Securitisation Concepts & Practices

Module 1
Concept of Securitisation

Common Practices
Based on collateral Securitisation

Existing Asset

Future Asset

Risk

MBS

ABS

OP. REV

Credit

Insurance

RMBS

CMBS
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Corporate Finance Vs Securitisation

Corporate Finance

Features of Securitisation

General claim against the assets of the company Mobilised against the general strength of the balance sheet Subject to entity wide risks Scalability subject to entity wide prudential limits and regulatory constraints

Claim against specific identified assets of the issuer Resource mobilisation by stripping the assets off the balance sheet and then servicing them Insulated from entity wide risks This is structured financing Highly scalable and not subject to regulatory / prudential constraints
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Bundling of Assets & Unbundling of Risks

The financial assets are cherry picked and then bundled into a pool The pool becomes a statistical phenomenon exhibiting a homogeneous character The risk associated with any single asset gets dispersed into the pool

Special Purpose Vehicle

This is a bankruptcy remote vehicle Normally an entity in the form of a Trust No other trading/business allowed Arms Length to me maintained with the originator

Special Features of SPV (1)

SPVs are prevention from dealing in any manner outside the assets pertaining to it and servicing the securities SPV cannot endanger the transaction by introducing new and different risk factors SPVs are not permitted to have any employees or to have general fiduciary responsibilities to third parties (eg: acting as a trustee All services required to maintain the SPV and its assets are subcontracted (outsourced) administering its receivables, company secretarial work etc. SPVs reliance on third parties to meet its obligations should be minimised Such dependence should be limited to other bankruptcy remote entities only
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Special Features of SPV (1)

Person who contract with the SPV is required to agree not to sue the SPV even in the event the SPV fails to perform under the contract SPV's liabilities (present and future) should be quantifiable, and shown to be capable of being met out of the resources available to it

Eg. various tax liabilities

Funds which are due to the SPV have to be separated and ring-fenced as soon as they are received
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The Parties to Securitisation

The loan originator (bank or financial intermediary), The loan purchaser (an affiliated trust, also called a special purpose vehicle or SPV), The loan structurer, A guarantor (credit enhancer), and Investors who buy the securities (mainly institutions such as banks, insurance companies, and pension funds).
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Securitisation Flowchart
Original Loan

Obligor
Interest & Principal Sale of Assets

Ancillary service provider

Credit enhancement measures

Issue of PTCs

Originator

SPV (Assignee & Issuer)

Investor
Servicing PTCs

Consideration for Assets

Subscription to PTCs

Structurer

Rating Agency

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Securitisation Process

SPV is created to hold titles to assets underlying the securities Originator (holder of assets) sells the assets (existing or future) to the SPV SPV (with the help of a merchant banker) issues securities (PTCs) to the investors SPV pays the originator for the assets with the proceeds of the securities
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Touchstones of Securitisation

Legal true sale of assets to an SPV Issuance of securities by SPV to investors collateralised by the underlying assets Reliance by the investors on the quality of the underlying assets Bankruptcy remoteness from the originator Credit enhancement measures Formal ratings for the instruments
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How is a Balance Sheet Vitalised by Securitisation?

Sources of Funds Share Capital Reserves & Surplus Secured Loans Unsecured Loans Current Liabilities & Prov. Total Application of Funds Housing Loans Investments Current Assets, Loans & Adv. Fixed Assets Total CAR% Mar-05 20 69 272 428 20 809 708 31 66 4 809 12.04 Mar-06 20 83 362 451 25 941 822 34 80 5 941 12.03 Mar-07 20 95 477 492 34 1118 951 36 125 6 1118 11.65 Jun-07 20 105 485 500 40 1150 980 37 127 6 1150 12.29 Jul-07 20 105 485 500 40 1150 880 37 227 6 1150 13.63 Mar-08 20 125 490 450 41 1126 950 39 130 7 1126 14.66

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CAR
11.00 12.00 13.00 14.00 15.00

CAR Chart

Period

M ar M 05 ay -0 Ju 5 l-0 Se 5 p0 N 5 ov -0 Ja 5 n0 M 6 ar M 06 ay -0 Ju 6 l-0 Se 6 p0 N 6 ov -0 Ja 6 n0 M 7 ar M 07 ay -0 Ju 7 l-0 Se 7 p0 N 7 ov -0 Ja 7 n0 M 8 ar -0 8

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MBS Growth in India

35000 30000 25000 20000 15000 10000 5000 0 2001-02 2002-03 2003-04 2004-05
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Rs. Crores

Investor Profile in Securitised Debts

9%

PSBs
23%

10%

Pvt Banks MFs

7%

Insurance Cos Foreign Banks

32%

19%

FIs

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Advantages

Structured features Tested in several bankruptcies East Asia Better Rating than the Corporate Rating Rating stability more stable than other securities Very few instances of default no default in Europe Total defaults 116 out of 13538 cases of securitisation (0.86%) S&P Study (of the above, 12 belonged to a single issuer of credit card transactions which was a fraud) High rate of default recovery
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Default Rate
9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 0.86% Default Rate 8.14%

Securitised Debt

Corporate Debt

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Rating Transition
18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Securitised Debt Corporate Debt Rating Transition

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Disadvantages

Uneconomical for lower requirements Discloses useful business information Costly compliances Rating of the originator will be based on the residuary assets Bankers to the originator do not favour this.

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Threats to Investors

Erratic cash flows Lack of recourse Lack of regulatory protection No control on the end use of the funds Difficult to enforce the duties of the trustee Interest rate risks Improper understanding of the structure
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Legal Risks

True sale Bankruptcy remoteness Compliance with local laws Validity of the mortgage Title to the underlying assets Payment of stamp duty

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Module 2
Procedures

Legal Documentation

The structuring of securitisation process Offer document Deed of assignment Trust deed Declaration of trust Servicing & paying agency agreement Agreement with credit rating agency Documents credit enhancement viz., Letter of Credit, Letter of Guarantee, Collateral etc.
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Legal Opinion

Validity/enforceability of the securitisation structure, recourse etc. Arms length between the originator and the trust The extent of true sale Compliance of local laws Legal position of the securitised instrument (PTC) its negotiability, transferability, stamping etc. Geographic pooling of the underlying assets for conveyancing/transfer of beneficial interest keeping in mind stamp duty Place of execution of trust deed and declaration of trust for stamp duty purpose
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Landmark Activities

Legal opinion as to the methodology (SARFAESI) Appointment of rating agency Finalising the securitisation structure Formation of a SPV/Trust Conveyancing of mortgaged assets Declaration of trust & other legal documentation Issue of PTCs and collection of proceeds Pool servicing

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Checklist of Activities (1)

Board approval Identification of the assets Valuation of assets Due diligence by the credit rating agencies Structuring Credit enhancement Legal opinions and documentation
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Checklist of Activities (2)

Creation of trust Declaration of trust Identification of investors in PTCs Marketing of the PTCs Issue opening & closing Allotment letters/demat credit Pool servicing Servicing the investors
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Stamp Duty Aspect

Stamp duty is a state subject and the state law where the deed is executed will be applicable True sale of underlying assets will attract stamp duty Registration of trust deed and declaration of trust will attract charges Issue of PTCs will attract stamp duty The originator will have to bear the entire stamp duties and registration charges
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Mandatory Expenses

Stamp duty charges as mentioned in the previous slide Registration charges as mentioned in the previous slide PTC coupon Demat Expenses

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Fees to Intermediaries

Rating fee and rating surveillance fee to rating agency Legal consultants fee Trustee fee Auditors fee Merchant bankers fee R&T Agents fee
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Services of a Merchant Banker

Advice in structuring Assistance in identification of assets Appointment of rating agencies, and trustees/SPV Liaison with rating agency and law firm Drafting of offer document Marketing and placement of PTCs Coordinating with investors Coordination with NSDL/CDSL Coordination with Registrars
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Other Services

Assistance in legal documentation Floating of separate SPV if required Coordination with the banker for the escrow account

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For your valuable time.

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