Securitisation

Module Number: 11

Agenda
Background Fundamentals of Securitisation Parties to a securitisation transaction Risk Analysis Structuring Credit Enhancement SPV Structuring Use of securitisation in project finance

What is securitization
Asset securitization transforms the risk-return characteristics of an asset to meet demands of the participants in the transaction
Securitization is a process of pooling / repackaging non-marketable, illiquid assets into tradable securities Involves true sale of the underlying assets Credit support provided by the originator/ issuer to enhance rating of the securitized paper Other kinds of credit enhancement is also used to obtain better rating

Generic deal diagram

Obligors
Collections Original Loan Cash flows

Credit Enhancement Providers

Credit enhancement Issue of securities

Servicer

Sale of asset

SPV
Rating

Servicing of securities

Investors

Originator

Subscription to securities

Purchase consideration Rating Agency

Arranger
Contracts Ongoing cash flows Initial cash flows

Structurer

Parties to a securitisation
Originator
Initial owner of the assets Sells its asset to the SPV

Obligor

Contractual debtor to Originator Pays cashflows that are securitised Set up specifically for transaction Purchases assets from Originator Company/Trust/ Mutual Fund Subscribe to securities issued by SPV

SPV

Investors

Parties to a securitisation (contd.)

Servicer Receiving & Paying Agent Credit Enhancement Provider Merchant Banker
Collects monies from Obligors, monitors and maintains assets Banker for the deal. Manages inflows& outflows, invests interim funds, accesses cash collateral Provides credit enhancement by way of swaps, hedges, guarantees, insurance etc. As structurer for designing& executing the transaction and as arranger for the securities

Parties to a securitisation(contd.)
Credit Rating Agency Legal & Tax Counsel
Provides a rating for the deal based on structure, rating of parties, legal and tax opinion etc Provide key opinions on the structure & underlying contracts Appointed for conducting due diligence both initial and during tenor of deal Appointed for safe custody of the underlying documents and registration/ transfer of securities

Auditor Custodian R&T Agents

Risk analysis
Risk
Credit risk and bankruptcy risk

Desc r ipt io n

Ability of the entity to pay its obligations and survive as a viable entity Performance risk Ability to fulfill contractual obligations Asset/ collateral Variation in the value of the risk underlying asset Payment / Ability of other parties, particularly counter party credit enhancement providers, to risk meet their obligations

Risk analysis (contd.)

Risk
Interest rate risk Exchange rate risk Liquidity risk

D escr ipt io n
Variation in interest rates Variation in exchange rates

Ability to liquidate the underlying assets or collateral to service the Investors in a timely manner Co-mingling risk Risk of loss of moneys collected and retained by the servicer for a short period before remitting to the SPV

Risk analysis (contd.)

Risk D esc r ip t io n
Prepayment risk Variation in maturity of the investments made by the investors due to prepayment by Obligors Reinvestment Variability in the returns earned on risk investments made by the SPV, for the period till the pre-specified dates (pay through structures) Legal / Interpretation of various laws regulatory / tax (including tax laws), regulations and risk complex documentation

Structuring Credit Enhancement

Insurance / Guarantee / Letter of credit
Can be full or partial Credit Enhancement Providers charges a premium or commission for providing this protection

Credit Tranching (senior/sub-ordinated structure)

First losses are borne by the sub-ordinated tranches Used to target investors with specific risk-return preferences

Over-collateralisation
Originator sets aside assets/cashflows in excess of the collateral required to be assigned to the SPV Additional comfort if part of the cashflows or assets or Obligors become impaired

Structuring Credit Enhancement (contd.)

Cash collateral
Quantum of money earmarked Liquidity support as well as credit support

Spread account
Difference between the yield on underlying assets and yield to the investors (excess spread) A spread account traps the excess spread (net of all running costs) Amount returned to the Originator after the payment of principal and interest to the investors.

Swaps and Options

Interest, price and exchange rate risks

SPV structuring
Characteristics of the SPV
Bankruptcy remoteness Formed for specified purpose; no other activities undertaken Does not add to the costs to the transaction - Capital efficient and tax efficient

Legal structure dependent on the regulatory and legal environment of its domicile
India - company / trust / mutual fund

SPV structuring
Alternative Payment structures
Pass Through structure - SPV remits any funds collected completely and immediately to the investors. Pay Through structures
De-synchronization of servicing of the securities from the underlying cash flows. SPV has discretion to re-invest the funds and pay investors according to a pre-determined schedule.

Use of Securitisation in Project Finance

Useful as a means of securing funds for the project (future receivables are secured by means of securitisation eg. road toll securitisation) On completion of the project and satisfactory performance for a short period, the SPV could securitise the project receivables and use it to refinance original high cost borrowings

Thank You