-By Vinod Kothari (firstname.lastname@example.org)
Securitisation is all about bankruptcy remoteness, and the common saying about bankruptcy remoteness is that it works as long as the entities are not in bankruptcy! The fact that any major bankruptcy has put bankruptcy remoteness to challenge is known world-over. In fact, the Global Financial Crisis itself put several never-before questions to legality of securitisation, some of them going into the very basics of insolvency law. There have been spate of rulings in the USA pertaining to transfer of mortgages, disclosures in offer documents, law suits against trustee, etc.
The Indian securitisation market has faced taxation challenges, regulatory changes, etc. However, it has so far been immune from any questions at the very basics of either securitisability of assets, or the structure of securitisation transactions, or issues such as commingling of cashflows, servicer transition, etc. However, sitting at the very doorstep of defaults by some major originators, and facing the spectrum of serious servicer downgrades, the Indian securitisation market clearly faces the risk of being shaken at its basics, in not too distant future.
Before we get into these challenges, it may be useful to note that the Indian securitisation market saw an over-100% growth in FY 2019 with volumes catapulting to INR 1000 billion. In terms of global market statistics, Indian market may now be regarded as 2nd largest in ex-Japan Asia, only after China.
Since the blowing up of the ILFS crisis in the month of September 2018, securitisation has been almost the only way of liquidity for NBFCs. Based on the Budget proposal, the Govt of India launched, in Partial Credit Guarantee Scheme, a scheme for partial sovereign guarantee for AA-rated NBFC pools. That scheme seems to be going very well as a liquidity breather for NBFCs. Excluding the volumes under the partial credit enhancement scheme, securitisation volumes in first half of the year have already crossed INR 1000 billion.
In the midst of these fast rising volumes, the challenges on the horizon seem multiple, and some of them really very very hard. This write up looks at some of these emerging developments.
Sale of assets to securitisation trusts questioned
In an interim order of the Bombay High court in Edelweiss AMC vs Dewan Housing Finance Corporation Limited, the Bombay High court has made certain observations that may hit at the very securitisability of receivables. Based on an issue being raised by the plaintiff, the High Court has directed the company DHFL to provide under affidavit details of all those securitisation transactions where receivables subject to pari passu charge of the debentureholders have been assigned, whether with or without the sanction of the trustee for the debentureholders.
The practice of pari passu floating charge on receivables is quite commonly used for securing issuance of debentures. Usually, the charge of the trustees is on a blanket, unspecific common pool, based on which multiple issuances of debentures are covered. The charge is usually all pervasive, covering all the receivables of the company. In that sense, the charge is what is classically called a “floating charge”.
These are the very receivables that are sold or assigned when a securitisation transaction is done. The issue is, given the floating nature of the charge, a receivable originated automatically becomes subject to the floating charge, and a receivable realised or sold automatically goes out of the purview of the charge. The charge document typically requires a no-objection confirmation of the chargeholder for transactions which are not in ordinary course of business. But for an NBFC or an HFC, a securitisation transaction is a mode of take-out and very much a part of ordinary course of business, as realisation of receivables is.
If the chargeholder’s asset cover is still sufficient, is it open for the chargeholder to refuse to give the no-objection confirmation to another mode of financing? If that was the case, any chargeholder may just bring the business of an NBFC to a grinding halt by refusing to give a no-objection.
The whole concept of a floating charge and its priority in the event of bankruptcy has been subject matter of intensive discussion in several UK rulings. There have been discussions on whether the floating charge concept, a judge-made product of UK courts, can be eliminated altogether from the insolvency law.
In India, the so-called security interest on receivables is not really intended to be a security device – it is merely a regulatory compliance with company law rules under which unsecured debentures are treated as “deposits”. The real intent of the so-called debenture trust document is maintenance of an asset cover, which may be expressed as a covenant, even otherwise, in case of an unsecured debenture issuance. The fact is that over the years, the Indian bond issuance market has not been able to come out of the clutches of this practice of secured debenture issuance.
While bond issuance practices surely need re-examination, the burning issue for securitisation transactions is – if the DHFL interim ruling results into some final observations of the court about need for the bond trustee’s NOC for every securitisation transaction, all existing securitisation transactions may also face similar challenges.
Rating agencies have recently downgraded two notches from AAA ratings several pass-through certificate transactions of a leading NBFC. The rationale given in the downgrade action, among other things, cites servicer risks, on the ground that the originator has not been able to obtain continuous funding support from banks. While absence of continuing funding support may affect new business by an NBFC, how does it affect servicing capabilities of existing transactions, is a curious question. However, it seems that in addition to the liquidity issue, which is all pervasive, the rating action in the present case may have been inspired by some internal scheme of arrangement proposed by the NBFC in question.
This particular downgrades may, therefore, not have a sectoral relevance. However, what is important is that the downgrades are muddying the transition history of securitisation ratings. From the classic notion that securitisation ratings are not susceptible to originator-ratings, the dependence of securitisation transactions to pure originator entity risks such as internal funding strengths or scheme of arrangement puts a risk which is usually not considered by securitisation investors. In fact, the flight to securitisation and direct assignments after ILFS crisis was based on the general notion that entity risks are escaped by securitisation transactions.
The biggest jolt may be a forced servicer transition. In something like RMBS transactions, outsourcing of collection function is still easy, and, in many cases, several activities are indeed outsourced. However, if it comes to more complicated assets requiring country-wide presence, borrower franchise and regular interaction, if servicer transition has to be forced, the transaction will be worse than originator bankruptcy.
Questions on true sale
The market has been leaning substantially on the “direct assignment” route. Most of the direct assignments are seen by the investors are look-alikes and feel-alikes of a loan to the originator, save and except for the true-sale opinion. Investors have been linking their rates of return to their MCLR. Investors have been viewing the excess spread as a virtual credit support, which is actually not allowed as per RBI regulations. Pari-passu sharing of principal and interest is rarely followed by the market transactions.
If the truth of the sale in most of the direct assignment transactions is questioned in cases such as those before the Bombay High court, it will not be surprising to see the court recharacterise the so-called direct assignments as nothing but disguised loans. If that was to happen in one case of a failed NBFC, not only will the investors lose the very bankruptcy-remoteness they were hoping for, the RBI will be chasing the originators for flouting the norms of direct assignment which may have hitherto been ignored by the supervisor. The irony is – supervisors become super stringent in stressful times, which is exactly where supervisor’s understanding is required more than reprimand.
NBFCs are passing through a very strenuous time. Delicate handling of the situation with deep understanding and sense of support is required from all stakeholders. Any abrupt strong action may exacerbate the problem beyond proportion and make it completely out of control. As for securitisation practitioners, it is high time to strengthen practices and realise that the truth of the sale is not in merely getting a true sale opinion.
Other Related Articles:
- Government Credit enhancement scheme for NBFC Pools: A win-win for all
- Dissecting the gois partial credit guarantee scheme
 For example, in a Lehman-related UK litigation called Perpetual Trustees vs BNY Corporate Trustee Services, the typical clause in a synthetic securitisation diverting the benefit of funding from the protection buyer (originator – who is now in bankruptcy) to the investors, was challenged under the anti-deprivation rule of insolvency law. Ultimately, UK Supreme Court ruled in favour of securitisation transactions.
 https://www.livelaw.in/pdf_upload/pdf_upload-365465.pdf. Similar observations have been made by the same court in Reliance Nippon Life AMC vs DHFL.
 See, for example, R M Goode, The Case for Abolition of the Floating Charge, in Fundamental Concepts of Commercial Law (50 years of Reflection, by Goode)
 Or partly, the device may involve creation of a mortgage on a queer inconsequential piece of land to qualify as “mortgage debentures” and therefore, avail of stamp duty relaxation.
A Business Conclave on “Partial Credit Guarantee Scheme” was organised by Indian Securitisation Foundation jointly with Edelweiss on September 16,2019 in Mumbai.
On this occasion, the presentation used by Mr. Vinod Kothari is being given here:
We have authored few articles on the topic that one might want to give a read. The links to such related articles are provided below:
[Updated as on 12th December, 2019]
By Financial Services Division, email@example.com
The Finance Minister, during the Union Budget 2019-20, proposed to introduce a partial credit guarantee scheme so as to extend relief to NBFCs during the on-going liquidity crisis. The proposal laid down in the budget was a very broad statement. On 13th August, 2019, the Ministry of Finance came out with a Press Release to announce the notification in this regard, dated 10th August, 2019, laying down specifics of the scheme.
The Scheme, however, did not sail through, as literally no transactions was conducted under the Scheme until November, 2019. Various stakeholders represented to the MOF to remove the bottlenecks in the structure. Subsequently, on 11th December, 2019, the Union Cabinet approved amendments to the Scheme (Amendments).
The scheme, known as “Partial Credit Guarantee offered by Government of India (GoI) to Public Sector Banks (PSBs) for purchasing high-rated pooled assets from financially sound Non-Banking Financial Companies (NBFCs)/Housing Finance Companies (HFCs)”, is referred to, for the purpose of this write, as “the Scheme”.
The Scheme is intended to address the temporary liquidity crunch faced by solvent HFCs/ NBFCs, so that such entities may refinance their assets without having to resort to either distress sale or defaults on account of asset-liability mismatches.
In this write-up we have tried to answer some obvious questions that could arise along with potential answers.
Scope of applicability
1.When does this scheme come into force?
The Scheme was originally introduced on 10th August, 2019 and has been put to effect immediately. The modifications in the Scheme were made applicable with effect from 11th December, 2019.
2. How long will this Scheme continue to be in force?
Originally, the Scheme was supposed to remain open for 6 months from the date of issuance of this Scheme or when the maximum commitment of the Government, under this Scheme, is achieved, whichever is earlier. However, basis the Amendments discussed above, the Scheme will remain open till 20th June, 2020 or till such date when the maximum commitment under the Scheme is achieved, whichever is earlier. The Amendments however, bestows upon the Finance Minister to extend the tenure by upto 3 months.
This signifies that the parties must complete the assignment and execution of necessary documents for the guarantee (see below) within the stipulated time period.
3. Who is the beneficiary of the guarantee under the Scheme – the bank or the NBFC?
The bank is the beneficiary. The NBFC is not a party to the transaction of guarantee.
4. Does a bank buying pools from NBFCs/HFCs (Financial Entities) automatically get covered under the Scheme?
No. Since a bank/ Financial Entities may not want to avail of the benefit of the Scheme, the Parties will have to opt for the benefit of the guarantee. The bank will have to enter into specific documentation, following the procedure discussed below.
5. What does the Bank have to do to get covered by the benefit of guarantee under the Scheme?
The procedural aspects of the guarantee under the Scheme are discussed below.
6. Is the guarantee specifically to be sought for each of the pools acquired by the Bank or is it going to be an umbrella coverage for all the eligible pools acquired by the Bank?
The operational mechanism requires that there will be separate documentation every time the bank wants to acquire a pool from a financial entity in accordance with the Scheme. There is no process of master documentation, with simply a confirmation being attached for multiple transactions.
7. How does this Scheme rank/compare with other schemes whereby banks may participate into originations done by NBFCs/HFCs?
The RBI has lately taken various initiatives to promote participation by banks in the originations done by NBFCs/ HFCs. The following are the available ways of participation:
- Direct assignments
- Loans for on-lending
Direct assignments and securitisation have been there in the market since 2012, however, recently, once the liquidity crisis came into surface, the RBI relaxed the minimum holding period norms in order to promote the products.
Co-lending is also an alternative product for the co-origination by banks and NBFCs. In 2018, the RBI also released the guidelines on co-origination of priority sector loans by banks and NBFCs. The guidelines provide for the modalities of such originations and also provide on risk sharing, pricing etc. The difficulty in case of co-origination is that the turnaround time and the flexibility that the NBFCs claimed, which was one of their primary reasons for a competitive edge, get compromised.
The third product, that is, loans for on-lending for a specific purpose, has been in existence for long. However, recent efforts of RBI to allow loans for on-lending for PSL assets have increased the scope of this product.
This Scheme, though, is meant to boost specific direct assignment transactions, but is unique in its own way. This Scheme deviates from various principles from the DA guidelines and is, accordingly, intended to be an independent scheme by itself.
The basic use of the Scheme is to be able to conduct assignment of pools, without having to get into the complexity of involving special purpose vehicles, setting enhancement levels only so as to reach the desired ratings as per the Scheme. The effective cost of the Financial Entities doing assignments under the Scheme will be (a) the return expected by the Bank for a GoI-guaranteed pool; plus (b) 25 bps. If this effectively works cheaper than opting for a similar rated pool on standalone basis, the Scheme may be economically effective.
A major immediate benefit of the Scheme may be to nudge PSBs to start buying NBFC pools. While the guarantee is effective only for 2 years that does not mean, after 2 years, the PSBs will either sell or sell-back the pools. Therefore, in ultimate analysis, PSBs will get comfortable with buying NBFC pools on direct assignment basis.
The Scheme may go to encourage loan pool transfers outside the existing DA discipline.
8. Is the Scheme an alternative to direct assignment covered by Part B of the 2012 Guidelines, or is it by itself an independent option?
While intuitively one would have thought that the Scheme is a just a method of risk mitigation/facilitation of the DA transactions which commonly happen between banks and Financial Entities, there are several reasons based on which it appears that this Scheme should be construed as an independent option to banks/ Financial Entities:
- This Scheme is limited to acquisition of pools by PSBs only whereas direct assignment is not limited to either PSBs or banks.
- This Scheme envisages that the pool sold to the banks has attained a BBB+ rating at the least. As discussed below, that is not possible without a pool-level credit enhancement. In case of direct assignments, credit enhancement is not permissible.
- Investments in direct assignment are to be done by the acquirer based on the acquirer’s own credit evaluation. In case of the Scheme, the acquisition is obviously based on the guarantee given by the GoI.
- There is no question of an agreement or option to acquire the pool back after its transfer by the originator. The Scheme talks about the right of first refusal by the NBFC if the purchasing bank decides to further sell down the assets at any point of time.
Therefore, it should be construed that the Scheme is completed carved out from the DA Guidelines, and is an alternative to DA or securitisation. The issue was clarified by the Reserve Bank of India vide its FAQs on the issue.
9. Is this Scheme applicable to Securitisation transactions as well?
Assignment of pool of assets can be happen in case of both direct assignment as well as securitisation transaction. However, the intention of the present scheme is to provide credit enhancements to direct assignment transactions only. The Scheme does not intend to apply to securitisation transactions; however, the credit enhancement methodology to be deployed to make the Scheme work may involve several structured finance principles akin to securitisation.
10. The essence of a guarantee is risk transfer. So how exactly is the process of risk transfer happening in the present case?
The risk is originated at the time of loan origination by the Financial Entities. The risk is integrated into a pool. Since the transaction is presumably a direct assignment (see discussion below), the risk transfer from the NBFC to the bank may happen either based on a pari passu risk sharing, or based on a tranched risk transfer.
The question of a pari passu risk transfer will arise only if the pool itself, without any credit enhancement, can be rated BBB+. Again, there could be a requirement of a certain level of credit enhancements as well, say through over-collateralisation or subordination.
Based on whether the share of the bank is pari passu or senior, there may be a risk transfer to the bank. Once there is a risk transfer on account of a default to the bank, the bank now transfers the risk on a first-loss basis to the GoI within the pool-based limit of 10%.
11. What is the maximum amount of exposure, the Government of India is willing to take through this Scheme?
Under this Scheme, the Government has agreed to provide 10% first loss guarantee to assets, amounting to total of ₹ 1 lakh crore. Here it is important to note that the limit of ₹ 1 lakh crore refers to the total amount of assets against which guarantee will be extended and not the total amount of guarantee. The maximum exposure that the Government will take under the Scheme is ₹ 10,000 crores (10% of ₹ 1 lakh crore). Both the amounts, Rs 1 lakh crore, as also Rs 10,000 crores, are the aggregate for the banking system as a whole.
12. What does 10% first loss guarantee signify?
Let us first understand the meaning for first loss guarantee. As the name suggests, the guarantor promises to replenish the first losses of the financier upto a certain level. Therefore, a 10% first loss guarantee would signify that any loss upto 10% of the total exposure of the acquirer in a particular pool will be compensated by the guarantor.
Say for example, if the size of pool originated by NBFC N is Rs. 1000 crores, consisting of 1000 borrowers of Rs. 1 crore each. Assume further that each of the loans in the pool are such that if a default occurs, the crystallised loss is 100% (that is, there is nil recovery estimated at the time of recognising the loan as a bad loan). We are also assuming that the loans in the pool are at least BBB+ rated; therefore, the pool gets a BBB+ rating.
Let us say this pool is sold by N to bank B. N retains a 10% pari passu share of the pool – thereby, the amount of the assets transferred to the B is Rs 900 crores. Assume that the fair value is also Rs 900 crores – that means, B buys the pool at par by paying Rs 900 crores. Assume B gets the acquisition guaranteed under the Scheme.
After its acquisition by B, assume a loan goes bad (see discussion below), and therefore, N allocates a loss of Rs 90 lacs (assuming there is pari passu sharing of losses) to B. B will claim this money by way of a guarantee compensation from GoI. B will keep getting such indemnification from GoI until the total amount paid by GoI reaches Rs. 90 crores (10% of the guaranteed amount). This, based on our hypothetical assumption of each loan having the same size, will mean loss of 100 loans out of the 1000 loans in the pool.
On the other hand, if it was to be understood that the pool will have to be first credit enhanced at the level of N, to attain a credit rating of BBB+, then N itself may have to provide a first-loss support at the transaction level. This may be, say, by providing a subordination, such that the share of N in the transaction is subordinated, and not pari passu. In that case, the question of any risk transfer to B, and therefore, an indemnification by GoI, will arise only if the amount of losses on account of default exceed the level of first loss support provided by N.
13. When is a loan taken to have defaulted for the purpose of the Scheme?
Para D of the Scheme suggests that the loan will be taken as defaulted when the interest and/or principal is overdue by more than 90 days. It further goes to refer to crystallisation of liability on the underlying borrower. The meaning of “crystallisation of liability” is not at all clear, and is, regrettably, inappropriate. The word “crystallisation” is commonly used in context of floating charges, where the charge gets crystallised on account of default. It is also sometimes used in context of guarantees where the liability is said to crystallise on the guarantor following the debtor’s default. The word “underlying borrower” should obviously mean the borrower included in the pool of loans, who always had a crystallised liability. In context, however, this may mean declaration of an event of default, recall of the loan, and thereby, requiring the borrower to repay the entire defaulted loan.
14. On occurrence of “default” as above, will be the Bank be able to claim the entire outstanding from the underlying borrower, or the amount of defaulted interest/principal?
The general principle in such cases is that the liability of the guarantor should crystallise on declaration of an event of default on the underlying loan. Hence, the whole of the outstandings from the borrower should be claimed form the guarantor, so as to indemnify the bank fully. As regards subsequent recoveries from the borrower, see later.
15. Does the recognition of loss by the bank on a defaulted loan have anything to do with the excess spreads/interest on the other performing loans? That is to say, is the loss with respect to a defaulted loan to be computed on pool basis, or loan-by-loan basis?
A reading of para D would suggest that the claiming of compensation is on default of a loan. Hence, the compensation to be claimed by the bank is not to be computed on pool basis.
16. Can the guarantee be applicable to a revolving purchase of loans by the bank from the NBFC, that is, purchase of loans on a continuing basis?
No. The intent seems clearly to apply the Scheme only to a static pool.
17. If a bank buys several pools from the same NBFC, is the extent of first loss cover, that is, 10%, fungible across all pools?
No. The very meaning of a first loss cover is that the protection is limited to a single, static pool.
18. From the viewpoint of maximising the benefit of the guarantee, should a bank try and achieve maximum diversification in a pool, or keep the pool concentric?
The time-tested rule of tranching of risks in static pools is that in case of concentric, that is, correlated pools, the limit of first loss will be reached very soon. Hence, the benefit of the guarantee is maximised when the pool is diversified. This will mean both granularity of the pool, as also diversification by all the underlying risk variables – geography, industry or occupation type, type of property, etc.
19. Can or should the Scheme be deployed for buying a single loan, or a few corporate loans?
First, the reference to pools obviously means diversified pools. As regards pools consisting of a few corporate loans, as mentioned above, the first loss cover will get exhausted very soon. The principle of tranching is that as correlation/concentricity in a pool increases, the risk shifts from lower tranches to senior tranches. Hence, one must not target using the Scheme for concentric or correlated pools.
20. On what amount should the first loss guarantee be calculated – on the total pool size or the total amount of assets assigned?
While, as we discussed earlier, there is no applicability of the DA Guidelines in the present case, there needs to be a minimum skin in the game for the selling Financial Entity. Whether that skin in the game is by way of a pari passu vertical tranche, or a subordinated horizontal tranche, is a question of the rating required for attaining the benefit of the guarantee. Therefore, if we are considering a pool of say ₹ 1000 crores, the originator should retain at least ₹ 100 crores (applying a 10% rule – which, of course, will depend on the rating considerations) of the total assets in the pool and only to the extent the ₹ 900 crores can be assigned to the purchasing bank.
The question here is whether the first loss guarantee will be calculated on the entire ₹ 1000 crores or ₹ 900 crores. The intention is guarantee the purchasing banks’ share of cash flows and not that retained by the originator. Therefore, the first loss guarantee will be calculated on ₹ 900 crores in the present case.
Scope of the GoI Guarantee
21. Does the guarantee cover both principal and interest on the underlying loan?
The guarantee is supposed to indemnify the losses of the beneficiary, in this case, the bank. Hence, the guarantee should presumably cover both interest and principal.
22. Does the guarantee cove additional interest, penalties, etc.?
Going by Rule 277 (vi) of the GFR, the benefit of the guarantee will be limited to normal interest only. All other charges – additional interest, penal interest, etc., will not be covered by the guarantee.
23. How do the General Financial Rules of the Government of India affect/limit the scope of the guarantee?
Para 281 of the GFR provides for annual review of the guarantees extended by the Government. The concerned department, DFS in the present case, will conduct review of the guarantees extended and forward the report to the Budget Division. However, if the Government can take any actions based on the outcome of the review is unclear.
24. Does the transaction of assignment of pool from the Financial Entity to the bank have to adhere to any true sale/bankruptcy remoteness conditions?
The transaction must be a proper assignment, and should achieve bankruptcy remoteness in relation to the Financial Entity. Therefore, all regular true sale conditions should be satisfied.
25. Can a Financial Entity sell the pool to the bank with the understanding that after 2 years, that is, at the end of the guarantee period, the pool will be sold back to the NBFCs?
Any sale with either an obligation to buyback, or an option to buy back, generally conflicts with the true sale requirement. Therefore, the sale should be a sale without recourse. However, retention of a right of first refusal, or right of pre-emption, is not equivalent to option to buy back. For instance, if, after 2 years, the bank is desirous of selling the pool at its fair value, the NBFC may have the first right of buying the same. This is regarded as consistent with true sale conditions.
26. If off-balance sheet treatment from IFRS/Ind-AS viewpoint at all relevant for the purpose of this transaction?
No. Off balance sheet treatment is not relevant for bankruptcy remoteness.
Buyers and sellers
27. Who are eligible buyers under this Scheme?
As is evident from the title of the Scheme, only Public Sector Banks are eligible buyers of assets under this Scheme. Therefore, even if a Private Sector Bank acquires eligible assets from eligible sellers, guarantee under this Scheme will still not be available.
This may be keeping in view two points – first, the intent of the Scheme, that is, to nudge PSBs to buy pools from Financial Entities. It is a well-known fact that private sector banks are, as it is, actively engaged in buying pools. Secondly, in terms of GFR of the GoI, the benefit of Government guarantee cannot go to the private sector. [Rule 277 (vii)] Hence, the Scheme is restricted to PSBs only.
28. Who are eligible sellers under this Scheme?
The intention of the Scheme is to provide relief from the stress caused due to the ongoing liquidity crisis, to sound HFCs/ NBFCs who are otherwise financially stable. The Scheme has very clearly laid screening parameters to decide the eligibility of the seller The qualifying criteria laid down therein are:
- NBFCs registered with the RBI, except Micro Financial Institutions or Core Investment Companies.
- HFCs registered with the NHB.
- The NBFC/ HFC must have been able to maintain the minimum regulatory capital as on 31st March, 2019, that is –
- For NBFCs – 15%
- For HFCs – 12%
- The net NPA of the NBFC/HFC must not have exceeded 6% as on 31st March, 2019
- The NBFC/ HFC must have reported net profit in at least one out of the last two preceding financial years, that is, FY 2017-18 and FY 2018-19.
- The Original Scheme stated that the NBFC/ HFC must not have been reported as a Special Mention Account (SMA) by any bank during year prior to 1st August, 2018. However, the Amendment even allows NBFC/HFC which may have slipped during one year prior to 1st August, 2018 shall also be allowed to sell their portfolios under the Scheme.
29. Can NBFCs of any asset size avail this benefit?
Apparently, the Scheme does not provide for any asset size requirement for an NBFC to be qualified for this Scheme, however, one of the requirement is that the financial institution must have maintained the minimum regulatory capital requirement as on 31st March, 2019. Here it is important to note that requirement to maintain regulatory capital, that is capital risk adequacy ratio (CRAR), applies only to systemically important NBFCs.
Only those NBFCs whose asset size exceeds ₹ 500 crores singly or jointly with assets of other NBFCs in the group are treated as systemically important NBFCs. Therefore, it is safe to assume that the benefits under this Scheme can be availed only by those NBFCs which – a) are required to maintained CRAR, and b) have maintained the required amount of capital as on 31st March, 2019, subject to the fulfilment of other conditions.
30. The eligibility criteria for sellers state that the financial institution must not have been reported as SMA-1 or SMA-2 by any bank any time during 1 year prior to 1st August, 2018 – what does this signify?
As per the prudential norms for banks, an account has to be declared as SMA, if it shows signs of distress without slipping into the category of an NPA. The requirement states that the originator must not have been reported as an SMA-1 or SMA-2 any time during 1 year prior to 1st August, 2018, and nothing has been mentioned regarding the period thereafter.
Therefore, if a financial institution satisfies the condition before 1st August, 2018 but becomes SMA-1 or SMA-2 thereafter, it will still be eligible as per the Scheme. The whole intention of the Scheme is eliminate the liquidity squeeze due to the ILFS crisis. Therefore, if a financial institution turns SMA after the said date, it will be presumed the financial institution has fallen into a distressed situation as a fallout of the ILFS crisis.
31. What are the eligible assets for the Scheme?
The Scheme has explicitly laid down qualifying criteria for eligible assets and they are:
- The asset must have been originated on or before 31st March, 2019.
- The asset must be classified as standard in the books of the NBFC/ HFC as on the date of the sale.
- The original Scheme stated that the pool of assets should have a minimum rating of “AA” or equivalent at fair value without the credit guarantee from the Government. However, through the Amendment, the rating requirement has been brought down to BBB+.
- Each account under the pooled assets should have been fully disbursed and security charge should have been created in favour of the originating NBFCs/ HFCs.
- The individual asset size in the pool must not exceed ₹ 5 crore.
- The following types of loans are not eligible for assignment for the purposes of this Scheme:
- Revolving credit facilities;
- Assets purchased from other entities; and
- Assets with bullet repayment of both principal and interest
Pools consisting of assets satisfying the above criteria qualify for the benefit of the guarantee. Hence, the pool may consist of retail loans, wholesale loans, corporate loans, loans against property, or any other loans, as long as the qualifying conditions above are satisfied.
32. Should the Scheme be deployed for assets for longer maturity or shorter maturity?
Utilising the Scheme for pools of lower weighted average maturity will result into very high costs – as the cost of the guarantee is computed on the original purchase price.
Using the Scheme for pools of longer maturity – for example, LAP loans or corporate loans, may be lucrative because the amortisation of the pool is slower. However, it is notable that the benefit of the guarantee is available only for 2 years. After 2 years, the bank will not have the protection of the Government’s guarantee.
33. If there are corporate loans in the pool, where there is payment of interest on regular basis, but the principal is paid by way of a bullet repayment, will such loans qualify for the benefit of the Scheme?
The reference to bullet repaying loans in the Scheme seems similar to those in DA guidelines. In our view, if there is evidence/track record of servicing, in form of interest, such that the principal comes by way of a bullet repayment (commonly called IO loans), the loan should still qualify for the Scheme. However, negatively amortising loans should not qualify.
34. Is there any implication of keeping the cut-off date for originations of loans to be 31st March, 2019?
As per the RBI Guidelines on Securitisation and Direct Assignment, the originators have to comply with minimum holding requirements. The said requirement suggests that an asset can be sold off only if it has remained in the books of the originator for at least 6 months. This Scheme has come into force with effect from 10th August, 2019 and will remain open till 30th June, 2020.
Already substantial amount of time has passed since the cut-off date, and even if we were to assume that the loan is originated on the cut-off date itself, it would mean that closer to the end of the tenure of the Scheme, the loan will be at least months seasoning as on the date of passing the Amendments. Such high seasoning requirements might not be motivational enough for the originators to avail this Scheme.
35. Is there is any maximum limit on the amount of loans that can be assigned under this Scheme?
Yes, the Scheme has put a maximum cap on the amount of assets that can be assigned and that is an amount equal to 20% of the outstanding standard assets as on 31st March, 2019, however, the same is capped to ₹ 5000 crores.
36. Is there a scope for assigning assets beyond the maximum limits prescribed in the Scheme?
Yes, the Scheme states that any additional amount above the cap of ₹ 5,000 crore will be considered on pro rata basis, subject to availability of headroom. However, from the language, it seems that there is a scope for sell down beyond the prescribed limit, only if the eligible maximum permissible limit gets capped to ₹ 5,000 crores and not if the maximum permissible limit is less than ₹ 5000 crores.
The following numerical examples will help us to understand this better:
|Total outstanding standard assets as on 31st March, 2019||₹ 20,000 crores||₹ 25,000 crores||₹ 30,000 crores|
|Maximum permissible limit @ 20%||₹ 4,000 crores||₹ 5,000 crores||₹ 6,000 crores|
|Maximum cap for assignment under this Scheme||₹ 5,000 crores||₹ 5,000 crores||₹ 5,000 crores|
|Amount that can be assigned under this Scheme||₹ 4,000 crores||₹ 5,000 crores||₹ 5,000 crores|
|Scope for further sell down?||No||No||Yes, upto a maximum of ₹ 1,000 crores|
37. When will it be decided whether the Financial Entity can sell down receivables beyond the maximum cap?
Nothing has been mentioned regarding when and how will it be decided whether a financial institution can sell down receivables beyond the maximum cap, under this Scheme. However, logically, the decision should be taken by the Government of India of whether to allow further sell down and closer towards the end of the Scheme. However, we will have to wait and see how this unfolds practically.
38. What are the permissible terms of transfer under this Scheme?
The Scheme allows the assignment agreement to contain the following:
- Servicing rights – It allows the originator to retain the servicing function, including administrative function, in the transaction.
- Buy back right – It allows the originator to retain an option to buy back its assets after a specified period of 12 months as a repurchase transaction, on a right of first refusal basis. Actually, this is not a right to buy back, it is a right of first refusal which the NBFC/ HFC may exercise if the purchasing bank further sells down the assets. See elsewhere for detailed discussion
Rating of the Pool
39. The Scheme requires that the pool must have a rating of BBB+ before its transfer to the bank. Does that mean there be a formal rating agency opinion on the rating of the pool?
Yes. It will be logical to assume that SIDBI or DFS will expect a formal rating agency opinion before agreeing to extend the guarantee.
40. The Scheme requires the pool of assets to be rated at least BBB+, what does this signify?
As per the conditions for eligible assets, the pool of assets to be assigned under this Scheme must have a minimum rating of “BBB+” or equivalent at fair value prior to the guarantee from the Government.
There may be a question of expected loss assessment of a pool. Initially, the rating requirement was pegged at “AA” or higher and there was an apprehension that the originators might have to provide a substantial amount of credit enhancement in order to the make the assets eligible for assignment under the Scheme. Subsequently, vide the Amendments, the rating has been brought down to BBB+. The originators may also be required to provide some level of credit enhancements in order to achieve the BBB+ rating.
Unlike under the original Scheme, where the rating requirement was as high as AA, the intent is to provide guarantee only at AA level, then the thickness of the guarantee, that is, 10%, and the cost of the guarantee, viz., 25 bps, both became questionable. The thickness of support required for moving a AA rated pool to a AAA level mostly is not as high as 10%. Also, the cost of 25 bps for guaranteeing a AA-rated pool implied that the credit spreads between AA and a AAA-rated pool were at least good enough to absorb a cost of 25 bps. All these did not seemed and hence, there was not even a single transaction so far.
But now that the rating requirement has been brought down to BBB+, it makes a lot of sense. The credit enhancement level required to achieve BBB+ will be at least 4%-5% lower than what would have been required for AA pool. Further, the spread between a BBB+ and AAA rated pool would be sufficient to cover up the guarantee commission of 25 bps to be incurred by the seller in the transaction.
Here it is important to note that though the rating required is as low as BBB+, but there is nothing which stops the originator in providing a better quality pool. In fact, by providing a better quality pool, the originator will be able to fetch a much lower cost. Further, since, the guarantee on the pool will be available for only first two years of the transaction, the buyers will be more interested in acquiring higher quality pools, as there could be possibilities of default after the first two years, which is usually the case – the defaults increase towards the end of the tenure.
Risk weight and capital requirements
41. Can the bank, having got the Pool guaranteed by the GoI, treat the Pool has zero% risk weighted, or risk-weighted at par with sovereign risk weights?
No. for two reasons –one the guarantee is only partial and not full. Number two, the guarantee is only for losses upto first 2 years. So it is not that the credit exposure of the bank is fully guaranteed
42. What will be the risk weight once the guarantee is removed, after expiry of 2 years?
The risk weight should be based on the rating of the tranche/pool, say, BBB+ or better.
43. Is there a guarantee commission? If yes, who will bear the liability to pay the commission?
As already discussed in one of the questions above, the Scheme requires the originators to pay guarantee commission of 25 basis points on the amount of guarantee extended by the Government. Though the originator will pay the fee, but the same will be routed through purchasing bank.
44. The pool is amortising pool. Is the cost of 25 bps to be paid on the original purchase price?
From the operational details, it is clear that the cost of 25 bps is, in the first instance, payable on the original fair value, that is, the purchase price.
Invocation of guarantee and refund
45. When can the guarantee be invoked?
The guarantee can be invoked any time during the first 24 months from the date of assignment, if the interest/ principal has remained overdue for a period of more than 90 days.
46. Can the purchasing bank invoke the guarantee as and when the default occurs in each account?
Yes. The purchasing bank can invoke the guarantee as and when any instalment of interest/ principal/ both remains overdue for a period of more than 90 days.
47. To what extent can the purchasing bank recover its losses through invocation of guarantee?
When a loan goes bad, the purchasing bank can invoke the guarantee and recover its entire exposure from the Government. It can continue to recover its losses from the Government, until the upper cap of 10% of the total portfolio is reached. However, the purchasing bank will not be able to recover the losses if – (a) the pooled assets are bought back by the concerned NBFCs/HFCs or (b) sold by the purchasing bank to other entities.
48. Within how many days will the purchasing bank be able to recover its losses from the Government?
As stated in the Scheme, the claims will be settled within 5 working days.
49. What will happen if the purchasing bank recovers the amount lost, subsequent to the invocation of guarantee?
If the purchasing bank, by any means, recovers the amount subsequent to the invocation of the guarantee, it will have to refund the amount recovered or the amount received against the guarantee to the Government within 5 working days from the date of recovery. However, if the amount recovered is more than amount of received as guarantee, the excess collection will be retained by the purchasing bank.
50. What will be the process for a bank to obtain the benefit of the guarantee?
While the Department of Financial Services (DFS) is made the administrative ministry for the purpose of the guarantee under the Scheme, the Scheme involves the role of SIDBI as the interface between the banks and the GoI. Therefore, any bank intending to avail of the guarantee has to approach SIDBI.
51. Can you elaborate on the various procedural steps to be taken to take the benefit of the guarantee?
The modus operandi of the Scheme is likely to be as follows:
- An NBFC approaches a bank with a static pool, which, based on credit enhancements, or otherwise, has already been uplifted to a rating of BBB+ or above level.
- The NBFC negotiates and finalises its commercials with the bank.
- The bank then approaches SIDBI with a proposal to obtain the guarantee of the GOI. At this stage, the bank provides (a) details of the transaction; and (b) a certificate that the requirements of Chapter 11 of General Financial Rules, and in particular, those of para 280, have been complied with.
- SIDBI does its own evaluation of the proposal, from the viewpoint of adherence to Chapter 11 of GFR and para 280 in particular, and whether the proposal is in compliance with the provisions of the Scheme. SIDBI shall accordingly forward the proposal to DFS along with a specific recommendation to either provide the guarantee, or otherwise.
- DFS shall then make its decision. Once the decision of DFS is made, it shall be communicated to SIDBI and PSB.
- At this stage, PSB may consummate its transaction with the NBFC, after collecting the guarantee fees of 25 bps.
- PSB shall then execute its guarantee documentation with DFS and pay the money by way of guarantee commission.
52. Para 280(i)(a) of the GFR states that there should be back-to-back agreements between the Government and Borrower to effect to the transaction – will this rule be applicable in case of this Scheme?
Para 280 has been drawn up based on the understanding that guarantee extended is for a loan where the borrower is known by the Government. In the present case, the guarantee is extended in order to partially support a sale of assets and not for a specific loan, therefore, this will not apply.
53. Is there any reporting requirement?
The Scheme does provide for a real-time reporting mechanism for the purchasing banks to understand the remaining headroom for purchase of such pooled assets. The Department of Financial Services (DFS), Ministry of Finance would obtain the requisite information in a prescribed format from the PSBs and send a copy to the budget division of DEA, however, the manner and format of reporting has not been notified yet.
54. What are to-do activities for the sellers to avail benefits under this Scheme?
Besides conforming to the eligibility criteria laid down in the Scheme, the sellers will also have to carry out the following in order to avail the benefits:
- The Asset Liability structure should restructured within three months to have positive ALM in each bucket for the first three months and on cumulative basis for the remaining period;
- At no time during the period for exercise of the option to buy back the assets, should the CRAR go below the regulatory minimum. The promoters shall have to ensure this by infusing equity, where required.
Other related articles-
- Government Credit enhancement scheme for NBFC Pools: A win-win for all
- GOI’s attempt to ease out liquidity stress of NBFCs and HFCs: Ministry of Finance launches Scheme for Partial Credit Guarantee to PSBs for acquisition of financial assets
- Government credit enhancement for NBFC pools: A Guide to Rating agencies
 Including Indian Securitisation Foundation
By Abhirup Ghosh , (firstname.lastname@example.org)(email@example.com)
Ever since the liquidity crisis crept in the financial sector, securitisation and direct assignment transactions have become the main stay fund raising methods for the financial sector entities. This is mainly because of the growing reluctance of the banks in taking direct exposure on the NBFCs, especially after the episodes of IL&FS, DHFL etc.
Resultantly, the transactions have witnessed unprecedented growth. For instance, the volume of transactions in the first quarter of the current financial year stood at a record ₹ 50,300 crores which grew at 56% on y-o-y basis from ₹ 32,300 crores. Segment-wise, the securitisation transactions grew by whooping 95% to ₹ 22,000 crores as against ₹ 11,300 crores a year back. The volume of direct assignments also grew by 35% to ₹ 28,300 crores as against ₹ 21,000 crores a year back.
The chart below show the performance of the industry in the past few years:
Direct Assignments have been dominating market with the majority share. During Q1 FY 20, DAs constituted roughly 56% of the total market and PTCs filled up the rest. The chart below shows historical statistics about the share of DA and PTCs:
In terms of asset classes, non-mortgage asset classes continue to dominate the market, especially vehicle loans. The table below shows the share of the different asset classes of PTCs:
|Q1 FY 20 share||Q1 FY 19 share||FY 19 share|
|Vehicle (CV, CE, Car)||51%||57%||49%|
|Mortgages (Home Loan & LAP)||20%||0%||10%|
Asset class wise share of PTCs
Shortcomings in the current securitisation structures
Having talked about the exemplary performance, let us now focus on the potential threats in the market. A securitisation transaction becomes fool proof only when the transaction achieves bankruptcy-remoteness, that is, when all the originator’s bankruptcy related risks are detached from the securitised assets. However, the way the current transactions are structured, the very bankruptcy-remoteness of the transactions has become questionable. Each of the problems have been discussed separately below:
In most of the current structures, the servicing of the cash flows is carried out of the originator itself. The collections are made as per either of the following methods:
- Cash Collection – This is the most common method of repayment in case of micro finance and small ticket size loans, where the instalments are paid in cash. Either the collection agent of the lender goes to the borrower for collecting the cash repayments or the borrower deposits the cash directly into the bank account of the lender or at the registered office or branch of the lender.
- Encashment of post-dated cheques (PDCs) – The PDCs are taken from the borrower at the inception of the credit facility for the EMIs and as security.
- Transfer through RTGS/NEFT by the customer to the originator’s bank account.
- NACH debit mandate or standing instructions.
In all of the aforesaid cases, the payment flows into the current/ business account of the originator. The moment the cash flows fall in the originator’s current account, they get exposed to commingling risk. In such a case, if the originator goes into bankruptcy, there could be serious concerns regarding the recoverability of the cash flows collected by the originator but not paid to the investors. Also, because redirection of cash flows upon such an event will be extremely difficult to implement. Therefore, in case of exigencies like the bankruptcy of the originator, even an AAA-rated security can become trash overnight. This brings up a very important question on whether AAA-PTCs are truly AAA or not.
This issue can be addressed if, going forward, the originators originate only such transactions in which repayments are to happen through NACH mandates. NACH mandates are executed in favour of third party service providers which triggers direct debit from the bank account of the customers every month against the instalments due. Upon receipt of the money from the customer, the third party service providers then transfer the amount received to the originators. Since, the mandates are originally executed in the name of the third party service providers and not on the originators, the payments can easily be redirected in favour of the securitisation trusts in case the originator goes into bankruptcy. The ease of redirection of cash flows NACH mechanism provides is not available in any other ways of fund transfer, referred above.
Will the assets form part of the liquidation estate of the lessor, since under IndAS the assets continue to get reflected on Balance Sheet of the originator?
With the implementation of Ind AS in financial sector, most of the securitisation transactions are failing to fulfil the complex de-recognition criteria laid down in Ind AS 109. Resultantly, the receivables continue to stay on the books of the originator despite a legal true sale of the same. Due to this a new concern has surfaced in the industry that is, whether the assets, despite being on the books of the originator, be absolved from the liquidation estate of the originator in case the same goes into liquidation.
Under the current framework for bankruptcy of corporates in India, the confines of liquidation estate are laid in section 36 of the IBC. Section 36 (3) lays what all will be included therein. Primarily, section 36 (3) (a) is the relevant provision, saying “any assets over which the corporate debtor has ownership rights” will be included in the estate. There is a reference to the balance sheet, but the balance sheet is merely an evidence of the ownership rights. The ownership rights are a matter of contract and in case of receivables securitised, the ownership is transferred to the SPV.
The bounds of liquidation estate are fixed by the contractual rights over the asset. Contractually, the originator has transferred, by way of true sale, the receivables. The continuing balance sheet recognition has no bearing on the transfer of the receivables. Therefore, even if the originator goes into liquidation, the securitised assets will remain unaffected.
Despite the shortcomings in the current structures, the Indian market has opened big. After the market posted its highest volumes in the year before, several industry experts doubted whether the market will be able to out-do its previous record or for that matter even reach closer to what it has achieved. But after a brilliant start this year, it seems the dream run of the Indian securitisation industry has not ended yet.
By Falak Dutta (firstname.lastname@example.org)
Up, Up & Above!
Yet another year went by and Indian securitization market certainly had a year to rejoice. Starting from the volume of transactions to innovative structures, the market has everything to boast about. Before we discuss each of these at length, let us take stock of the highlights first:
- The securitization volumes doubled during the year, as securitization in India became a trillion rupee market.
- DAs continued to be the preferred mode of transaction with Mortgages as the dominant asset class.
- Clarity on Goods & Services Tax, increased participation of private banks, NBFCs and mutual funds along with healthy demand for non-priority sector loan were primary reasons for this sharp growth.
- DHFL & IL&FS rushed to securitize as traditional sources of funding dried up due to concerns of debt servicing in the 2nd half of 2018.
- The country witnessed the first issuance of covered bonds during year.
- Several new structures were tried, namely, lease receivables securitization, corporate loan securitization, revolving structures etc.
Securitization volumes reaching all time high
The volume of retail securitization grew by 123% as figures soared to ₹1.9 lakh crore compared to ₹85,000 crore in fiscal ’18. Mortgages, vehicle loans and microfinance loans constituted the three major asset classes comprising of 84% of the total volume. The growth was primarily propelled by a combination of three factors.
First, a few big players who stayed away from the market returned after the GST Council clarified that securitized assets are not subject to GST.
Second, Two non-banking companies (DHFL& IL&FS) rushed to securitize their receivables as traditional sources of financing dried up after September 2018. After this, banks started preferring portfolio buyouts over taking credit exposure on the NBFCs.
Third, subsequent to the liquidity crisis faced by several NBFCs, RBI relaxed guidelines of minimum holding period requirement for securitization transactions backed by long duration loans leading to greater number of eligible securitized assets.
The graph below shows the performance of the Indian securitization market over the years:
Source: CRISIL Estimates. Figures in ₹10 Billions
Traditionally the bulk of securitization transactions have been driven by Priority Sector Lending (PSL) from banks. At present though, securitization transactions are being increasingly backed by non PSL assets that are making their presence felt as they gain market traction. The trend has been clear. The share of non-PSL assets as a part of total transaction rose to a record of 42% in 2018, up from 33% in 2017 and a relatively moderate share of 26% in 2016. Banks are focusing on securing long term assets such as mortgages that have displayed fairly stable asset quality to expand their retail asset portfolio.
The case for PSLCs
An additional recurring theme is the growing popularity in PSLCs which serves as a direct alternative to securitization. The volume of transactions have skyrocketed to ₹ 3.3 lakh crore in fiscal ’19 up from ₹ 1.9 lakh crore in fiscal ‘18 and ₹ 49,000 crore in fiscal ‘17. PSLCs which were introduced in 2015, was an idea which appeared in the report of a Dr. Raghu Ram Rajan led Committee- A Hundred Small Steps. Out of the four kinds of PSLCs, the PLSC- General and PSLC- Small and Marginal Farmers remain the highest traded segments. The supply side consists of private sector banks with excess PSL in the general PSLCs category and Regional Rural Banks in SFMF category.
PTCs vs. DAs
Another point of note is the increasing share of the DA’s in the securitization market. The move from PTCs to DA isn’t surprising given the absence of credit enhancements, amount of capital requirements and relatively less regulatory due diligence in DAs. The fact that the share of PTC transaction fell from 47% in fiscal ‘17 to 42% in fiscal ’18 and further to 36% in fiscal ’19 serves as a case in point. However, one hasn’t impeded the growth for the other. DA transactions soared a record 146%. Whereas PTCs soared 95% reaching a volume of ₹69,000 crore. Also, mortgages still remain the preferred asset class, accounting for almost 74% of DA volumes and 46% of total securitization volumes.
Source: CRISIL1 Estimates
India on the Global Map
2018 was a landmark year for global securitization with over a trillion dollars’ worth of issue, as the memories of the 2008 crisis gradually fade into oblivion. The U.S has been the major player in the global market, issuing over half of the total transactions by volume. Europe recorded a surge in volume clocking $106 billion against $82 billion in 2017. In Asia, China both grew and remained the dominant player in Asia at $310 billion, followed by Japan at $58 billion. Elsewhere issuance in Australia and Latin America declined. Some potential factors that could affect the global markets in the coming future include the Brexit uncertainty, market volatility, rising interest rates, renegotiations of existing trade agreements and liquidity. Some of these are contentious issues, the effects of which could sustain beyond the near future.
Source: SP Global, Values in $US Billion
Heading into the next fiscal year, some of the tailwinds that propelled the market in fiscal 2019 are fading gradually. Pent-up supply following the implementation of the Goods and Services Tax (GST) has almost exhausted, the funding environment for non-banks have been steadily stabilizing and the relaxation on the minimum holding period will be only available till May 2019. The entry of a new segment of investors- NBFC treasuries, foreign portfolio investors, mutual funds and others such brought about differing risk appetites and return aspirations which paved the way for newer asset classes. The trend for education loan receivables and consumer durables loan receivables accelerated in fiscal 2019. Although, the overall volumes of these unconventional asset classes are relatively small at present, investor presence in these non-AAA rated papers is a good sign for the long term prospects of the securitization markets.
“The Indian securitization market in 2018 have attained several significant milestones: from significant growth in non-PSL volumes, to asset class diversity, to attracting new investor base, to innovative structures, the market seems ready to launch into a new trajectory.”, stated Mr. Vinod Kothari, Director at Vinod Kothari Consultants.
He added, “It is only in stressful times that securitization has shone globally– the Indian financial sector has gone through some stress scenarios in the recent past, and securitization has been able to sustain the growth of the financial sector.”
By Vinod Kothari & Sikha Bansal
Present-day businesses sweep across multiple entities, such that the “enterprise” consisting of multiple entities, often in multiple jurisdictions, is referred to as a “group”. While accounting standards and securities market regulators have moved on to the concept of “business groups”, the ghost of the 19th century ruling in Salomon v. Salomon & Co continues to hover over corporate laws and, consequentially, over insolvency laws too. Read more