance completed securitisation of Rs 55 crore of its assets, the fourth such deal
during the current fiscal.

SKS Microfinance completes Rs 80.81-crore securitisation deal ET 12 Dec 2013, 03:03 IST

SKS Microfinance Ltd said it has completed a securitisation deal of Rs 80.81 crore though a
nationalised bank.

SKS Microfinance completes securitisation deal of Rs 55.56 crore ET 31 Jan 2014, 02:55 IST

SKS Microfinance, India's only listed micro-lender, said it completed a securitisation deal of Rs
55.56 crore though a private sector bank.

SKS Mircofinance completes Rs 215 crore in debt securitisation ET 19 Dec 2013, 20:07 IST

Under the PSL guidelines, banks are mandated to lend nearly 40 per cent of their annual lending
to the priority sector.

Shriram Transport to raise Rs 2000 crore through NCDs in FY15 ET 09 Feb 2014, 17:32 IST

We will be securitising up to Rs 4,000 crore of our portfolio during the quarter as banks look to
achieve their priority sector lending targets.

Sebi likely to tighten screws on non-serious MFs: PwC ET 16 Dec 2013, 23:39 IST

"Sebi could adopt a more stricter approach towards `non-serious' asset managers," PwC India
leader for asset management Gautam Mehra said.

61
13.1. Frequently Asked Questions on Securitization:

 What is Securitization?
Securitization is a means of rearranging illegal assets so that they can be
formed into a security.

 What is securitization?
Securitization Securitization is the process of transforming collateral or
obligations into traded securities. An easy way to understand this is through
example. The mortgage backed

 What Is Wholesale Debt Securitization?

Debt securitization is a process that transforms conventional debt products -
say, credit card balances and mortgages - into financial products, also known
as securities. Financial

 What is securitization?
A security is an investment product that is put into a form that can be bought
and sold by investors who do not have to go through the process of
underwriting a loan or making

 What Are Problems With Securitization?

The main problem is with legal and accounting isues.

 What Is A Securitization Trust?

The trust is usually subcontracts the administration and servicing of the
securitisation

 What is Foreclosure?
Home foreclosure is a process by which a lender regains a property which they have
financed. Typically, this is because the borrower or homeowner is behind on house
payments and is unable to catch up, often due to circumstances outside of his or her
control. When the lender forecloses on the home, the homeowner must move out of the
house, therefore losing all possession of the property and jeopardizing any possible
equity that the homeowner may have in the home

62
  Should I file for bankruptcy to save my house?
You should speak with an Attorney before making those decisions. Sometimes after
bankruptcy, it is easier to make a mortgage payment because other debts have been
discharged.
 Do I have enough time to stop foreclosure?
Up until the foreclosure sale occurs there is still hope. If a sale date for your house has
been set you need to act fast. Some attorneys have stopped sales set for the next day but
this is very risky and some lenders will not agree to it. You're best option is to take
action immediately to stop foreclosure before it goes too far.

 What is Securitization Rating? ( CARE Rating)

Securitisation is the process in which the underlying pool of assets are structured or
packaged and sold as financial instruments to investor(s) either directly or through a
Special Purpose Vehicle (SPV). Typically in India, the originators or sellers are Banks,
NBFC, HFC & others. The underlying assets are mainly secured loans like housing
loans, auto loans, commercial vehicle loans, construction equipment loans, two-wheeler
loans, tractor loans, three-wheeler loans and unsecured loans like personal loans,
consumer durable loans. The SPV is formed in the form of trust, settled and managed
by a trustee. The trust purchases the pool for a consideration either at par or premium.
The investors subscribe to the Pass through Certificates (PTCs) issued by the trust.

These PTCs are backed by the underlying loan receivables and the beneficial interest
lies with investors. The Servicer (typically, Originator in India) is appointed by the trust
to service the loans. Servicer passes on the periodic collections from the underlying
borrowers to the trust which is further passed on to the investors as per scheduled
payouts. Credit Enhancement is provided to an SPV to cover the losses associated with
the pool of assets. Credit Enhancement may be divided into First Loss facility and
Second Loss facility. First loss facility represents the first level of financial support to a

63
SPV as part of the process in bringing the securities issued by the SPV to investment
grade. The provider of the facility bears the bulk (or all) of the risks associated with the
assets held by the SPV. Second loss facility represents a credit enhancement providing a
second (or subsequent) tier of protection to an SPV against potential losses. Liquidity
Facility is provided to assure investors of timely payments. These include smoothening
of timing differences between payment of interest and principal on pool of assets and
payments due to investors. In India, the Direct Assignment structure is also prevalent
in which there is no intermediate trust and the transaction is on a bilateral basis
between seller and buyer.

 What is Securitization Rating Process

 What do you mean by securitization of loans? what is the benefit? how is it

related to mutal funds?

Chapter: 14.Conclusion

64
 In today’s environment, study of securitization is of great importance
because of the opportunities it offers as a source of financing.
 Therefore it is considered that securitization is another venue for financial
institutions to demonstrate their competitiveness and to broaden their
markets.
 Not only in US & Europe but also in other parts of world, securitization
has emerged as one of the most effective means of capital creation. India
is not far behind though it is in its early stage in India because of the large
benefits it holds for banks and financial institutions the concept has picked
up. While securitization can be a means to manage balance sheet risks
and operational risk by banks and financial institutions it should be
emphasized that banks and financial institutions should not consider it
as a means to get rid of their obligations.
 Securitization has in particularly proved to be a boon to fund starved
infrastructure projects. While more complex securitization transactions
and public issuance of securitized papers are a far dream, clear legislation
and investor education can prove to be a catalyst for Indian
securitization market. Securitization as a financial instrument has been
prevalent in India since 1990s. It has been a tremendous boon for banks/
financial institutions which are beleaguered by excess illiquid and non-
performing assets.
 However, laws governing such transactions, which were introduced later,
although tried to regulate securitization but left much to be desired
owing to ambiguity and shortcomings. Hopefully, the gaps will be
plugged and the necessary steps will be taken soon to alleviate all concerns.

 The SARFAESI Act 2002 is an important step by Indian government as it

provides the much needed legal sanctity to securitization by recognizing

65
 the securitization instrument as a security under the SCR Act. Development
of the market for securitization in India will need efforts of the Central
Government, State Governments, Reserve Bank of India and Security
Exchange Board of India (SEBI) has permitted mutual funds to invest in
these securities. To galvanize the market Foreign Institutional Investors (FIIs)
can also be allowed to invest in securitized debt within certain. FIIs are
already familiar with these instruments in other markets and can, therefore
be expected to help in the development of this market. However the
government and regulatory authorities in India should realize that the
measures taken up by them are incomplete and more dedicated efforts are
necessary for a robust growth of asset securitization market in India.

 Securitization is an important tool used in finance. Finance studies and addresses

the ways in which individuals, businesses, and organizations raise, allocate, and
use monetary resources over time, taking into account the risks entailed in their
projects. Structured finance encompasses all advanced private and public
financial arrangements that serve to efficiently refinance and hedge any
profitable economic activity beyond the scope of conventional forms of on-
balance sheet securities (debt, bonds, equity) in the effort to lower cost of capital
and to mitigate agency costs of market impediments on liquidity.

 Securitization provides the method utilized by the participants of structured

finance to create the pools of assets that are used in the creation of the end
product financial instruments. The resulting financial instruments not only
increase the supply of funds but also enable the institutions in better
performance and risk management.

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 Securitisation is as necessary to the economy as any organized markets are.
Securitisation in India has been in existence since early 1990s, though essentially
as a device of bilateral acquisition of portfolios of finance companies.

 Moreover, it is needless to mention that securitisation of loans, advances and

receivables is mostly applicable to banks, financial institutions and non-banking
financial companies (NBFCs), where such assets form a major component in the
balance sheets, and as such in order to facilitate such organizations to allocate
capital more efficiently, access diverse and cost effective funding sources and
better manage business risks in an efficient manner, the concept of securitisation
of loans and receivables has emerged. Securitisation is necessary to realize the
full potential of this innovative financing mechanism in India.

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14.1. Recommendations:

Legal and taxation issues in securitisation are only as significant as they are complicated
Securitisation poses inordinate legal problems in most jurisdictions of the world.
Following is the recommendations for the problems/issues mentioned in earlier chapter

Stamp Duty

 Applicable on the transfer/sale of receivables involved in securitisation, range is

3%- 13%
 Maharashtra, Tamil Nadu, Gujarat, Kamataka and West Bengal have reduced
stamp duty on securitisation transactions to 0. 1 %

Recommendation

 Uniform stamp duty of 0. 1 % be levied in all states

 Monetary cap of Rs Two lakh be placed on such stamp duty

Registration Act, 1908

 Registration charges payable impose additional costs to the transaction

Recommendation

 Every State Government prescribe a nominal sum, subject to a cap as registration

for securitisation deed
 Registration should not be required on issuance/transfer of securities/
certificates issued pursuant to a registered Securitisation Deed

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Transfer of Property Act, 1882

 common definition of securitisation is required

Recommendation

'Securitisation' shall mean:

(a) the transfer by sale/ assignment of the whole or part of the assets including
actionable claims by any entity which owns or has the rights, title interests in the assets
to an SPV; (b) issuance of securitised debt receipts or securities, equity or certificates
entitling holder thereof to the receipts of monies on account of the assets (including by
virtue of any credit enhancement or liquidity facilities obtained by the SPV or specified
person) by assignee under clause a) above.

 Easier assignment for mortgage backed receivables

 To transfer a claim for a mortgage backed debt or claim for other types of
secured debt, the definition of actionable claim should be amended

Recommendation

 Actionable Claim shall include a claim to a debt or any part including debt
secured by mortgage of, or charge on immovable property or by charge,
hypothecation or pledge of moveable property or beneficial interest in moveable
property or receivables whether such claim or interest is existent, accruing,
conditional or contingent
 Easier and automatic assignment of future receivables
 Section 5 states that whilst transfer may take place at present or in future, the
property that is the subject matter of transfer must exist in present. A transfer of
property that is not existing operates as a contract to be performed in the future
(an executory contract)

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Recommendation

 An actionable claim accruing in the future or conditional or contingent upon any

event shall be deemed to be a property capable of being transferred in present

Foreclosure Laws

Existing laws make it difficult to transfer property in case of default, as they are silent
in:

1. The procedure for transfer of mortgages from the principal lender to any other entity

2. The procedure for speedy foreclosure and recovery against the mortgage without the
cumbersome and time-consuming process involving the intervention of the Courts.

Recommendation

In the case of a mortgaged asset, the securitisation SPV shall have the right of sale of the
mortgaged property without the intervention of the court or obtaining a decree from
the Court in case the following are satisfied:

a. There is a delay of 60 days in the payment of principal or interest, and the mortgagor
is notified of the default by the SPV or its representative,

b. Giving the mortgagor further 30 days period to make the payment of principal or
interest due in full, and

c. The mortgagor fails to make such payment within the said period of additional 30
days provided that the mortgagor while mortgaging the property and securing of the
debt had specifically agreed to application of the summary procedures as defined above
to his mortgage debt.

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Companies Act, 1956

 Filing of Forms 8 & 13 under Sec135 is necessary for effecting modification of

charge

Recommendation

 To avoid multiplicity of filing forms, in case of transfer of charges pursuant to

securitisation, the Central Government must designate the Department of
Company Affairs as the sole repository of any alteration required to the Register
of Charges

SEBI (Mutual Funds) Regulations, 1996

 The Act states that MFs may invest in asset-backed securities excluding MBS

Recommendation

 Removal of prohibition on investments in MBS (as a class of securitised debt) by

MFs

Income Tax Act, 1961

The taxation issues arising in the process of asset securitisation are with reference to:

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Obligor

1. Under the Act, tax is deductible at source in case of payment of certain incomes.
According to current law, TDS would be deductible twice, once when obligor pays the
SPV and next, when the SPV pays the investors. This would involve locking of funds
with the IT Department and would affect the yield the investor would get.

Recommendation

 Exempt the obligor from deducting TDS and the primary responsibility of
deduction of tax be on the SPV

Originator

1. Sec60 provides that in case of transfer of income without transfer of asset, the income
would be taxable in the hands of the transferor. Securitisation of future flows of income
of an asset which is not transferred may be taxable in the hands of the transferor e.g.
lease finance receivable where not the asset, but rent receivable is transferred.

Recommendation

 Provide in Sec60 that such transaction would not be hit by the said provision

2. In case of securitisation of future flows, the originator would get NPV of future
incomes at one stroke. If income tax is payable on this NPV in year one, there would be
an acceleration of taxation of income. This would affect cash flows of the originator. It
has been suggested that any money received for future cash flows by the originator be
treated as borrowing until its treatment as a securitised asset could be decided upon.

Recommendation

Taxation of future incomes should be spread over the period to which it belongs

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3. In case of securitisation of future incomes on a depreciable asset like lease, the
question arises whether depreciation should be granted on such an asset or not

Recommendation

Provision should be made for allowance of such depreciation

4. Securitisation of loans advanced to finance, industrial, agricultural or infrastructure

development facility or construction or purchase of houses be recycled, if such loans
can be securitised. This would accelerate the creation of assets, which are socially
desirable.

Recommendation

Such entities (financial corporation as Originator) should continue to derive the

deduction under Section 36(1)(viii) even after the loans have been taken off its balance
sheet for accounting purposes after securitisation

Recommendation

They should continue to enjoy the exemption even after asset securitisation

SPV

1. the Act should provide for specific tax neutrality to the SPV. The net profit of the SPV
which is not to be passed over to investors, should be liable to tax at the normal rate.

2. The SPV should not be treated as a representative assessee

Servicer

1. The income received by the servicer (fees received for managing assets and
administration of the SPV) is taxable at the normal rate of tax.

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Investor

1. To encourage investors to participate in securitisation, benefit of Sec88 should be

granted on investment in any paper of the SPV, which has securitised any asset related
to housing or infrastructure

2. Investors would be taxed on the incomes arising out of securitisation. It is suggested

that incomes, which flow out of asset securitised in the next 3 years, should be made
exempt from Income Tax. After 3 years, there should be partial deduction and thus, this
income can be included in Sec8OL

Sales Tax

 hire purchase transaction, delivery of goods on hire purchase agreement/

transfer of right to use is a deemed sale and attracts sales tax.
 In case of sales of receivable along with underlying assets by the originator to the
SPV in a different state, the same would attract sales tax at the point of
securitisation.

Recommendation

 Exemption should be granted from sales tax to assets covered in securitisation

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Chapter: 15.Refrences

 http://www.theglobaljournals.com/ijar/file.php?val=MjI4NA==
 http://www.microfinancegateway.org/gm/document-1.9.25698/38969_file_22.pdf
 http://jgateplus.com- A college data base website
 http://searchproquest.com- A college data base website
 www.rbi.org.in –website of Reserve Bank of India
 Indian Journal of Applied Research-volume: 3/issue3, Published on March 2013, on
Securitisation by-Suman Chakraborty and Sabat Kumar Digal
 Institute of Financial Management and Research
 Economic Times News paper for News Articles on Securitisation
 Yahoo answer India and Answer.com wiki for FAQ’s

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