– Kanakprabha Jethani, Ass. Manager
The first half of this financial year came with lots of schemes to “apparently” support the financial sector during this time of crisis starting from moratoriums, restructuring, interest subvention and so much more. All these schemes were then adorned with an extension of their time limits, so much that at one point the borrower would altogether tend to forget he has an outstanding liability with some lender.
While the credit risk is an issue lenders cannot ignore, they also cannot ignore the fact that a huge chunk of their borrowers are not going to or will not be able to pay. Considering this, they are bound to allow moratoriums and offer restructuring benefits to them.
A lending transaction is between the lender and the borrower. Providing benefits such as moratorium, restructuring etc. is a matter of agreement between the two. However, in certain cases where there is an involvement of external parties, such as in the case of securitisation or direct assignment of a loan pool, practical dfficulties may arise.
The following FAQs intend to answer the basic questions regarding providing the restructuring benefit to borrowers of loans that have been securitised/assigned by the originator.
Stage1: While contemplating the decision to provide benefit of the schemes
1. Can the originator provide such benefit?
The originator retains/invests in a very small portion of the portfolio. The rest of it is sold off to the assignee/SPV. The moment an originator sells off the assets, all its rights over the assets stand relinquished. However, after the sale, it assumes the role of a servicer. Legally, a servicer does not have any right to confer any relaxation of the terms to the borrowers or restructure the facility.
Therefore, if at all the originator/ servicer wishes to extend moratorium to the borrowers, it will have to first seek the consent of the investors or the trustees to the transaction, depending upon the terms of the assignment agreement.
On the other hand, in the case of the direct assignment transactions, the originators retain only 10% of the cash flows. The question here is, will the originator, with a 10% share, be able to grant moratorium? The answer again is No. With just 10% share in the cash flows, the originator cannot suo-moto grant moratorium, hence, approval of the assignee has to be obtained.
2. Is approval of investors required?
As discussed above, when an asset is securitised/assigned, the investor becomes the ultimate owner of the asset to the extent of his/her investment in the said asset. Hence, any change in the terms of the loan impacts the rights/liabilities of such investors. Hence, the investors, being the actual owners of the asset, must agree to offer the benefit of any restructuring, moratorium etc.
As for schemes which provide an additional/separate credit facility to the existing borrower such as ECLGS scheme, such facilities are treated as separate facilities and are not linked with the existing loans (the one which is securitised). Hence, in such cases, the approval of the investor or trustee shall not be required. However, it is recommended that a NOC is obtained from the investor or trustee to the effect that the originator is providing the additional funding based on the existing lending exposure on the borrower.
3. How will the approval be obtained ?
The investors may decide on the manner of providing approval. The originator, in the capacity of the investor (to the extent of retention in the transaction), may propose and initiate the process and obtain approval of other investors.
4. Is it mandatory for the investor to approve?
The investors, like in any other investment, has the right to consider their benefits and losses and accordingly decide on whether to approve. Further, investors may also give conditional approvals, say a change in payout structure, alteration of interest rate etc., considering the increased risk and the fact that investor is, for the time being, foregoing its returns.
5. What happens if investors do not agree?
In case the investors do not agree, no benefit of restructuring/moratorium can be provided to the borrower. But, considering the liquidity crunch in the economy, it is very likely that the borrower will fail to pay the loan instalments, thereby resulting in reduced cashflows from the borrower. However, in case the investors did not agree to grant restructuring benefits and amend the payout structure, they will have to be paid. This would call for the credit support to be utilised. Over time, when credit enhancement is utilised, the rating of the PTCs may be downgraded.
6. What happens if investors agree?
In case the investors agree for providing the benefit to the borrower, the same shall come be put into effect by a revision in payout structure for the investors. The payout structure will be revised as per the terms of restructuring or moratorium as the case may be.
7. What happens with the remaining investors if the majority agrees?
The assignment agreement usually provides the nature of approval required to amend the payment terms- either majority or else 100% of the investor, either in number or in value (usually 100%). Hence, in case the majority has agreed, the rest of the investors shall have to bear the outcome of moratorium/restructuring.
8. What will be the immediate impact on investors agreeing to provide the benefit?
When the investors agree for providing any such benefits, they simultaneously agree for an added arrangement concerning the payout structure. Hence, the immediate impact shall be on the cashflows arising out of the underlying assets.
9. What will be the impact on the agreed payout structure?
The payouts may be reduced or deferred or structured in any other way as per the restructuring terms.
10. Can the investors in a securitisation transaction agree for moratorium/restructuring but not for reschedulement or recomputation of payout structure?
In case the investors agree for moratorium/restructuring, such approval would inherently come with reschedulement or recomputation of the payout structure. This is because, if moratorium/restructuring benefit is provided, the cashflows on the underlying asset would be impacted. This, in turn, would affect the cashflows in the securitisation transaction. Hence, when agreeing to provide the benefit to the borrower, investors must bear in mind that there would be a simultaneous change in their payout structure as well.
11. Can the credit enhancements be used to make payments to the investors in case they have agreed to provide the benefit?
Credit enhancements are utilised usually when there is a shortfall due to credit weakness of the underlying borrower(s). In case the investor have agreed for the restructuring, consequently the payout structure must have also been revised and hence, avoiding any default leading to utilisation of the credit enhancement. Irrespective of granting the restructuring benefit, if there is still default, though credit enhancements can be utilised, however, it will reduce the extent of support, weaken the structure of the transaction and may lead to rating downgrade.
12. What will be the impact on the rating of the transaction?
Usually, any delays in payout, defaults etc. lead to a downgrade in the rating of the transaction. However, here it is important to consider that in a securitisation or a direct assignment, the transaction mirrors the quality of the underlying pool. Now, in case of moratorium, there will be a standstill on asset classification and in case of restructuring, the asset classification will be upgraded to standard. Hence, there is no impact on the credit quality of the underlying asset.
If the credit quality of the loans remain intact, then there is no question of the securitisation or the direct assignment transaction going bad. Therefore, we do not see any reason for rating downgrade as well.
Further, the SEBI had on March 30, 2020, issued a circular directing rating agencies to not consider delays/defaults caused due to COVID disruption, as a default event for the purpose of rating.
13. What will be the impact in the books of the investor?
In case of securitisation, the income will be booked by the investor as per the revised payout structure. In case of direct assignment, the assignee shall take the impact of restructuring in its books. Say, in case there is a reduction in interest rate, the asset must be booked at such revised interest rate in the books.
14. What will be the impact on asset classification and provisioning for such loans?
In case of moratorium, the asset classification will be on a standstill for the period for which moratorium is granted. After the moratorium period is over, the asset classification as per IRAC norms shall be applied. Further, as per the RBI guidelines for moratorium, additional provisions shall be required to be maintained.
In case of restructuring, the asset classification shall be on the revised loan, as per the IRAC norms.
15. Who will be required to maintain additional provisions?
Usually, investors maintain provisions corresponding to the PTCs held by them. The asset classficiation and provisioning is done on the basis of payout from such PTCs. Similarly, any additional provision that is required to be maintained, shall be maintained by the investor corresponding to the value of PTCs held.
Further, in the case of DA,both the assignee and assignor shall maintain the provisions, in their respective share of interest in the loan.
16. Suppose, after restructuring, the borrowers still fails to pay as per the restructured terms, what will be the impact on the rating?
In case the borrower fails to repay as per the restructured terms, it is a case of default beyond the moratorium/restructuring allowed by the RBI. This would result in a downgrade in the quality of the underlying asset. Hence, it is quite probable that the rating of the transaction may downgrade.
17. In case there is a rating downgrade, can the size of classes/tranches be changed?
The prime motivation for tranching a securitisation transaction is to obtain high rating for atleast a part of the transaction. Hence, the upper class, say class A, gets the maximum amount of credit support and is sized in a manner that it is able to get superior rating.
Now, when there is a threat of rating downgrade, the size of classes/tranches cannot be changed to maintain the rating. It is crucial to consider that the rating is allotted based on the structure of the transaction and not the other way round.
Hence, if at all, the originator intends to maintain the rating to the transaction, it may introduce further credit support to the transaction, but the size of classes should not be changed.