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Loan securitization is the process of pooling various types of receivables, including mortgage loans and credit card receivables,

and using them as collateral to issue securities. This structured finance process enables the originators of various types of loans to reduce their risk and adjust their finances. Home loans, auto loans, student loans and credit card receivables are the most common type of loans used as collateral to issue securities. Beginning of Loan Securitization Traditionally, banks and lending institutions held loans till their maturity or until the time they were paid off. These loans were funded by deposits and direct loans (which were not backed by any type of assets). However, the rising demand for credit forced these banks to search for alternate funding options. Securities backed by mortgage loans were the first ones to be issued in February 1970. Securitization techniques used in the housing loan segment were successfully adopted in the case of automobile loans in 1985. The process was then emulated in the case of credit card receivables and student loans. Over the past several years, loan securitization has been successfully utilized in the case of Community Reinvestment ACT (CRA) loans, which were targeted at low and moderate income borrowers, equipment leases and even small business loans. Process of Loan Securitization The process of loan securitization is conducted through a Special Purpose Vehicle (SPV) or a trust specially created for the purpose. The loan receivables of the originator are transferred to the SPV or the Trust, which then uses the assets purchased as collateral to issue securities to investors. The interest and principal payments received from the borrowers are used to pay off the interest on the securities. The performance of the securities is totally dependent on the assets backing them. Securities backed by assets are often split into tranches representing varying degrees of subordination. Each level of security represents a different level of credit protection or risk exposure, and the senior classes have the first claim on cash flows received by the SPV. Loan securitizations are often structured as sequential bonds, wherein the first tranche receives all the principal payments until it is retired; then the second tranche begins to receive principal, and so forth. Another type of structure used in loan securitization is the pro rata bond structure, wherein each tranche is paid a proportionate share of the principal throughout the life of the security.

DETAILS Securitisation process can be perceived as a two-stage process. First stage: Transfer of mortgage debt from the primary lending institution (Originator) to a Special Purpose Vehicle (NHB SPV Trust set up by NHB through declaration) with or without the underlying security.
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Second stage: The mortgage debt so acquired will be converted into tradable debt instruments (say in the form of Pass Through Certificates) without any recourse to the originator or the SPV. Securitisation of Mortgage Debt : NHB SPV may purchase and convert the housing loans into securities/ PTCs concurrently and issue them in the capital market for investment by investing institutions. Execution of Memorandum of Agreement with NHB Based on the willingness to sell or securitise its portfolio of housing loans, the Primary Lending Institution is required to enter into an umbrella agreement (called Memorandum of Agreement) with NHB to sell/securitise its portfolio of housing loans. The Memorandum of Agreement encapsulates the entire MBS transaction and entitles NHB to take necessary steps to purchase or securitise an identified pool of housing loans, including circulation of the Information Memorandum and collection of subscription amount from investors, as the case may be. Selection of Pool of Housing Loans The pool of housing loans would be selected by the Primary Lending Institution from its existing housing loans based upon a pool selection criteria. ELIGIBILITY CRITERIA FOR HOME LOANS TO QUALIFY FOR SECURITISATION The home loans should satisfy the following standards for being considered for selection in the Mortgage Pool offered for securitization:

The borrower should be individual(s). The home loans should be current at the time of selection/securitization. The home loans should have a minimum seasoning of 12 months (excluding moratorium period). The Maximum Loan to Value (LTV) Ratio permissible is 80%. Housing loans originally sanctioned with an LTV of more than 80% but where the present outstanding is within 80% of the value of the security, will be eligible. The Maximum Instalment to (EMI) to Gross Income ratio permissible is 45%. The loan should not have overdues outstanding for more than three months, at any time throughout the period of the loan. The Quantum of Principal Outstanding Loan size should be in the range of Rs.0.50 lakh to Rs.100 lakhs. The pool of housing loans may comprise of fixed and/or variable interest rates. The Borrowers have only one loan contract with the Primary Lending Institution (PLI). The loans should be free from any encumbrances/charge on the date of selection/securitization. The sole exception to this norm being loans refinanced by NHB (In such cases, the loans may be securitised subject to the originator substituting the same with other eligible housing loans conforming with the provisions of the refinance schemes of NHB). The Loan Agreement in each of the individual housing loans, should have been duly executed and the security in respect thereof duly created by the borrower in favour of the PLI and all the documents should be legally valid and enforceable in accordance with the terms thereof. The Bank/HFC has with respect to each of the housing loans valid and enforceable mortgage in the land/building/dwelling unit securing such housing loan and have full and absolute right to transfer and assign the same to NHB. The Pool selection criteria may be modified by NHB from time to time at its sole discretion. Submission of Pool Information The Primary Lending Institution will be required to submit loan details relating to the pool as under (in prescribed formats attached).
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Due Diligence Audit The Primary Lending Institution will get a due diligence review of the loan accounts conducted by Statutory Auditors of the Company or a firm of Chartered Accountants acceptable to NHB and shall submit a due diligence audit report to NHB after execution of the MoA certifying the following:

Each of the housing loans in the pool conforms and satisfies the selection criteria laid down by NHB. All the information furnished by the Primary Lending Agency to NHB with regard to the Borrower of the said agency is true and correct. All the documents connected with the pool of housing loans proposed for sale to/securitisation through NHB are legally valid and enforceable and the said agency has good and assignable right to each of the housing loans free and clear of any set off, cross-claims, demands, encumbrance, equity, pledge, charge, claim or security interest thereon. None of the housing loans has been sold, assigned, transferred or pledged to any person and the HFC is sole legal and full beneficial owner of these housing loans and has full right to transfer and assign the housing loans to NHB. Valuation of the pool and Consideration of Assignment NHB will consider making payment of purchase consideration to the Primary Lending Agency under the following methodology, with a view to obtain a sound and efficient pricing structure to the benefit of originators: (i) Par Pricing Methodology: The consideration payable to the Primary Lender for transferring the pool would be equal to the total future outstanding principal balances of the individual loans on a Cut-Off Date. (ii) Premium Pricing Methodology: The consideration paid to the Primary Lender for transferring the pool would be decided and paid on the basis of discounting of future stream of net cashflows relating to the pool. It shall normally be higher than the total outstanding principal balances of the individual loans on a Cut-Off Date as the discounting rate used shall be lower than the weighted average coupon of the pool. (iii) Discount Pricing Methodology: The consideration paid to the Primary Lender for transferring the pool would be lower than the total outstanding principal balances of the individual loans on a Cut-Off Date as the discounting rate used shall be higher than the weighted average coupon of the pool due to higher risk perception. Salient aspects of valuation:

The outstanding principal of the underlying home loans should not be less than the face value of the RMBS papers. Pool Receivables: The HFC shall assign, transfer and convey to NHB (either in its corporate capacity or in the capacity of Trustee) for securitization the balance outstanding principal of these housing loans as on the cut off date and all future interest due thereon together with all its other rights, titles and interest in relation thereto and in the mortgage or other securities therefor. As per the structure of the arrangement between NHB and the PLI, interest differential portion of the pool (i.e. Weighted Average Coupon of the pool less the Total Cost of the Transaction including coupon interest payable to the buyer of housing loans/investors in MBS, as the case may be), may be structured as continuous stream of subordinated cashflows in the form of either an Excess Servicing Fee or Income on Investment in a particular class of MBS or in some other form. Note: In respect of (ii) and (iii) stated above, the net cashflows shall be arrived at by deducting the recurring
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expenses such as rating surveillance fee, trustee fee, registrars fee, listing fee, audit/out-of-pocket expenses, and any other form of credit enhancement measure as decided in the structure, from the gross cashflows. The discounting factor shall be determined on the basis of some realistic assessment of the prevalent rate of interest in the debt market in respect of similarly rated papers as well as risk being transferred under the transaction and the risk premium perceived thereagainst, including assessment of the capabilities / creditworthiness of the service provider. NHB will not purchase any overdue EMIs or penal interest/out-of-pocket expenses outstanding in the originators books as on the cut-off date. These amounts as and when collected from the respective borrowers will be retained by the originator or shall be allowed to be deducted from the first months collection after the cut off date as agreed to between parties. Working out cut off date balances The outstanding principal as on the cut-off date, may be worked out by adjusting the original loan amount to the extent of the principal component of the EMIs payable up to the cut-off date together with the adjustment for any prepayments received during this period. Any EMI/other charges remaining unpaid as on the cut off date shall be shown separately as the cut off date receivables. Credit Enhancement In order to maintain a AAA rating and to improve the performance of the pool as also to ensure uninterrupted cashflow for yielding the indicated coupon interest to the purchaser or subsequent investors in the MBS paper, the Rating Agency or NHB may insist for additional credit support (called credit enhancement) under the transaction. The credit enhancement may be provided in various forms such as setting aside a cash pool (called cash collateral account), limited corporate guarantee, third party guarantee, setting aside an additional mortgage pool (called over-collateralisation), investment in sub-ordinated MBS paper (in the event of securitisation) etc. In the event of securitisation of mortgage debt abinitio, credit support will be sought on the basis of recommendation of the credit rating agency. Liquidity Adjustment Facility In view of delayed receipt of instalments from some borrowers at times and grace periods allowed by the primary lending agencies to its borrowers, collection efficiencies may vary from month to month leading to inadequacy of cashflow required for servicing. In order to protect the purchaser of housing loans/investors in MBS from such uncertainties, there may be a need to set up a Liquidity Adjustment Facility as a temporary stopgap arrangement. NHB may decide the size/quantum of such a facility and require the seller of housing loans to provide such a facility separately or in combination with the credit enhancement provided by them. NHB may also consider outsourcing such a facility at a cost to be borne by the seller or out of the pool cashflows depending on the structure of the arrangement. Custody of Mortgage Documents While the mortgage debt or the receivables pertaining to the MBS transaction will be legally transferred to NHB/SPV Trust, the originator (primary lending agency) will continue to physically hold the title documents in respect of the housing properties, obtained as security on the loans issued, in the capacity of a custodian to NHB/SPV Trust and deal with the same or all realisations therefrom only in accordance with the directions of NHB. Also, the originator shall , on being so advised by NHB, give notice to the Borrower/s and/or third parties and enforce the security/ies in its own name, if so required, for realisations of the outstanding due/s which is/are unpaid by the Borrowers and shall, when so advised by NHB in writing, transfer or deliver to the NHB all relative documents, records, contracts and writing and papers in respect of the housing loans and securities connected therewith. Design of MBS Instruments The mortgage debt will be purchased by NHB with a right to securitize them on the same/at a later date.
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However, irrespective of whether the proposal is for purchase of mortgage debt or for securitization of housing loans, NHB will be free to design and issue any kind of innovative instruments as it may deem fit. Appointment of Various Agencies In the event of securitization of mortgage debts by NHB, NHB may decide to get the MBS instrument(s) rated by one or more rating agencies, engage the services of one or more Issue Arrangers for preparation of the Memorandum of Information pertaining to the issue and placement of the issue on private placement or public issue basis, appoint the originator (Primary Lending Agency) or any other agency as the Servicing and Paying Agent under the transaction, engage the services of Registrar and Transfer Agent (in the event of securitization) and such other agencies as NHB may consider appropriate for smooth operation of the scheme. NHB may consider getting the MBS instrument listed in one or more Stock Exchanges and dematerialized the same with any of the Depositories at its sole discretion. Payment of Consideration NHB will make payment of consideration for the purchase of mortgage debts (for holding it in its own book or for the purpose of securitization abinitio) after issue of allotment letters to investors or after execution of the legal documents relating to the transaction or on such date as mutually agreed to between the buyer and the seller. Establishment of Special Purpose Vehicle for Issue of MBS In the event of securitization of housing loans, NHB may set up one or more Special Purpose Vehicles (SPVs) in the form of Trust(s) or any other constitution for implementation of the scheme. Post Issue Servicing and Reporting Requirements The Servicing and Paying Agent appointed by NHB shall submit monthly reports in respect of collections in the transferred pool of mortgages and such other MIS Reports, Statement of Accounts and Trial Balances as prescribed by NHB from time to time. NHB or a firm of Chartered Accountants appointed by NHB in this behalf will have the right to carry out inspection and/or audit of the loan account to verify the correctness of the reports and statements. Hierarchy of Appropriation of Collection mounts (Payment Waterfall) The hierarchy of payments shall generally be as follows:

Payment to Service Providers viz. Trustee, Servicing Agent, Rating Agency, & other service providers Payment of Interest to Senior Class RMBS (Class A PTC) holders Payment of Principal to Senior Class RMBS (Class A PTC) holders Replenishment of Cash Collateral / Guarantee / such other form of credit enhancement Payment of Principal to Subordinate RMBS (Class B PTC) holders Payment of Residual Income to Subordinate (Class B PTC) holders The Servicing and Paying Agent appointed by NHB shall continue to make all reasonable endeavours to collect the monthly instalments from the borrower and shall continue to administer the housing loans and undertake to devote such time and to exercise such skill, due care and diligence in the administration and enforcement of the rights, powers, privileges and securities in respect of the housing loans as it would have exercised had the entire beneficial interest in housing loans been retained by it and release and return specific documents relating to any housing loan Agreement under advice to NHB, if and only if, the relative borrower has paid his entire dues. The Servicing and Paying Agent will continue to follow the standard norms (as being followed in respect of its other borrowers) for appropriation of monies received from the borrowers. For specific deviation of norms or use of discretion by the Servicing and Paying Agent especially relating to waiver of penal interest, interest,
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treatment of prepayments, transfer out cases, re-schedulement of loans, conversion of loans from fixed rate to variable rate etc. specific or general approval of the buyer (NHB) shall be taken. Fees Structure NHB may seek reimbursement of upfront /out-of pocket expenses as may be mutually agreed upon by the originator and NHB. A trusteeship fee at a prescribed rate will be payable to NHB in its capacity as a trustee. Besides these, NHB may levy additional fees as may be mutually agreed upon between the originator and the NHB for carrying out any additional services as may be required by the originator or servicing and paying agent. One time fee/charges (Initial Costs) Issue arrangers fee As per actuals Rating fee Stamp duty and registration charges on Documentation Actuals as may be negotiated between the originator and rating agency As per actuals [In the state of Gujarat this shall amount to Rs.2.00 lacs (approx.) plus legal charges (about Rs.20,000)

Stamp duty and registration charges on As per actuals issue of PTCs (if issued in physical form) Issue of PTCs issued in dematerialised form to investors Due diligence charges PTC Printing charges [if issued in physical form] Actuals as may be charged by NSDL and CDSL [NSDL charges Rs.10/- per PTC subject to a maximum absolute ceiling of Rs.500/-] As per actuals As per actuals

On going fees * (in addition to the PTC Coupon) Servicing and Paying Agent fee (if 0.25% of the outstanding pool value, Originator is S&PA, the fee is payable to payable monthly ( to be decided on Originator) consultation with Originator ) Surveillance fee [payable to the rating agency] Trusteeship fee [payable to NHB] Auditors fees/ Out-of-pocket expenses Actuals (as may be negotiated between Originator and Rating Agency) 0.05% (for banks), 0.02% of outstanding pool value payable monthly (for HFCs) As per actuals.As per actuals.

All the terms would be as mutually agreed upon between the Originator and NHB The above fees can be structured so as to be adjusted to the residual income of the pool. Payment to Investors Coupon: The PTC A holders are paid the specified coupon on their holdings every month out of the income received from the pool. Residual income: The cash flows remaining after making the payments to the service providers as per the payment schedule specified are designated as residual cash flows and are paid to the PTC B holder. Principal: The principal amount is paid as per the redemption schedule to the PTC A holders. Once, the PTC
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A principal is fully redeemed, the principal is utilised to redeem the PTC B principal. Prepayment and pre-payment charges: These amounts are paid to the PTC A and PTC B holders on a pro-rata basis depending upon the outstanding principal amount in each case. Mortgage Enforcement in event of Default NHB in its capacity as a purchaser of mortgages, or as trustee under a securitization transaction may empower the Primary Lender under the provisions of the S&P Agent agreement to enforce the mortgages in case of defaults on the pool. The associated costs for enforcement of the mortgages would be met out of collections from the borrowers. Any payments received on enforcement of the mortgages would be passed on to NHB for their suitable appropriation. Any other matters Any other matter(s) pertaining to the transaction, which have not been specifically addressed, shall be dealt with separately on the basis of mutual agreement between parties. Banks are running short of sources to raise funds. Securitization of home loan portfolio has witnessed a sharp fall and dropped to a third of previous years level, says the data showcased by rating agency Icra. In 2006, securitization was estimated to stand at Rs 5,000 crore whereas it is Rs 1,600 crore in 2007. The overall value of securitisation soars to Rs 37,000 crore (i.e. by 44%), largely due to bilateral deals among banks. The spectrum included auto, corporate, autos, and home loans. The securitisation of home loan portfolio is better known as Residential Mortgage Backed Securitisation (RMBS). Stringent liquidity conditions and increasing interest rates have come forward as the factors contributing to slowdown in the securitisation, says the report compiled by Icra. The RBI directives regarding securitisation specified that selling bank, also called as originating banks, should assign capital on the securitized loans. This discouraged the originating banks to offload loans through securitization. However, the securitization of corporate loans (loan sell offs, LSOs) has grown from mere Rs 1,200 crore to Rs 11,700 crore in the corresponding period in 2006. Consequently, the share of LSOs in the total securitisation activity reached to 32% much higher than the 8% share as estimated in the last two years. Icra expects the ABS market to grow in 2007; given the capital constraints that bank may face in the ongoing phase of loan growth, says Icra. Securitisation would serve as a critical funding tool especially for originators who find it hard to access the conventional debt market, adds the report.