Professional Documents
Culture Documents
INDIA
CONVENTIONAL BOND
STRUCTURE
Earning Bonds
s Power Issuer Investo
Structure of a etc Cash r
normal debt
instrument A debt instrument is the obligation of the issuer
Normally, the credit profile of the issuer depends on the aggregated earnings power of
its businesses in the context of its financial risk profile and management capability
It is these businesses that would need to generate the cash flows for bond redemption
LIMITATIONS OF CONVENTIONAL
DEBT FUNDING
Limited flexibility to enhance the credit quality of the borrower
Largely standardized loan products homogenizing credit quality across cross-section of asset side
inflows and liability side outflows
Firms unable to package out different levels of risk to meet varying needs of investors
Are Consequently, cost of funds linked to average credit profile of different cash flows
alternatives
available?
SECURITIZATION -
BASICS
Securitization is the pooling of “homogeneous”, “financial"," cash flow
producing”, “illiquid” assets and issuing claims on those assets in the form of
marketable / tradable securities
In securitization, the lender / originator sells the right to receive the future
receivables to a third party and receives the present value of the receivables
at the initiation of the transaction
The higher yield associated with these securities attracts investors who are
willing to bear the associated credit, prepayment and liquidity risk
SECURITIZATION -
BASICS
The basic principles of direct assignment remain the same - the
only difference being that the investor records the transaction as
‘loans’ in its books and doesn’t invest in a tradable security
Typically both principal and interest Monthly interest; bullet principal payments
repaid monthly
Rating cannot be higher than the issuer
debt rating
Credit enhancement helps in getting
a higher rating than the issuer
Securitization vs Bilateral Assignment
Receivables based financing
Full Recourse
On Balance
Sheet Limited Recourse
Limited Recourse Off Balance Sheet
No capital Relief Off Balance Sheet
No gain on Sale Release of capital
Release of capital Possible gain on
Bilateral or CMI Possible gain on Sale
Sale Banks and capital
No capital market market investors
investors
Subscribe to securities
Investors issued by SPV
PARTIES TO A SECURITISATION
Proceeds Proceeds
Finance Company Ltd.
(Originator) Trust (SPV) Investors
Sale of assets Asset-Backed
Securities
Trust Agreement
Trustee
EXCHANGE OF FUNDS - ONGOING
Loan Rating
repayments
Monthly loan Monthly investor
Finance Company Ltd. repayments payments
(acting as servicer) Trust (SPV) Investors
Monthly
Collection reports
Trustee Responsibilities reports
Trustee
Par
ParStructures
Structures Premium
PremiumStructures
Structures
Investor
Investor pays
pays aa consideration
consideration equal
equal to
to the
the present
present value
value of
of future
future
Investor
Investor pays
pays aa consideration
consideration equal
equal to
to the
the principal
principal cash
cash flows. The investor pays a premium to receive the excess
flows. The investor pays a premium to receive the excess
outstanding (par value) of the pool
outstanding (par value) of the pool interest
interestspread
spread
In
In return,
return, investor
investor isis entitled
entitled to
to receive
receive scheduled
scheduled principal
principal In
In return,
return, investor
investor receives
receives the
the entire
entire cash
cash flows
flows generated
generated from
from the
the
repayments along with a contracted
repayments along with a contracted yield yield pool
pool
Typically,
Typically, interest
interest generated
generated on on the
the pool
pool isis higher
higher than
than the
the
yield
yield to the investor, the difference is called excess interest
to the investor, the difference is called excess interest No
Noexcess
excessinterest
interestin
inthe
thestructure
structure
spread
spread(EIS)
(EIS)
EIS
EIS provides
provides credit
credit support
support to
to the
the investors.
investors. the
the originator
originator The
The rating
rating takes
takes care
care of
of the
the fact
fact that
that the
the investor
investor payouts
payouts are
are higher
higher
retains a subordinated right to receive the EIS.
retains a subordinated right to receive the EIS. and credit enhancement is calculated accordingly
and credit enhancement is calculated accordingly
Prepayments
Prepayments in
in the
the underlying
underlying pool
pool are
are passed
passed on
on to
to the
the As
As investor
investor principal
principal outstanding
outstanding isis higher
higher than
than the
the pool
pool principal,
principal, the
the
investor
investor credit enhancement is utilized to cover the prepayment shortfall
credit enhancement is utilized to cover the prepayment shortfall
BENEFITS OF
SECURITIZATION
Efficient use of capital
Off balance sheet treatment and hence release of a portion of capital tied up by these
assets
Allows the company to continuously churn assets and expand business volumes even
when capital availability is scarce
Off-balance sheet treatment and upfront profit generated has a positive impact on
financial results like Return of Assets, Earnings per share, Net spread etc.
Securitization is an alternative source of funding that does not use up limits set up by
banks / institutions on the company and allows allocation of funds by investors over
and above these limits
BENEFITS OF
SECURITIZATION
Rating enhancement resulting in lower cost of funds
Capital markets and other investors demand yields linked to the rating of the
issuers for direct debt investment
Typically, the originator acts as servicer for the transaction and hence continues
to be the point of interaction with the obligors.
ORIGINATOR’S
OBJECTIVES
Each originator should define the objectives desired to be
achieved through the proposed securitization transaction in
Structure of order of priority
securitizatio
n may vary
Access to an alternate source of funds / investor class
significantly Optimization of regulatory capital requirement
based on the
priority of Rating enhancement and reduction in cost of funds
objectives of
the
Balance sheet management : liquidity, asset-liability
matching, debt-equity ratio
originator
Limited recourse financing
Risk management – Sector exposure / company exposure
WHAT CAN BE SECURITIZED
1200 100
1000
80
ABS market dipped in 2009
800
600
60
Absence of banks from this market
40
400
4%
CVs emerged as dominant asset class largely
2% 4% driven by Shriram, Tata Motors finance and
New/ used Cars and UV Two wheeler Magma
Personal loan SME loan
Mixed pool Others Microfinance loans and gold loans are the
Source: ICRA Research & Industry
emerging asset classes
TOP ABS ORIGINATORS
Banks have largely been non-existent in ABS market for last one year as the retail
asset growth has been minimal / negative
ABS continues to be a viable resource raising avenue for NBFCs focusing on asset
finance
Top originators for 2009-10 till date are Reliance Capital, Tata Motors Finance and
Shriram Transport Finance Limited
WHAT AN ORIGINATOR LOOKS
FOR
Capital relief
k
Ban
capital), Unsecured Asset (125% risk weight and
Capital 9% capital)
Relief
C
NBF
12%, 10% in case of Asset Finance Companies
Bank
rating (typically 100% risk weight & 9% capital).
Capital
Unrated to be fully deducted. No reset.
knock off for
Collateral
C
To be fully deducted out of capital. No reset
NBF
allowed. Basel applicability??
Bank
requirement
Cost of Reduces priority sector requirement
funds NBFC Reduces cost of funds. More important in case of
Non Asset Finance NBFCs where provisioning
requirement by Banks is leading to higher costs
BANKRUPTCY
REMOTENESS
True sale of assets from the seller to the trustee
Unlike US, the rise in delinquencies has not led to widespread downgrades
or defaults in securitised papers