Securitisation

Introduction
• Securitization is “the issuance of marketable securities backed by the
expected cash flows from specific assets (receivables)”
• Securitization is a process used by banks to create securities from
loans and other income producing assets.
• The securities are sold to investors.
• This removes the loans from the banks’ Balance sheets and enables
the banks to expand their lending faster than they would otherwise
be able to do.
Introduction
• In securitization, homogeneous pool of assets are identified and then
they are packaged into a new instrument that can be sold to
investors, whose payments are supported by the cash flows from that
pool.
• In a structured finance arrangement, the essential characteristic of
promise to repay the investor in a security is backed by
• The value of the underlying financial asset
• The credit support of a third party to the transaction
Participants
• The Originator: A firm that wants to securitize its assets is called
originator
• The Special Purpose Vehicle: Set up specifically for transaction. Purchases
assets from Originator. Company/Trust/ Mutual Fund.
• Obligors: The loan customers.
• Investors: Subscribe to securities issued by SPV
• Collection Agent : Collects money from Obligors, monitors and maintains
assets. Usually the originator
• Credit Rating Agency: Provides a rating for the deal based on structure,
rating of parties & portfolio, legal and tax opinion etc
Participants
• Credit Enhancement Provider : Provides credit enhancement by way
of swaps, hedges, guarantees, insurance etc.
• Merchant Banker: As structurer for designing & executing the
transaction and as arranger for the securities
Classification
• Mortgage-Backed Securities
• Residential Mortgage Loans
• Commercial Mortgage Loans
• Asset-Backed Securities
• Credit card Receivables
• Auto Loan Receivables
• Personal Loan Receivables
• Lease Receivables
• Trade Receivables
• Export Receivables
Mechanism of Securitization
• Pass-Through Certificates: In a PTC, the SPV issues PTCs which are
essentially participation certificates that enable the investors to take a direct
exposure on the performance of the securitized assets. These certificates
imply that the investors hold a proportional beneficial interest in the assets
held by the SPV.
• Investors are serviced as and when cash flows are generated from the
underlying assets.
• Any delay or disruption in cash flows is shielded to the extent of the credit
enhancement available.
• In PTCs, the securities are serviced directly from the cash flows or the
installment of the loans.
Mechanism of Securitization
• Pay-Through structure: A pay through structure gives only a charge
against the cash flows arising from the securitized assets while the
ownership of the assets lies with the SPV.
• In a pay-through arrangement, cash flows of the underlying assets and
the services of the securitized papers are delinked.
• The SPV issues a secured debt instrument to the investors as a
securitized paper.
• The SPV invests all the cash flows received form the asset pools in govt.
securities or other securities.
• Later, the proceeds from such investments are used to service the
investors.
Benefits of Securitization
• For Originator
1. Off-balance sheet financing.
2. Improves capital requirements.
3. Enhances Liquidity
4. Concentrate on core business.
5. Reduction in borrowing costs.
6. Another mode of Financing
Benefits of Securitization
• For Investors
1. Advantage to earn a high return on risk adjusted basis.
2. Opportunity to invest in a pool of high quality credit enhanced assets
3. Portfolio diversification – alternate investment vehicle.
4. Bankruptcy Remoteness – Investors are not affected by the insolvency of the
originator.
Risk Assessment in Securitization
• Collateral Risk: Extent to which the borrowers of underlying assets will
default.
• Structural Risk: Risk involved in passing on the cash flows from asset
pools and credit enhancement to the investors.
• Legal Risk: Extent to which the regulatory action can delay or prevent
the payment to investors.
• Third Party Risk: Failure of performance of third parties such as
servicer, trustees, bankers etc.
Securitisation -Indian context
• First deal in India between Citibank and GIC Mutual Fund, in 1990 for Rs. 160
million.
• Securitization of cash flow of high value customers of Rajasthan State Industrial
and Development Corporation in 1994-95, structured by SBI cap.
• Securitisation of overdue payments of UP government to HUDCO by issue of tax-
free bonds worth Rs. 500 million
• Securitisation of Sales Tax deferrals by Government Of Maharashtra in August
2001 for Rs. 1500 million with a green shoe option of Rs. 75 million.
• First deal in power sector by Karnataka Electricity Board for receivables worth Rs.
1940 million and placed them with HUDCO.
• Data indicate that ICICI had securitised assets to the tune of Rs. 27500 million in
its books at end March 1999.
Securitisation -Indian context
Some of the companies that have been Involved in this are
– Ashok Leyland finance
– Cholamandalam investment & finance
– Esanda finance
– Sakthi finance
– Tata finance
– SRF finance
MORTGAGE-BACKED SECURITIES IN
INDIA
• The beginning of Mortgage-Backed Securities (MBS) in India was
made in August 2000,
• when National Housing Board (NHB) issued the first MBS with issue
size of INR 59.7 crores, originated by HDFC Ltd.
Problems in Securitization in India
• Stamp Duty: is heavy in some states.
• Accounting Treatment: No clear guidelines
• Lack of Standardization: Format of the mortgage loan agreement is
not uniform.
• Foreclosure Laws: No separate Law for securitization
Regulation of Securitization in India
• In 2007, SCRA (Securities Contract Regulation Act) was amended to
include the securitized instruments in the definition of the term
securities.
• This has lead to listing and trading of securitized papers in the stock
exchanges.
• SEBI has released draft regulations for public offering and listing of
securitized debt instruments in June 2007, which is yet to be
formalized as a regulation.
Mortgage-backed securitization and subprime
crisis
• Subprime lending : “Subprime” is any loan that does not meet “prime”
guidelines. Making a loan to borrowers who are not qualify for the market best
interest rates.
• Subprime lending is risky for both lenders and borrowers due to the combination
of high interest rates, poor credit history, and adverse financial situations usually
associated with subprime applicants.
• From a servicing standpoint, these loans have higher collection defaults andv
experience higher repossessions and charge offs. Lenders use the higher interest
rate to offset these anticipated higher costs.
• Housing Babble: (2000-2005):
- Very low interest rates, property prices were on a rising trend and the sub prime
borrowers were able to meet their obligations by selling the properties or getting
the properties refinanced .This created ‘The Housing Bubble’
• 2006-2008
• More subprime borrowers failed to pay their debts
• Securities held by mortgages lost value globally
• Global investors also drastically reduced purchases of
• mortgage-backed debt and other securities
• On December 1, 2008, the National Bureau of Economic Research announced
that the economy had entered into a recession in December of 2007.

• Real GDP increased by only 0.4 percent for the year 2008, and it decreased at
annual rates of 5.4 percent in the 4th quarter of 2008 and 6.4 percent in the 1st
quarter of 2009.

• The unemployment rate increased from 4.9 percent in December of 2007 to 9.5
percent in June of 2009.

• The total real estate equity in The United States was valued at $13 trillion during
the 2006 peak, had fallen to $8.8 trillion by mid 2008.
Subprime Crisis in Brief
• The US subprime mortgage crisis was a set of events and conditions that led to a
financial crisis and subsequent recession that began in 2008
• Characterized by a rise in the inability to pay housing mortgages resulting in the
decline of securities backed by mortgages
• These mortgage-backed securities (MBS) initially offered attractive rates of return
• However, the lower credit quality ultimately caused massive defaults
• The money was sucked out of several banks, financial institutions and the economy
as a whole in September 2008
• Several European and developing countries had invested heavily in American banks
• The subsequent loss of funds resulted in the Global Recession of 2008
Reasons
• DOT COM COLLAPSE – 2000
• SEPTEMBER 11 TERRORIST ATTACK
• Low interest rates
• Increase in loan incentives
• Easy credit conditions
The Main Players
The Federal Reserve:
• Continued Reduction in Fed Rates
• Sudden increase in Money supply
• Rates remained low till 2005
• High Liquidity
The Main Players
Commercial Banks
• Lowered to lending rates to increase loan off take
• As the prime market was nearing saturation, began lending to subprime
borrowers
• Aggressively sold MBS, CDO
• Additional funds raised by securitization was redeployed in the same
manner
The Main Players
• Investment Banks
• Increased use of Secondary mortgage market
• Lenders sold their mortgages in the secondary market
• Pooled mortgages into securities like CDOs and MBS
The Main Players
Investors:
• Investors were the ones willing to purchase these CDOs at
ridiculously low premiums over Treasury bonds.
• These enticingly low rates are what ultimately led to such huge
demand for subprime loans.
The Main Players

Hedge Funds:
• Fuelled volatility through credit arbitrage
• Credit Default Swaps
• Influenced banks to bring out more MBS & CDOs as it was a good
avenue to invest in