By Abhirup Ghosh , (email@example.com)(firstname.lastname@example.org)
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 Vinod Kothari [email@example.com]; Abhirup Ghosh [firstname.lastname@example.org]
With the 12th Feb., 2018 having been struck down by the Supreme Court, the RBI has come with a new framework, in form of Directions, with enhanced applicability covering banks, financial institutions, small finance banks, and systematically important NBFCs. The Directions apply with immediate effect, that is, 7th June, 2019.
The revised framework [FRESA – Framework for Resolution of Stressed Accounts] has much larger room for discretion to lenders, and unlike the 12th Feb., 2018 circular, does not mandate referral of the borrowers en masse to insolvency resolution. While the RBI has reserved the rights, under sec. 35AA of the BR Act, to refer specific borrowers to the IBC, the FRESA gives liberty to the members of the joint lenders forum consisting of banks, financial institutions, small finance banks and systemically important NBFCs, to decide the resolution plan. The resolution plan may involve restructuring, sale of the exposures to other entities, change of management or ownership of the borrower, as also reference to the IBC.
The resolution timelines have 2 components – a Review Period and Resolution Period.
The first period, of 30 days, starts immediately in case of borrowers having aggregate exposure of Rs 2000 crores or more from the banking system, and in case of borrowers with aggregate exposure of Rs 1500 crores to Rs 2000 crores, it starts from 1st Jan 2020. For borrowers with aggregate borrowings of less than Rs 1500 crores, there is no defined timeline as of now – thereby leaving all small moderate loan sizes out of the scope of the FRESA.
During the review period, the lenders will have presumably agreed on the resolution plan. The plan itself has 6 months of implementation.
The 6 months’ implementation timeline is not a hard timeline. If the timeline is breached, the impact is additional provisioning. If the implementation fails the 6 month deadline, there is an additional provision of 20% for period upto 1 year from the end of the review period, and 35% for period beyond 1 year.
Directions are centered around banks
Though the FRESA has made applicable to scheduled commercial banks, AIFIs, small finance banks and NBFCs, however, the same revolves around banks and financial institutions. For the framework to get triggered, the borrower must be reported as default by either an SCB, AIFI or small finance bank. The provisions under the paragraph shall not get triggered with an NBFC declaring an account as default.
Similarly, for reckoning the amount outstanding credit for determining the reference date for implementation, only the credit exposures of the SCBs, AIFIs and small finance banks have to be considered.
It seems these Directions have been made applicable to NBFCs, only to bind them by the proceedings under FRESA, in case of borrowers having multiple lenders.
Mechanics of the FRESA
On an account being declared as default, the lenders will, within a period of 30 days, have to review the account and decide the course of action on the account. That is, during this period, an RP will have to be prepared. The lenders can either resolve the stress under this framework or take legal actions for resolution and recovery.
If the lenders decide to resolve the stress under this framework, ICA must be signed among them. The ICA must provide for the approving authority of the RP, the rights and duties of the majority lenders, safety and security of the dissenting lenders.
Upon approval of the RP, the same must be implemented within a period of 180 days in the manner prescribed in the Directions. After the implementation, the same must be monitored during the monitoring period and the extended specified period, discussed below.
Implementation conditions for RPs
The implementation of RPs also comes with several conditions. The pre-requisites of implementing an RP are:
- Where there are multiple lenders involved, approval of 75% of the lenders by value and 60% of the lender by number must have been obtained.
- The RPs must be independently rated – where the aggregate exposure is ₹ 1 billion or above, at least from 1 credit rating agency; and where the aggregate exposure is ₹ 5 billion or above, at least from 2 credit rating agencies. The rating obtained from the CRAs must be RP4 or better.
- The borrower should not be in default as on 180th day from the end of Review Period.
- An RP involving restructuring/ change in ownership, shall be deemed to be implemented only if,
- All the legal document have been executed by the lenders in consonance with the RP;
- The new capital structure and/ or changes in the terms and conditions of the loans get duly reflected in the books of the borrower;
- The borrower is not in default with any of the lenders
Restructuring with several covenants
Restructuring was no brainer earlier and was the device to keep bad loans on the books without any action.
The FRESA provides that upon restructuring, the account [having an aggregate exposure of more than Rs 100 crores] will be upgraded to standard status only on investment grade by at least one rating agency (two in case of aggregate exposure of Rs 500 crores and above). Also, after restructuring, the account should at least pay off 10% of the aggregate exposure.
Prudential norms in case of restructuring/ change in ownership
- In case of restructuring –
- Upon restructuring, the account will be immediately be downgraded to sub-standard and the NPAs shall continue to follow the asset classification norms as may be applicable to them.
- The substandard restructured accounts can be upgraded only after satisfactory performance during the following period:
- Period commencing from the date of implementation of the RP up to the date by which 10% of the outstanding credit facilities have been repaid (monitoring period); or
- 1 year from the date of commencement of the first payment of interest or principal, whichever is later.
- However, for upgradation, fresh credit ratings, as specified above, will have to be obtained.
- If the borrower fails to perform satisfactorily during this period, an additional provision of 15% will have to be created by all the lenders at the end of this period.
- In addition to above, the account will have to be monitored for an extended period upto the date by which 20% of the outstanding credit facilities have been repaid. If the borrower defaults during this period, then a fresh RP will have to be required. However, an additional 15% provision will have to be created at the end of the Review Period.
- Any additional finance approved under the RP, shall be booked as “standard asset” in the books of the lender during the monitoring period, provided the account performs satisfactorily. In case, the account fails to perform satisfactorily, the same shall be downgraded to the same category as the restructured debt.
- Income in case of restructured standard assets should be booked on accrual basis, in case of sub-standard assets should be booked on cash basis.
- Apart from the additional provisioning mentioned above, the lenders shall follow their normal provisioning norms.
- In case of change of ownership, the accounts can be retained as standard asset after the change in ownership under FRESA or under IBC. For change in ownerships under this framework, following are the pre-requisites:
- The lenders must carry out due diligence of the acquirer and ensure compliance with section 29A of the IBC.
- The new promoter must acquire at least 26% of the paid up equity capital of the borrower and must be its single largest shareholder.
- The implementation must be carried out within the specified timelines.
- The new promoter must be in control of the borrower.
- The account must continue to perform satisfactorily during the monitoring period, failing which fresh review period shall get triggered. Also, it is only upon satisfactory performance during this period that excess provisions can be reversed.
- Reversal of additional provisions:
- In case, the RP involves only payment of overdues, the additional provisions may be reversed only of the borrower remains not in default for a period of 6 months from the date of clearing the overdues with all its lenders.
- In case, the RP involves restructuring/ change in ownership outside IBC, the additional provisions created against the exposure will be reversed upon implementation of the RP.
- In case, the lenders initiate insolvency provisions against the borrower, then half of the provisions created against the exposure will be reversed upon submission of application and the remaining amount may be reversed upon admission of the application.
- In case, the RP involves assignment/ debt recovery, the additional provision may be reversed upon completion of the assignment/ debt recovery.
Project loans where date of commencement of commercial operations (DCCO) has been deferred, will be excluded from the scope of the circular.
Hierarchy of periods
- Review period – 30 days for preparing the resolution plan
- Implementation period – 6 months from the end of the review period – for implementing the resolution plan
- Monitoring period for upgradation – 1 year from date of commencement of first payment of interest or principal or reduction of aggregate exposure by 10%, whichever is later
- Specified period – until the aggregate exposure is repaid by at least 20% – if there is a default, a fresh resolution plan will be required.
Other provisions of the FRESA
Some common instructions from the earlier directions have been retained in this framework as well, namely:
- Identification of an account under various special mention accounts. Where the default in account is between 1-30 days, the same must be treated as SMA-0. Where the default is between 31-60 days, it must be reported as SMA-1. Where the default is between 61-90 days, it must be reported as SMA-2.
- Reporting requirements to CRILC for accounts with aggregate exposure of ₹ 50 million will continue.
- The framework requires the lenders to adopt a board approved policy in this regard.
- For actions by the lenders with an intention to conceal the actual status of accounts or evergreen the stressed accounts, will be subjected to stringent supervisory / enforcement actions as deemed appropriate by the Reserve Bank, including, but not limited to, higher provisioning on such accounts and monetary penalties. Further, references under IBC can also be made.
- Disclosures under notes to accounts have to be made by the lenders with respect to accounts dealt with under these Directions.
- The scope of the term “restructuring” has been expanded under the Directions.
- Sale and leaseback transaction involving the assets of the borrower shall be treated as restructuring if the following conditions are met:
- The seller of the assets is in financial difficulty;
- Significant portion, i.e. more than 50 per cent, of the revenues of the buyer from the specific asset is dependent upon the cash flows from the seller; and
- 25 per cent or more of the loans availed by the buyer for the purchase of the specific asset is funded by the lenders who already have a credit exposure to the seller.
- If borrowings/export advances (denominated in any currency, wherever permitted) for the purpose of repayment/refinancing of loans denominated in same/another currency are obtained:
- From lenders who are part of Indian banking system (where permitted); or
- with the support (where permitted) from the Indian banking system in the form of Guarantees/Standby Letters of Credit/Letters of Comfort, etc., such events shall be treated as ‘restructuring’ if the borrower concerned is under financial difficulty.
- Exemptions from restrictions on acquisition of non-SLR securities with respect to acquisition of non-SLR securities by way of conversion of debt.
- Exemptions from SEBI (ICDR) Regulations with respect to pricing of equity shares.
Withdrawal of earlier instructions
The following instructions, earlier issued by the RBI have been withdrawn with immediate effect:
Framework for Revitalising Distressed Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in Ownership outside SDR, and Scheme for Sustainable Structuring of Stressed Assets (S4A) stand withdrawn with immediate effect. Accordingly, the Joint Lenders’ Forum (JLF) as mandatory institutional mechanism for resolution of stressed accounts.
 The Directors lay down various categories ratings. RP4 resembles debt facilities carrying moderate risk with respect to timely servicing of financial obligations.
By Vallari Dubey (email@example.com)
Complementing the Ordinance on Non-Performing Assets (NPA) which originally brought a whole new breeze in the resolution space in India, RBI has come up with a press release as a further to the first step in crystallizing the concept as laid down in the Ordinance. RBI has brought a lot of changes for the purpose of implementation of the NPA Ordinance. The Sequel two in the Ordinance story has been released in form of a press release by RBI dated 22nd May 2017, laying down the Action Plan to implement the NPA Ordinance.