SECURITISATION OF FINANCIAL ASSETS

SECURITISATION OF FINANCIAL ASSETS

Why Securitisation: 1. A convenient mechanism to suit changing needs of borrowers and lenders 2. Matches supply of funds with demand demands for funds through floating negotiable securities 3. Shifts the source of repayment from earning to a pool of assets

SECURITISATION OF FINANCIAL ASSETS

Genesis and Growth: 1. Severe financial crisis faced by certain states in US during 1969-70 2. Federal government restriction on inter-state lending and borrowing 3. Raised funds from surplus states by issuing instruments backed by mortgaged properties

SECURITISATION OF FINANCIAL ASSETS

Elements of Securitisation: 1. Conversion of existing illiquid assets like loans, advances and receivables into tradable security 2. Reconverting them into fresh assets through capital market operations

SECURITISATION OF FINANCIAL ASSETS

Benefits of Securitisation:
1.
2.

3.

Separates the credit risk of the assets from the credit risk of the Originator Lower the cost of borrowing for Originator as the security is independent of the rating of the corporate securitising these assets Illiquid assets converted into marketable securities and thus provide alternate funding source

SECURITISATION OF FINANCIAL ASSETS

Benefits of Securitisation : (contd)
4. 5. 6.

7.

Remove assets from balance sheet and thus improve capital adequacy Operations in a particular portfolio of assets can be increased without increasing total exposure Creates a highly diversified portfolio in terms of assets and geography (seanoning) Dependability of cash flows from the assets as signified by the ageing of the portfolio

SECURITISATION OF FINANCIAL ASSETS

The Players and their Role:
1.
2.

Originator: An entity making loans to borrowers or having receivables from customers Special Purpose Vehicle: The entity which buys assets from Originator and packages them into security for further sale
a. b.

Bankruptcy remote Separates the risk of assets from the credit risk of the seller

3.

Credit Enhancer: To reduce the overall credit risk of a security issue by providing senior subordinate structure, over-collateralization or a cash collateral

SECURITISATION OF FINANCIAL ASSETS

The Players and their Role: (contd)
4.
5.

6.

7.

Credit Rating Agency: To provide value addition to security Insurance Company / Underwriters: To provide cover against redemption risk to investor and / or under-subscription Obligors: Whose debts and collateral constitute the underlying assets of securitisation Investor: The party to whom securities are sold

SECURITISATION OF FINANCIAL ASSETS

Requirements for Eligible Collaterals:
1.
2.

3.
4.

Assets to be securitised to be homogeneous in terms of: Underlying assets Maturity period Cash flow profile

SECURITISATION OF FINANCIAL ASSETS

Eligible Collaterals: 1. Housing finance 2. Term loan finance 3. Car loan 4. Credit card receivables 5. Export credit 6. Etc.

SECURITISATION OF FINANCIAL ASSETS

Eligible Collaterals: 1. Housing finance 2. Term loan finance 3. Car loan 4. Credit card receivables 5. Export credit 6. Etc.

SECURITISATION OF FINANCIAL ASSETS

Structure of Securitisation: 1. Pass Through Certificates: Sale of asset to SPV Investors purchase interest in the assets of SPV Cash flow (interest and principal) passed through as and when occurred without any reconfiguration Payments made are most often on monthly basis Reinvestment risk carried by investor

SECURITISATION OF FINANCIAL ASSETS

2.

Pay Through Certificates:

Sale of assets to SPV SPV issues a debt security collateralized by asset cash flows Cash flows (interest and principal) reconfigured to suit the requirements of the investors i.e. based on the maturity period of the security Reinvestment risk carried by SPV Each trench is redeemed one at a time Payments would be at different time intervals than the flows from the underlying assets

SECURITISATION OF FINANCIAL ASSETS

Instruments: Depending on the structure of securitisation, the instrument would be pass-through certificate (PTC), a promissory note, a bond or debenture. 1. The PTC passes the cash flows from borrowers in the same form to investors. However, negotiability is restricted as the investor has to return the PTC to SPV 2. Promissory note / bonds / debentures make available different tenor maturities and yield to different investors

SECURITISATION OF FINANCIAL ASSETS

Securitisation Process: 1. Selection of assets by the Originator 2. Packaging of designated pool of loans and advances (assets) 3. Underwriting by underwriters 4. Assigning or selling to of assets to SPV in return for cash 5. Conversion of the assets into divisible securities

SECURITISATION OF FINANCIAL ASSETS

6. 7. 8.

9.

SPV sells them to investors through private placement or stock market in return for cash Investors receive income and return of capital from the assets over the life time of the securities The risk on the securities owned by investors is minimized as the securities are collateralisied by assets The difference between the rate of the borrowers and the return promised to investors is the servicing fee for originator and SPV

SECURITISATION OF FINANCIAL ASSETS

Legislations / Enactments and their impact on securitisation transactions: The Companies Act 1956 affect the SPV in the following manner: 1. Framing of Memorandum and Article of Association of the SPV and formation of SPV as a Limited Company 2. Management of affairs viz. Board of Directors, Borrowing Powers / delegation of powers for recovery of receivables etc. 3. Share Capital Structure 4. Issuance of Bonds / Debentures etc. to investors (whether by public issue or private placement) and servicing the investors