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Securitization refers to the process of pooling and selling existing
assets in the books of a lender/creditor(The ‗Originator‘) to a
Special Purpose Vehicle(SPV) and repackaging them into tradable
,asset-backed securities(ABS).The essential features of
securitization are :-
1)the sale proceeds are available to the Originator of the
transaction(i.e. the seller) immediately;
2)the assets are taken off the Originator‘s books and are not
available to the Originator‘s creditors in the event of his
bankruptcy;
3)can have higher credit ratings than the Originator‘s , depending
on the quality of assets securitized and credit enhancements
made available

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 The different entities-:
 Originator
• The original lender is called the originator.
• It is the entity on whose books the assets to be securitized exist.
• Typically, the Originator is a bank, a Non-banking finance company(NBFC), a housing finance company
or, occasionally even a manufacturing/service company.

 Special Purpose Vehicle

• SPVs are companies with small capital, or sometimes trusts, formed for the specific purpose of issuing
securities in securitization transactions whose ownership and management are independent of the
Originator.
• In order to ensure that the assets actually achieve the bankruptcy remoteness, it is essential to move
them out of the balance sheet of the Originator and park them with another independent entity.

• The SPV is critical in a securitization transaction because it is this entity that delinks the
credit of the entity seeking funding from the creditworthiness of the securities that are
created in a securitization.

 Obligor
• The Obligor(s): The Obligor is the Originator's debtor (borrower of the original
loan).The amount outstanding from the Obligor is the asset that is transferred to
the SPV. The credit standing of the Obligor(s) is of paramount importance in a
securitization transaction 4
 Servicer
• The servicer collects the moneys due from individual borrowers in the pool, makes payouts
to the investors and follows up on delinquent accounts.
• The servicer also furnishes periodic information to the rating agency and the trustee on
pool performance.

Trustee
• The trustees have a fiduciary role role to oversee the performance of the transaction until
maturity with a view to protect the interest of the investors.
• The trustee is vested with necessary powers including the, in particular, the power to
changer the Servicer, if necessary
• Trustees tend to be reputed banks, financial institutions or firms of Chartered Accountants
or
Solicitors.

Rating Agency
• Credit rating agencies rate the securities which are issued to provide an external
perspective on the liabilities being created and help the investor make a more informed
decision.
• The rating process would assess the strength of the cash flow and the mechanism
designed to ensure full and timely payment by the process of selection of loans of
appropriate credit quality, the extent of credit and liquidity supp5ort provided and the
 Structurer
• Normally, an investment banker is responsible as structurer for
bringing together the Originator, credit enhancer/s, the investors and
other partners to a securitization deal. It also works with the
Originator and helps in structuring deals.

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 Credit Enhancement-
• It refers to the various means that attempt to buffer investors
against losses on the asset collateralizing their investment.
• Securities generated in a securitization deal are "credit
enhanced”, meaning their credit quality is increased above that
of the originator's unsecured debt or underlying asset pool.
• This increases the likelihood that the investors will receive cash
flows to which they are entitled, and thus causes the securities
to have a higher credit rating than the originator.

Credit Enhancements are either external(third party) or

internal(structural or cash-flow driven).

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* External Credit Enhancements:-
i.Insurance-
 Full insurance is provided against losses on the assets. This tantamounts to a 100
per cent guarantee of a transaction‘s principal and interest payments. The issuer of
the insurance looks to an initial premium or other support to cover credit losses.

ii.Third-Party guarantee
 This method involves a limited/full guarantee by a third party to cover losses that
may arise on the non-performance of the collateral.

iii.Letter of credit
 For structures with credit ratings below the level sought for the issue, a third party
provides a letter of credit for a nominal amount. This may provide either full or
partial cover of the issuer‘s obligation.

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*
i. Credit Tranching
 The SPV issues two(or more) tranches of securities and establishes a
predetermined priority in their servicing, whereby first losses are
borne by the holders of the subordinate tranches(at times originator
itself).Apart from providing comfort to holders of senior debt, credit
tranching also permits targeting investors with specific risk-return
preferences.
ii.Over Collateralisation
 The originator sets aside assets in excess of the collateral
required to be assigned to the SPV. The cash flows from these assets
must first meet any overdue payments of the main pool, before they
can be routed back to the originator.
iii.Cash Collateral
 This works in the same way as over-collateralisation.However,
since the quality of cash is higher than assets yet to be converted
into cash, the quantum of cash required to meet the desired rating
would be lower than asset over-collateral to that extent.
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iv. Spread Account
 For each period, the difference between the cash flow generated by the pool
of loans and receivables and the interest paid to the holders of the asset-
backed securities and the fees paid (primarily for servicing) is in effect the
monthly profit. In securitization terminology, it is referred to as the excess
spread.
 Only realizations in excess of this specified amount are routed back to the
Originator. This amount is returned to the Originator after the payment of
principal and interest to the investors.

True Sale-
• The genesis of securitization lies in giving the investors rights over specific
assets of the originator, such that the investors are not affected by the
performance, or bankruptcy of the originator. This would obviously necessitate
that the investors, or the SPV which is a conduit on behalf of the investors, has
legally acquired the assets.
• True sale involves legal separation of the Originator from the assets, with
the purpose of putting them beyond the reach of the Originator or its
creditors, even in the event of bankruptcy of the Originator. This is known as
‘bankruptcy remoteness’ of the transaction
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 Why is True Sale required?

• Bankruptcy Remoteness ensures that the cash flows from the securitized assets are
available solely for the benefit of the SPV and its creditors, namely the holders of the
PTCs, or ,in other words , to allow investors an unqualified right over the assets being
securitized.

 What if a transfer is not a true sale?

If the transfer of assets for the benefits of investors is not a true sale, it
might mean:

* the investors are unsecured lenders

* the transfer is regarded as creating security interest in favour of investors; so
the investors are secured lenders (whether such security interest is perfected
or not will depend on the procedure relating to perfection of security
interests)
* worst of all, since the transaction would not have been backed by loan
documentation, the investors may not be regarded as lenders as well -
meaning, they might only have an equitable right to recover their money but
would not stand as unsecured lender1s1.
 Pass through Certificates(PTCs) & Pay Through Securities(PTS)

 Pass through Certificates-

• Cash flows are passed through‘ to the holders of the securities in the form of
monthly payment of interest, principal and pre-payments.
• They reflect ownership rights in the assets backing the securities.
• Pre-payment precisely reflects the payment on the underlying mortgage. If it
is a home loan with monthly payments, the payments on securities would also
be monthly but at a slightly less coupon rate than the loan.

 Pay through Securities

• This permits the issuer to restructure receivables flow to offer investment
maturities to the investors associated with varied yields and risks. The issuer
owns the receivables and sells the the debt backed by the assets.
• The cash flows can be remade into various debt tranches with different
maturities.

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 ILLUSTRATION OF A SECURITIZATION

* We use a hypothetical securitization to illustrate the key elements of a

securitization and the parties to a transaction. Our hypothetical firm is the
Ace Corporation, a manufacturer of specialized equipment for the
construction of commercial buildings. Some of its sales are for cash, but
the bulk are from installment sales contracts. For simplicity, we assume
that the installment period is typically seven years. The collateral for each
installment sales contract (sometimes loosely referred to herein as a loan)
is the construction equipment purchased by the borrower. The loan
specifies the interest rate the customer pays.
* The decision to extend a loan to a customer is made by the credit
department of Ace Corporation based on criteria established by the firm,
referred to as its underwriting standards. In this securitization, Ace
Corporation is referred to as the originator because it has originated the
loans to its customers. Moreover, Ace Corporation may have a department
that is responsible for collecting payments from customers, notifying
customers who may be delinquent, and, when necessary, recovering and
disposing of the collateral (i.e., the construction equipment in our
illustration) if the customer fails to make loan repayments by a specified
time. These activities are referred to as servicing the loan. While the
servicer
. of the loans need not be the originator of the loans, in our
illustration we are assuming that Ace Corporation is the servicer.
 ILLUSTRATION OF A SECURITIZATION

* Suppose that Ace Corporation currently has $400 million in installment

sales contracts (i.e., its accounts receivable). The chief financial officer
(CFO) of Ace Corporation wants to use its installment sales contracts to
raise $320 million rather than issue a traditional corporate bond. To do so,
the CFO will work with its legal staff to set up a legal entity referred to as
a special purpose vehicle (SPV), also referred to as a special purpose
entity (SPE).
* The SPV is critical in a securitization transaction because it is this entity
that delinks the credit of the entity seeking funding (Ace Corporation) from
the creditworthiness of the securities that are created in a securitization.
Assume that the SPV set up by Ace Corporate is called Financial Ace Trust
(FACET). Ace Corporation sells $320 million of the loans to FACET and
receives from FACET $320 million in cash, the amount the CFO wanted to
raise. Since Ace Corporation is the originator of the loans and has sold
these loans to FACET, Ace Corporation is referred to as the
originator/seller in this transaction.

.
 ILLUSTRATION OF A SECURITIZATION

* It is critical that the sale of the loans transferred be a true sale by Ace
Corporation to FACET. By a true sale it is meant that the sale of the assets
closely substantively resembles a commercial sale of such assets by Ace
Corporation. If it is subsequently determined in a bankruptcy proceeding
that the so-called sale by Ace Corporation was merely a nomenclature or a
camouflage, then a bankruptcy judge can rule that the assets were never
sold and were merely pledged as collateral for a financing. In that case, in
the event of a bankruptcy filing by Ace Corporation, the bankruptcy judge
can have the assets of FACET treated as part of the assets of Ace
Corporation. This would defeat the purpose of setting up the SPV. Typically,
a true sale opinion letter by a law firm is sought to provide additional
comfort to the parties in the transaction.
* Where does FACET obtain the $320 million to buy the assets? It does so by
issuing asset-backed securities, called bond classes or tranches. A simple
transaction can involve the sale of just one bond class with a par value of
$320 million. The payments to the bond classes are obtained from the
payments made by the obligors (i.e., the buyers of the construction
equipment). The payments from the obligors include principal repayment
and interest. However, most securitization transactions involve a more
complex structure than simply one bond class. For example, there can be
rules for distribution of principal and interest other than on a pro rata
basis to different bond classes. The creation of different bond classes
allows the distribution of the collateral‘s risk among different types of
investors: investors with different appetite‘s for interest rate risk (i.e.,
price sensitivity to changes in interest rates) and credit risk.
 ILLUSTRATION OF A SECURITIZATION

* An example of a more complicated transaction is one in which two bond

classes are created, bond class A1 and bond class A2. The par value for
bond class A1 is $120 million and for bond class A2 is $200 million. The
priority rule set forth in the structure can simply specify that bond class
A1 receives all the principal generated from the collateral until all the
entire $120 million of bond class A1 is paid off and then bond class A2
begins to receive principal. Bond class A1 is then a shorter-term bond than
bond class A2. This type of tranching is used to create securities with
different exposures to interest rate risk.

* Also, as will be explained in later chapters, in most securitizations there is

more than one bond class and the various bond classes differ as to how
they share any losses resulting from the obligor defaults. For example,
suppose FACET issued $290 million par value of bond class A, the senior
bond class, and $30 million par value of bond class B, a subordinated bond
class1.3As long as there are no defaults by obligors that exceed $ 30 million
then bond class A receives full repayment of its $290 million.
Typical Securitization Structure

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*
First securitization deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160
mnRs 160 mn
&T raised Rs 4,090 mn through the securitization of future lease rentals to raise capital for its
power plant in 1999.capital for its power plant in 1999.
India‘s first securitization of personal loan by Citibank in 1999 for Rs 2,841 mn
India‘s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in 2001.
securitization of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through off shore
SPV.
India‘s first sales tax deferrals securitization by Govt of Maharashtra in 2001 for Rs1,500
mn.1,500 mn.
India‘s first deal in the power sector by Karnataka Electricity Board for receivables-India‘s first
deal in the power sector by Karnataka Electricity Board for receivables worth Rs 1,940 mn and
placed them with HUDCO. worth Rs 1,940 mn and placed them with HUDCO.
India‘s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002.
India‘s first floating rate securitization issuance by Citigroup of Rs 2,810 mn in 2003 The fixed
rate auto loan receivables of Citibank and Citicorp Finance India included in the securitization
India‘s first securitization of sovereign lease receivables by Indian Railway Finance Corporation
(IRFC) of Rs 1,960 mn in 2005.The receivables consist of lease amounts payable by the ministry
of railways to IRFC.
India‘s largest securitization deal by ICICI bank of Rs 19,299 mn in 2007.Theunderlying asset
pool was auto loan receivables.

 http://www.financialexpress.com/news/Indian-securitization/191022/0http://www.financialexpress.com/news/Indian-securitization/191022/0

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*Types of Securitization:
 Asset Backed securities (ABS) :
•ABS refers to the securitization of non-mortgage retail loans. Till the late 1990s, assets classes
securitized under ABS in India included only car loans and commercial vehicle loans.
Thereafter, construction equipment loans, two wheeler loans, utility vehicle loans, and personal loan pools,
have also been securitized.

 Mortgage Backed Securities (MBS)

• (MBS) are asset-backed securities whose cash flows are backed by the principal and interest payments of a set of
mortgage loans.
• Since the underlying home loans in MBS pool have a floating-rate, the scheduled cash flow on such pools is
uncertain and liable to change, depending on actual interest rate. Moreover, options to convert from fixed to
floating rate and vice-versa, coupled with negotiated re-pricing of loans, added to the uncertainty of the cash
flow in the MBS pool.
• With the underlying loans earning floating rates, Pass Through Certificates (PTCs) in MBS issues are also being
predominantly priced on a floating rate basis. In 2005, 52% of issuance was based on a floating rate.
 Collateralized Debt Obligation (CDO) :
• In CDO transactions, the debt securities issued by the SPV are backed by a diversified loan or bond
portfolio. There is thus a basic difference between CDOs and ABS, the latter being homogeneous pools of
assets such as mortgages or credit card receivables, in contrast to the diversified portfolios backing
CDOs.
 Collateralized Loan Obligations :
Where the originating bank transfers a pool of loans, the bonds that emerge are called collateralized
loan obligations or CLOs.

Collateralized Bond Obligations :

Where the bank transfers a portfolio of bonds and16securitizes the same, the resulting could be called
collateralized bond obligations or CBOs.
 Benefits
• Originator :
• Off – balance – sheet financing
• Concentrate on the core business
• Upfront booking of profits – acting as a servicer, additional
fee income accrues – enhances profitability
• Improves capital requirements – When assets taken off
from balance sheet capital to risk weighted asset ratio
(CRAR) need not be maintained.
• Recycling of funds
• Leverage effect
• Reduction in borrowing costs – Securitized papers are
rated – sell at a reduced interest rates
• Best practice
• Investors :
• Best avenue of investment with varying degree of risk
• Economy:
• Introduction of new class of instrument to the capital
market fulfilling the various risk return preference of the
investors.
• Creation of market in financial claims , else would have
remained as receivables in the books of the FI
• Wider distribution of financial products in the system
• Increase in the asset turnover
• Cost effective lending to the borrower – improve the
entire financial system’s efficiency.
 SARFAESI ACT, 2002
SARFAESI ACT, 2002:Securitisation and Reconstruction of
financial assets and enforcement of security interest
act.
Securitisation means acquisition of financial assets by a
securitisation or reconstruction company from the
originator
Such acquisition may be by raising of funds by such
companies from Qualified Institutional Buyers by issue of
security receipts representing undivided interest in the
financial asset or otherwise
The concept and modality of securitisation is new for the
Indian laws and Indian markets
• This is a process where non –liquidated financial assets are converted
into marketable securities
• ( security receipts that can be sold to the investors)
• It is also a process of converting receivables and other assets into
securities ( security receipts that can be placed in the market for
trading)
• In Indian law there is no provision for transfer of claims that are
secured by any security. Now SARFAESI act has made it possible
• On acquisition of financial assets, the securitisation company
becomes the owner of financial asset and steps into the shoes of the
lender bank or FI. This acquisition can be said to be sale of asset
without recourse to the bank.
• RBI is the regulatory authority for securitisation or reconstruction
company
• Minimum capital requirement for securitisation company is Rs. 200
crore at the time of registration and these companies have to
maintain CAR of 15% of total asset acquired or Rs 100 crore whichever
is less
• Securitisation company needs registration both under companies act
1956 and SARFAESI act 2002 with RBI
• The securitisation company can set up separate trusts scheme wise
and act as trustees for such schemes. The investors in the
securitisation company are the beneficiaries of such trusts
• Security agreement means an agreement, instrument, or any other
document or arrangement under which security interest is created in
favour of the secured creditor. This includes creation of mortgage by
deposit of title deeds with the secured creditors
• When the bank decides that the financial asset be now acquired
by the securitisation company, a notice may be given about
such acquisition to the obligor. However, giving such notice is
optional. In case the obligor is a company and creation of
charge has been registered, then also giving of notice to the
respective registrar is optional.
• If notice of acquisition is given as above, it is necessary that the
obligor should make payment to the concerned securitisation
company. Such payment amounts to a valid discharge of liability
of the obligor making the payment
• Where notice is not given, payment received by the bank from
the obligor shall be held in trust and shall be handed over to the
company
• The securitisation company raises funds for acquisition of assets
as above. Only the qualified institutional buyers can buy these
securities. The security receipts are not issued to the public.
When securitisation company decides to raise funds from QIBs,
following conditions apply:
• For each financial asset acquired there should be a separate
scheme
• Scheme-wise and asset-wise distinct accounts are to be
maintained
• Realisation of the asset is held and applied towards redemption
• Where there is no repayment as above, QIBs of not less than 75%
of the total value of the security receipts are entitled to call a
meeting of all QIBs and the resolutions passed in such meeting
are binding on the concerned securitisation company
 Due to trust arrangement the money held by the company are held in
trust and do not form the assets of the company. In the eventuality of
the liquidation such money does not pass to the hands of the liquidator
• When the securitisation company issues security receipts the holder is
entitled to an undivided interest in the financial asset. In such event
the security receipt does not require registration under Indian
registration act, 1908
Acquisition of rights or interest in financial assets:
• The securitisation company can acquire financial assets of any bank or
financial institution by following ways:
1. By issuing a debenture or a bond or any other security in the nature of
debenture for agreed consideration and agreed terms and conditions
between the bank/FI and financial institution and securitisation
company/reconstruction company as the case may be
• The securitisation company or the reconstruction company can acquire
financial asset without execution of any deed of assignment or
transfer in its favour by the concerned bank or the FI. Assignment is
complete on the acquiring company issuing a debenture or bond and
incorporating therein the terms and conditions of acquisition. There is
no need for execution of any other document
• Securitisation transaction involves two stages. The first is acquisition
of financial assets and undivided interest therein . The second is issue
of security receipts in favour of investors for the purpose of raising
money from investors
• If the bank or FI is a lender in relation to any financial asset acquired
by the securitisation company or reconstruction company then such
company is deemed as lender in context with that acquired property.
Therefore all the rights of such bank or FI in the security vests in such
company acquiring the rights
• The statutory provisions say that the acquiring company shall have
all the rights of the creditor vested with it.
• The provisions have excluded the liabilities. In other words if there
is some liability that the bank/FI is obliged to perform the same will
not pass on to the securitisation company. RBI in this regard has
made the provision as follows:
- acquisition of funded assets should not include takeover of
outstanding commitments
- liability under non-fund-based transactions should continue with the
bank or FI till demand arises
• In relation to financial assets, all contracts, deeds, bonds,
agreements, PAs etc are fully enforceable in place of banks/FIs in
favour of the securitisation company
• Any suit, appeal, or other proceeding related to the asset is not
affected by the transaction and that same can be continued against
the securitisation company
Documents involved in a securitisation transaction:
1. Offer document: The RBI has mentioned about the details in its
guidelines of 2003 about the form of affer and details to be
incorporated therein. Full details and and particulars about the
financial assets, loan details of the bank, trustees’ details etc. are
included. These include details about profit-loss, prepayments,
expenses, defaults, collection etc
2. Debenture: A debenture for payment of consideration to be paid to
the bank or FI for acquisition of financial asset from it. The rate of
interest offered can not be less than 1.5% above the bank rate as on
the date of issue
3. An agreement: It is with the originator to continue to service the
assets of the securitisation
4. Security receipt: It is in favour of the investors
• Giving of notice to the obligor about securitisation is optional
• The securitisation company raises funds for acquisition by issue of
security receipts
• Only the Qualified institutional buyers can buy these security receipts
• The investment in security receipts is complicated and involves much
risk assessment
• That is the reason why individuals are debarred from investing in these
• Holders of security receipts are entitled to an undivided interest in the
financial asset. In such event the security receipt does not require
registration under registration act 1908
• Registration of security receipt is required in following cases:
- there is transfer of security receipt
- if the security receipt is creating, declaring, assigning, limiting or
extinguishing any right ,title, or interest