2019 Securitisation volumes in India reach record high

By Falak Dutta (finserv@vinodkothari.com)

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

Source: CRISIL[1]

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[2], 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.”



1) https://www.crisil.com/content/dam/crisil/our-analysis/reports/Ratings/documents/2018/june/securitization-resilient-despite-roadblocks.pdf

6) https://www.spglobal.com/en/research-insights/articles/global-structured-finance-outlook-2019-securitization-continues-to-be-energized-with-potential-1-trillion-in-volume-expected-ag

[1] https://www.crisil.com/content/dam/crisil/pr/press-release/2017/12/retail-securitization-volume-doubles-to-rs-1point9-lakh-crore.pdf

[2] https://www.spglobal.com/en/research-insights/articles/global-structured-finance-outlook-2019-securitization-continues-to-be-energized-with-potential-1-trillion-in-volume-expected-ag

Securitisation laws prevailing in various countries are listed below :

  • Singapore:
  1. Monetary Authority of Singapore (MAS) Guidelines on Securitisation (The guidelines were finalized in 2000)
  2. Amendment in 2018
  3. Amendment in 2007
  4. News on Securitisation
  5. Rules on Securitisation
  • USA:
  1. 15 U.S. Code § 78o–11. Credit risk retention:
  2. Dodd-Frank Wall Street Reform and Consumer Protection Act [Public Law 111–203] [As Amended Through P.L. 115–174, Enacted May 24, 2018]
  3. Securitisation Market
  4. Laws on Securitisation
  • Australia:
  1. Australian Prudential Standard (APS) 120 made under section 11AF of the Banking Act 1959 (the Banking Act) By Australian Prudential Regulation Authority
  2. Covered Bonds issued under Part II, Division 3A of the Banking Act 1959 (Cth)
  3. Laws on Securitisation
  4. Securitisation Market
  • Indonesia:
  1. Bank Indonesia Regulation No. 7/4/PBI/2005 Prudential Principles in Asset Securitisation for Commercial Banks
  2. Securitisation Market
  • Hong Kong: 
  1. There is no specific legislative regime for securitisation. Securitisation is subject to various Hong Kong laws, depending on the transaction structure, transaction parties, underlying assets, and the nature of the offering of the securities
  2. Securitisation Market
  • Canada:
  1. Office of the Superintendent of Financial Institutions, Government of Canada
  2. Securitisation Market
  • European Union:(UK, Germany, France,Italy, Sweden, Poland, Spain, Greece, Finland, Malta)
  1. Regulation(EU) 2017/2402 (the Securitisation Regulation) as on December 12,2017
  2. Regulation (EU) 2017/2402 of the European Parliament and of the Council of September 30, 2015
  3. Securitisation Market:


  • Italy:
  1. Law 130 of 30 April 1999, Italian securitisation law
  2. Securitistion Market
  • Greece:
  1. GREEK LAW 3156/2003
  • France:
  1. Order No. 2017-1432 of October 4, 2017 , Modernizing the Legal Framework for Asset Management and Debt Financing (Initial Version)
    Version in force on 26/03/2019
  2. Securitisation Market:
  • Japan: Securitisation in Japan is governed by laws and regulations applicable to specific types of transactions such as the Civil Code (Law No. 89, 1896), the Trust Act (Law No. 108, 2006) and the Financial Instruments and Exchange Law (Law No. 25, 1948) (FIEL).
  1. https://www.fsa.go.jp/common/law/fie01.pdf
  2. http://jafbase.fr/docAsie/Japon/CodCiv.pdf
  3. http://www.japaneselawtranslation.go.jp/law/detail_download/?ff=09&id=1946
  4. Laws on Securitisation
  5. Securitisation Market
  • China:
  1. Administrative Rules for Pilot Securitization of Credit Assets(the Administrative Rules) on April 2005
  2. Securitisation Market
  • Ireland:
  1. European Union (General Framework For Securitisation And Specific Framework For Simple, Transparent And Standardised Securitisation) Regulations 2018 (Central Bank of Ireland)
  • South Africa:
  1. In South Africa, securitisations are regulated according to the securitisation regulations issued under the Banks Act 94 of 1990 (the Banks Act)
  1. Government Gazette 30628 of 1 January 2008 (Securitisation Regulations)
  2. Laws on Securitisation
  3. Securitisation Market
  • Morocco:
  1. Law No. 33-06 on Securitization
  2. Draft amendment of Law on Securitization

Accounting for Direct Assignment under Indian Accounting Standards (Ind AS)

By Team IFRS & Valuation Services (ifrs@vinodkothari.com) (finserv@vinodkothari.com)


Direct assignment (DA) is a very popular way of achieving liquidity needs of an entity. With the motives of achieving off- balance sheet treatment accompanied by low cost of raising funds, financial sector entities enter into securitisation and direct assignment transactions involving sale of their loan portfolios. DA in the context of Indian securitisation practices involves sale of loan portfolios without the involvement of a special purpose vehicle, unlike securitisation, where setting up of an SPV is an imperative.

The term DA is unique to India, that is, only in Indian context we use the term DA for assignment of loan or lease portfolios to another entity like bank. Whereas, on a global level, a similar arrangements are known by various other names like loan sale, whole-loan sales or loan portfolio sale.

In India, the regulatory framework governing Das and securitisation transactions are laid down by the Reserve Bank of India (RBI). The guidelines for governing securitisation structures, often referred to as pass-through certificates route (PTCs) were issued for the first time in 2006, where the focus of the Guidelines was restricted to securitisation transactions only and direct assignments were nowhere in the picture. The RBI Guidelines were revised in 2012 to include provisions relating to direct assignment transactions.

Read more

RBI temporarily relaxes the Guidelines on Securitisation for NBFCs

By Financial Services Division, finserv@vinodkothari.com


In the wake of the recent hues and cries of the entire country in anticipation of a liquidity crisis in the NBFC sector, the Reserve Bank of India, on 29th November, 2018, issued a notification[1] to modify the Securitisation Guidelines.The amendment aims to relax the minimum holding period requirements of the guidelines, subject to conditions, temporarily. Therefore, the changes vide this notification come with an expiry date. The key takeaways of the notification have been discussed below:

a. Relaxation in the MHP requirements: As per the notification, NBFCs will now be allowed to securitise/ assign loans originated by them, with original maturity of more than 5 years, after showing record of recovery of repayments of six monthly instalments or two quarterly instalments (as applicable). Currently, for loans with original maturity more than 5 years, the MHP requirements are repayment of at least twelve monthly instalments or four quarterly instalments (as applicable).

b. Change in MRR requirements for the loans securitised under this notification: The benefit mentioned above will be available only if the NBFC retains at least 20% of the assets securitised/ assigned. Currently, the MRR requirements ranges between 5%-10% depending on the tenure of the loans.

c. Timeline for availing this benefit: As already stated above, this is a temporary measure adopted by the RBI to ease out the tension relating to liquidity issues of the NBFCs; therefore, this comes with an expiry date, which in the present case is six months from the date of issuance of the notification. Therefore, this benefit will be available for only those loans which are securitised/ assigned during a period of six months from the date of issuance of this notification.

The requirements under the guidelines remains intact.

Further, the RBI has extended the relaxation till December 31, 2019 vide its notification dated May 29, 2019.

To summarise, the MHP requirements and the MRR requirements on securitisation/ assignment of loans looks as such –

Loans assigned between 29th November, 2018 – 30th December, 2019 Loans assigned after 31st December, 2019
MHP requirements for loans with original maturity less than 5 years Loans upto 2 years maturity – 3 months


Loans between 2 – 5 years – 6 months

Loans upto 2 years maturity – 3 months


Loans between 2 – 5 years – 6 months

MHP requirements for loans with original maturity less than 5 years If revised MRR requirements fulfilled – 6 months


If revised MRR requirements not fulfilled – 12 months

Loans upto 2 years maturity – 3 months


Loans between 2 – 5 years – 6 months

MRR requirements for loans with original maturity of less than 5 years Loans with original maturity upto 2 years – 5%


Loans with original maturity more than 2 years – 10%

Loans with original maturity upto 2 years – 5%


Loans with original maturity more than 2 years – 10%

MRR requirements for loans with original maturity of more than 5 years If benefit of MHP requirements availed – 20%


If benefit of MHP requirements not availed – 10%

Loans with original maturity upto 2 years – 5%


Loans with original maturity more than 2 years – 10%


Vinod Kothari comments: 

  •  Loans with original maturity of more than 5 years are essentially home loans and LAP loans. Home loans are housed mostly with HFCs. These guidelines ought to have come from NHB rather than RBI, but given the tradition that RBI guidelines are followed in case of HFCs as well, this “relaxation” will be more applicable to HFCs rather than NBFCs.
  • In case of LAP loans, given the current credit scenario prevailing in the country, taking exposure on LAP loans itself is subject to question. Issue is – will the relaxation prompt NBFCs to write LAP loans, or will it simply allow them to package and sell existing pools of lap loans sitting on their books waiting for the MHP of 12 months to get over? It is more likely to be latter than the former.
  • However, the so-called relaxation comes with a give-and-take – the MRR is 20%. The NBFC has, therefore, 2 options – wait for 12 months to be over and just do a transaction with 10% MRR, or avail the so-called relaxation and put in on-balance funding of 20%. Therefore, it is only for those who are desperate for refinancing that the so-called relaxation will seem appealing.
  • Our interaction with leading NBFCs reveals that there are immediate liquidity concerns . Banks are not willing to take on-balance sheet exposure on NBFCs; rather they are willing to take exposure on pools. Therefore, for more than 6 months and less than 12 months seasoned LAP pools, this might provide a temporary packaging opportunity.
  • This is indeed the best time to think of covered bonds. The proposition has been lying unresolved for last few years. If banks are willing to take exposure on pools, why not dual recourse by way of covered bonds? That indeed provides ideal solution, with ring fenced pools providing double layers of protection.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11422&Mode=0

For more articles on Securitisation and Covered Bonds, refer our page here.

Also refer our article: The name is Bond. Covered Bonds.


GST on assignment of receivables: Wrong path to the right destination

Team Vinod Kothari Consultants P. Ltd


There has been a lot of uncertainty on the issue of exigibility of direct assignments and securitisation transactions to goods and services tax (GST). While on one hand, there have been opinions that assignments of secured debts may be taxable being covered by the circuitous definition of “actionable claims”, there are other views holding such assignments of debts (secured or unsecured) to be non-taxable since an obligation to pay money is nothing but money, and hence, not  “goods” under the GST law[1]. The uncertainty was costing the market heavily[2].

In order to put diverging views to rest, the GST Council came out with a set of Frequently Asked Questions on Financial Services Sector[3], trying to clarify the position of some arguable issues pertaining to transactions undertaken in the financial sector. These FAQs include three separate (and interestingly, mutually unclear) questions on – (a) assignment or sale of secured or secured debts [Q.40], (b) whether assignment of secured debts constitutes a transaction in money [Q.41], and (c) securitisation transactions undertaken by banks [Q.65].

The end-result arising out of these questions is that there will be no GST on securitisation transactions. However, the GST Council has relied on some very intriguing arguments to come to this conclusion – seemingly lost between the meaning of “derivatives”, “securities”, and “actionable claims”. If one does not care about why we reached here, the conclusion is most welcome. However, the FAQs also reflect the serious lack of understanding of financial instruments with the Council, which may potentially create issues in the long run.

In this note[4] we intend to discuss the outcome of the FAQs, but before that let us first understand what the situation of the issue was before this clarification.

Situation before the clarification

  1. GST is chargeable on supply of goods or services or both. Goods have been defined in section 2(52) of the CGST Act in the following manner:

“(52) “goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;”

Services have been defined in section 2(102) of the CGST Act oin in the following manner:

““services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;”

Money, is therefore, excludible from the scope of “goods” as well as “services”.

Section 7 details the scope of the expression “supply”. According to the section, “supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.” However, activities as specified in Schedule III of the said Act shall not be considered as “supply”.

It may be noted here that “Actionable claims, other than lottery, betting and gambling” are enlisted in entry 6 of Schedule III of the said Act; therefore are not exigible to GST.

  1. There is no doubt that a “receivable” is a movable property. “Receivable” denotes something which one is entitled to receive. Receivable is therefore, a mirror image for “debt”. If a sum of money is receivable for A, the same sum of money must be a debt for B. A debt is an obligation to pay, a receivable is the corresponding right to receive.

Coming to the definition of “money”, it has been defined under section 2(75) as follows –

““money” means the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.”

The definition above enlists all such instruments which have a “value-in-exchange”, so as to represent money. A debt also represents a sum of money and the form in which it can be paid can be any of these forms as enlisted above.

So, in effect, a receivable is also a sum of “money”. As such, receivables shall not be considered as “goods” or “services” for the purpose of GST law.

  1. As mentioned earlier, “actionable claims” have been included in the definition of “goods” under the CGST Act, however, any transfer (i.e. supply) of actionable claim is explicitly excluded from being treated as a supply of either goods or services for the purpose of levy of GST.

Section 2(1) of the CGST Act defines “actionable claim” so as to assign it the same meaning as in section 3 of the Transfer of Property Act, 1882, which in turn, defines “actionable claim” as –

“actionable claim” means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent;”

It may be noted that the inclusion of “actionable claim” is still subject to the exclusion of “money” from the definition of “goods”. The definition of actionable claim travels beyond “claim to a debt” and covers “claim to any beneficial interest in movable property”. Therefore, an actionable claim is definitely more than a “receivable”. Hence, if the actionable claim represents property that is money, it can be held that such form of the actionable claim shall be excluded from the ambit of “goods”.

There were views in the industry which, on the basis of the definition above, distinguish between — (a) a debt secured by mortgage of immovable property, and a debt secured by hypothecation/pledge of movable property on one hand (which are excluded from the definition of actionable claim); and (b) an unsecured debt on the other hand. However, others opined that a debt, whether secured or unsecured, is after all a “debt”, i.e. a property in money; and thus can never be classified as “goods”. Therefore, the entire exercise of making a distinction between secured and unsecured debt may not be relevant at all.

In case it is argued that a receivable which is secured (i.e. a secured debt) shall come within the definition of “goods”, it must be noted that a security granted against a debt is merely a back-up, a collateral against default in repayment of debt.

  1. In one of the background materials on GST published by the Institute of Chartered Accountants of India[5], it has been emphasised that a transaction where a person merely slips into the shoes of another person, the same cannot be termed as supply. As such, unrestricted expansion of the expression “supply” should not be encouraged:

“. . . supply is not a boundless word of uncertain meaning. The inclusive part of the opening words in this clause may be understood to include everything that supply is generally understood to be PLUS the ones that are enlisted. It must be admitted that the general understanding of the world supply is but an amalgam of these 8 forms of supply. Any attempt at expanding this list of 8 forms of supply must be attempted with great caution. Attempting to find other forms of supply has not yielded results however, transactions that do not want to supply have been discovered. Transactions of assignment where one person steps into the shoes of another appears to slip away from the scope of supply as well as transactions where goods are destroyed without a transfer of any kind taking place.”

Also, as already stated, where the object is neither goods nor services, there is no question of being a supply thereof.

  1. Therefore, there was one school of thought which treated as assignment of secured receivables as a supply under the GST regime and another school of thought promoted a view which was contrary to the other one. To clarify the position, representations were made by some of the leading bankers and the Indian Securitisation Foundation.

Situation after the clarification

  1. The GST Council has discussed the issue of assignment and securitisation of receivables through different question, extracts have been reproduced below:


  1. Whether assignment or sale of secured or unsecured debts is liable to GST?

Section 2(52) of the CGST Act, 2017 defines ‘goods’ to mean every kind of movable property other than money and securities but includes actionable claim. Schedule III of the CGST Act, 2017 lists activities or transactions which shall be treated neither as a supply of goods nor a supply of services and actionable claims other than lottery, betting and gambling are included in the said Schedule. Thus, only actionable claims in respect of lottery, betting and gambling would be taxable under GST. Further, where sale, transfer or assignment of debts falls within the purview of actionable claims, the same would not be subject to GST.

Further, any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

  1. Would sale, purchase, acquisition or assignment of a secured debt constitute a transaction in money?

Sale, purchase, acquisition or assignment of a secured debt does not constitute a transaction in money; it is in the nature of a derivative and hence a security.

  1. What is the leviability of GST on securitization transactions undertaken by banks?

Securitized assets are in the nature of securities and hence not liable to GST. However, if some service charges or service fees or documentation fees or broking charges or such like fees or charges are charged, the same would be a consideration for provision of services related to securitization and chargeable to GST.


  1. The fallacy starts with two sequential and separate questions: one dealing with securitisation and the other on assignment transactions. There was absolutely no need for incorporating separate questions for the two, since all securitisation transactions involve an assignment of debt.


  1. Next, the department in Question 40 has clarified that the assignment of actionable claims, other than lottery, betting and gambling forms a part of the list of exclusion under Schedule III of the CGST Act, therefore, are not subject to GST. This was apparent from the reading of law, therefore, there is nothing new in this.


However, the second part of the answer needs further discussion. The second part of the answer states that – any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

There are multiple charges or fees associated in an assignment or securitisation transaction – such as  servicing fees or excess spread. While it is very clear that the GST will be chargeable on servicing fees charged by the servicer, there is still a confusion on whether GST will be charged on the excess spread or not. Typically, transactions are devised to give residuary sweep to the originator after servicing the PTCs. Therefore, there could be a challenge that sweep right is also a component of servicing fees or consideration for acting as a servicing agent. The meaning of consideration[6] under the CGST Act is consideration in any form and the nomenclature supports the intent of the transaction.

Since, the originator gets the excess spread, question may arise, if excess spread is in the nature of interest.  This indicates the need for proper structuring of transactions, to ensure that either the sweep right is structured as a security, or the same is structured as a right to interest. One commonly followed international structure is credit-enhancing IO strip. The IO strip has not been tried in Indian transactions, and recommendably this structure may alleviate concerns about GST being applied on the excess spread.

  1. Till now, whatever has been discussed was more or less settled before the clarification, question 41 settles the dispute on the contentious question of whether GST will be charged on assigned of secured debt. The answer to question 41 has compared sale, purchase, acquisition or assignment of secured debt with a derivative. The answer has rejected the view, held by the authors, that any right to a payment in money is money itself. The GST Council holds the view that the receivables are in the nature of derivatives, the transaction qualifies to be a security and therefore, exempt from the purview of supply of goods or supply of services.

While the intent of the GST Council is coming out very clear, but this view is lacking supporting logic. Neither the question discusses why assignments of secured receivables are not transactions in money, nor does it state why it is being treated as derivative.

Our humble submission in this regard is that assignment of secured receivables may not be treated as derivatives. The meaning of the term “derivatives” have been drawn from section 2(ac) of the Securities Contracts (Regulation) Act, 1956, which includes the following –

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices, of underlying securities.

In the present case, assignment of receivables do not represent any security nor does it derive its value from anything else. The receivables themselves have an inherent value, which get assigned, the fact that it is backed a collateral security does not make any difference as the value of the receivables also factor the value of the underlying.

Even though the logic is not coming out clear, the intent of the Council is coming out clearly and the efforts made by the Council to clear out the ambiguities is really commendable.


[1] Refer: GST on Securitisation Transactions, by Nidhi Bothra, and Sikha Bansal, at  http://vinodkothari.com/blog/gst-on-securitisation-transactions-2/; pg. last visited on 06.06.2018

[2] At the recently concluded Seventh Securitisation Summit on 25th May, 2018, one leading originator confirmed that his company had kept transactions on hold in view of the GST uncertainty. It was widely believed that the dip in volumes in FY 2017-18 was primarily due to GST uncertainty.

[3] http://www.cbic.gov.in/resources//htdocs-cbec/gst/FAQs_on_Financial_Services_Sector.pdf

[4] Portions of this note have been adopted from the article – GST on Securitisation Transactions, by Nidhi Bothra and Sikha Bansal.

[5] http://idtc-icai.s3.amazonaws.com/download/pdf18/Volume-I(BGM-idtc).pdf; pg. last visited on 19.05.2018

[6] (31) “consideration” in relation to the supply of goods or services or both includes––

(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;

(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:

Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;

Indian securitisation market remains stagnant as PSLCs rule the market

Despite the economic slowdown due to GST, the Indian securitization market has performed fairly well, though it has not been able to match the volume of last year. During FY 17-18, the overall volume of the market stood at Rs. 84,000 crores, which is Rs. 1000 crores less than what happened a year back. Of the total volume, there were direct assignments worth Rs. 49000 crores and the remaining were pass through certificates. After the introduction of the securitization distribution tax in 2012, the market shifted towards DAs and the same continued until 2016 when the same was removed. This also reduced the gap between DAs and PTCs, however, the gap has increased once again. The following two graphics show the trend of securitization and the market composition (DAs vs PTCs) during the last few years.

The market showed a 72% YoY growth on issuance of pass through certificates from Rs 25000 crores in FY16 to Rs 43000 crores in FY17 however, and a 24% decrease in FY18 to Rs 34800 crores. The slowdown in securitisation was mainly due to lack of clarity surrounding incidence of Goods & Services Tax on the ‘assignment’ of secured loan receivables as well as a sharp spike in PLCS lending volume.

The volume of PSLC market leapfrogged to around Rs 1.84 lakh crore in FY18 from mere Rs 50,000 crore in FY17. Trading of PSLC was introduced in 2016 and FY18 was the first full year of its use. Here, banks needed to meet priority sector loan targets buy the priority sector obligation certificate from the seller bank without the transfer of risks or loan assets. Seller banks earn a fee without reduction in the loan portfolio unlike in securitization or direct assignment deals. The PLCS are also easier to execute as happens without any real transfer of assets whereas PTCs require pooling of assets and selling it.

Despite a slowdown in the market, several new asset classes were tried during the year. For the first time, asset classes like educational loans, consumer durable loans were tried. The market also witnessed return of Collateralised Loan Obligations.

7th Securitisation Summit, 2018 & 2nd Indian Securitisation Awards

Vinod Kothari Consultants, along with the Indian Securitisation Foundation, has also announced the 7th Securitisation Summit, 2018 on 25th May, 2018 at World Trade Center, Mumbai. This is an industry forum where stakeholders from the entire industry gather to discuss various issues concerning the market and try to take up issues with the regulatory authorities so as to make the environment facilitating in India. The details of the event can be viewed at: www.vinodkothari.com/secsummit/

Also, during this years’ summit, Indian Securitisation Foundation will also announce the second edition of the Indian Securitisation Awards. There are five categories award – most innovative deal of the year, large and small arrangers of the year, trustee of the year and law firm of the year.  Details can be viewed at:


Chinese securitization market continues to grow – S&P Report

By Nidhi Bothra (finserv@vinodkothari.com)


Amdist slowdown of the Chinese economy, bulging debt load and excessive investments, the impetus has been on securitisation to convert assets into asset-backed bonds. China’s ABS market has wide range of assets such as loans, real estate, toll ways, auto loans, housing loans etc. Read more


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Pensive mood prevails at IMN gathering

The asset-backed market has suffered major jolts in the past few months. The latest news of sub-prime auto ABS originator AmeriCredit scaling up its losses due to revaluation of cashflows from auto securitization deals has not surprised many.

The mood at the recently concluded industry event organised by IMN was pensive, with undertones of tension. One participant is reported to have said: ""We are in a critical point of the ABS market. We are paying for the sins of the past. We were hiding behind growth and covering our mistakes."

The ABS market has passed through the largest bankruptcy of an ABS issuer – Conseco Finance. Recently, it also witnessed a case of mismanagement of cashflows in National Century fiasco.

Added to that is the regulatory oversight and increased accounting worries.

Looking forward, much depends on the health of the consumer, speakers at the conference said. But that outlook looks decidedly downbeat. If consumers — whose spending accounts for two-thirds of the U.S. economy — falter, it spells problems not only for the economy, but also for the returns on asset-backed securities, analysts said. "It's going to be a tough year for the ABS market. There's significant likelihood that the consumer in general will be much more distressed," said a panelist from Moody's.

South African legal dispute to put questions on securitisation structure

Over a very short span of development, the South African securitisation market has seen a failed securitisation conduit, as also failed securitisation originators. Soon, it might also see a court ruling either affirming or rejecting the transfer of assets to securitisation SPVs.

A company called Siltek that securitised its assets has gone bankrupt, and its liquidators have pleaded that the transfer of assets to securitisation SPV was a fraud on creditors and the taxmen. The bank that bought the securities in the deal has been issued summons.

The deal was structured by a securitisation conduit called Mettle. The book debts of Siltek were transferred to a vehicle called Xavier.

Also challenged by the liquidator is the tax impact of the transaction, particularly the issue of preference shares by the SPV to Siltek.

Comment On a first look, there seems to be nothing wrong in the structure of the deal. Originators do go bust, and that is why securitisation exists. Issue of preference shares to the originator as a first loss piece is also fine and cannot in any way be dubbed as a tax dodging device.

Germany takes the synthetic route to CLOs

The German Structured Finance public term market doubled its volumes in 2002 compared with 2001. However, looking at the synthetic issuance volume, the notional values nearly tripled over the previous year in 2002.

A recent S&P report provides data about cash versus synthetic deals in Germany. The total volumes (including notional values of unfunded deals) added up to USD 39.3 billion in 2002 compared with $19.6 billion in 200. Howeever, unfunded volumes tripled to $29.7 billion in 2002 compared with $10.6 billion a year earlier. Germany takes a staggering 72% share of the total European unfunded issuance.

From the end of 1999, almost all German CLO, RMBS, and CMBS transactions have been synthetic in nature. The market for these types of transactions was nonexistent prior to 1999 yet now stands at $29.7 billion.

Besides the regular KfW-assisted deals, there were several new features in 2002:

  • There was a deal called Gelt 2002-1, the first synthetic leasing ABS transaction. It was arranged by DZ Bank AG.
  • Non-SPE synthetic structures are increasingly becoming common: the first such deal in Germany was a synthetic RMBS transaction, Building Comfort 2002-1, was arranged by Bayerische Hypo- und Vereinsbank AG (HVB)

SME loan CLOs gather speed in Europe

CLOs backed by thousands of small business loans became a popular asset class in several European countries. Partly with government support, this might be the way to lend to small businesses.

Part of these CLOs were based on the cash structure, but of late, banks have been stressing more on the transfer of risks than raising of liquidity and going for synthetic structures.

A whole lot of such SME loan CLOs have emerged from Germany, where KfW runs a program targeted at SME lending called Promise. [See below for more]. CLOs under the Promise template have become a regular feature in Germany. However, Germany is not the only country to have SME loan CLOs. There have been cash funded deals from Spain, the Netherlands, and UK. The Spanish transaction is also based on a partial guarantee from the government.

An S&P report gives a list of SME CLOs in Europe as under:

European CLOs of SMEs Transactions
Transactions rated by Standard & Poor's   Originator   Closing date   Maturity date   Issuance (Mil. €)   Funding   Note collateral  
CORE 1999-1 Ltd. Deutsche Bank AG March 1, 1999 March 17, 2009 2,297 Fully funded cash flow SME loans
CORE 1999-2 Ltd. Deutsche Bank AG June 30, 1999 April 30, 2004 1,216 Fully funded cash flow SME loans
GELDILUX 1999-2 Ltd. Bayerische Hypo- und Vereinsbank AG Sept. 16, 1999 Sept. 30, 2003 750 Fully funded synthetic Pfandbriefe, MTN program, and cash deposit
CAST 1999-1 Deutsche Bank AG Dec. 6, 1999 Dec. 31, 2008 392 Partially funded synthetic Pfandbriefe and credit-linked notes
CAST 2000-1 Deutsche Bank AG June 30, 2000 June 20, 2009 340 Partially funded synthetic Pfandbriefe and credit-linked notes
CAST 2000-2 Deutsche Bank AG Dec. 8, 2000 June 20, 2009 220 Partially funded synthetic Credit-linked notes
Promise-I 2000-1 PLC IKB Deutsche Industriebank AG Dec. 19, 2000 Feb. 5, 2010 213 Partially funded synthetic Schuldscheine
Promise-K 2001-1 PLC Dresdner Bank AG May 22, 2001 June 22, 2008 58 Partially funded synthetic Schuldscheine
Promise-Z 2001-1 PLC DZ Bank AG Deutsche Zentral-Genossenschaftsbank Aug. 15, 2001 April 27, 2011 137 Partially funded synthetic Schuldscheine
Promise-I 2002-1 PLC IKB Deutsche Industriebank AG March 26, 2002 Sept. 5, 2009 4,170 Partially funded synthetic Schuldscheine
Promise-A-2002-1 PLC Bayerische Hypo- und Vereinsbank AG March 28, 2002 July 28, 2012 1,620 Partially funded synthetic Schuldscheine
GELDILUX 2002-1 Ltd. Bayerische Hypo- und Vereinsbank AG May 27, 2002 June 17, 2007 3,000 Fully funded synthetic Pfandbriefe and cash deposits
Promise-C 2002-1 PLC Commerzbank AG Nov. 5, 2002 Oct. 28, 2010 119 Partially funded synthetic Schuldscheine
   The Netherlands
SMILE Securitisation Company 2001 B.V. ABN AMRO Bank N.V. Dec. 13, 2001 Nov. 22, 2027 5,000 Fully funded cash flow SME loans
Fondo de Titulización de Activos BBVA-2 Banco Bilbao Vizcaya Argentaria, S.A. Dec. 6, 2000 Jan. 21, 2019 900 Fully funded cash flow SME loans
Melrose Financing No. 1 PLC Bank of Scotland Feb. 27, 2001 Feb. 15, 2011 1,103 Fully funded cash flow SME loans
*CORE 1998-1 Ltd. was redeemed for the full amount in November 2002.

Links For more on CLOs, see our page here.

Spain: 2002 was brilliant, and 2003 is promising

Securitisation activity performed brilliantly in Spain in year 2002, with volumes (including Spain-related assets for cross-border issuances) increasing some 70%. A recent S&P special report says that this is by far the largest volumes achived in Spain. Over just 4 years, the volume of issuance in Spain has quadrupled.

Spain is the 5th largest market in Europe – followed by UK, Italy, Germany and the Netherlands.

In 2002, the growth was pulled mainly by repeat issuances from originators who have already tasted the benefits of securitisation. Besides, securitisation of small business loans, known as PYMEs in Spain, became a strong asset class. However, like in many other countries, RMBS is still the larget component of Spanish ABS.

On the legislative front, the 2002 Spanish Finance Act was passed last November, which created mortgage transfer certificates ("certificados de transmisión de hipoteca"). These, together with mortgage participations, now allow originators to securitize both conforming and nonconforming loans through a fondo de titulización de activos.

According to the S&P report, For the same reasons as in 2002, the Spanish securitization market in 2003 will continue to grow at a brisk pace. Some repeat originators are already working on transactions for the first quarter, others will go to market later in the year. There will be recurrent issuances from established originators and new types of transactions will be structured. Some corporate originators are already looking into the possibility of taking advantage of this source of financing.

Links See also our country page on Spain here.

ISDA and other bodies jointly respond to Basle securitization paper

ISDA, American Securitization Forum, European Securitisation Forum, and International Association of Credit Portfolio Managers recently jointly commented on the second BIS paper on securitization. The second working paper was issued in October 2002 by the Secu-ritisation Group of the Basel Committee on Banking Supervision.

The highlights of the joint response are as under:

  • The proposed risk weightings for lower rated tranches under the RBA remain higher than justified, which will cause significant market disruption. As such, the bodies recommended that the Securitisation Group return to basic principles by aligning the RBA more closely with the underlying credit function and the actual practices of banks and by harmonising ABS risk weights with the Committee’s proposals for corporate positions.
  • Regulatory capital requirements for synthetic securitisations remain too high and dis-criminate against synthetic transactions as compared with traditional securitisations.
  • For super-senior positions in synthetic securitisations, there should be no need to seek external credit protection as the same is unwarranted additional cost for a position at which there is no appreciable risk.
  • With regard to revolving securitisations, the requirement that there be a pro rata sharing of interest, principal, expenses, losses and recoveries based on the beginning of the month balance of receivables out-standing is redundant and too restrictive and should be eliminated.
  • In addition, the 100% credit conversion factor (80% for controlled amortisation) for committed retail and all non-retail exposures implies that no risk is transferred to investors. This requirement should be reduced significantly or at least explained, as it is clear that risk is indeed transferred.

Links For more on regulatory issues in securitisation, see our page here.

New accounting rules to hurt several deals

According to accounting experts, the new US accounting rules on consolidation will hurt several deals including asset backed commercial paper conduits, several CDOs and other complex structured finance transactions.

For full text of the story on Reuters, click here.

On this site, we have posted a presentation by Deloitte Touche on the impact of the new rules, also containing an implementation guide. Martin Rosenblatt of Deloitte, one the World's best experts on securitization accounting, has kindly contributed this presentation. The presentation is available on the premium section of the website. To get access to the premium content, join our premium list here.

National Century investors to lose about 2/3rds

According to reports in US press, National Century will complete winding up in next about 4-5 months, and the investors in the asset-backed bonds may be forced to write off at least 2/3rds of their investments. Of the USD 3.3 billion owned by the company, it is expected to realise only about USD 1.2 billion of assets at most.

In the meantime, investors have already started writing off their investments. Some National Century bondholders have already written off most of the value of their investments. Credit Suisse, which underwrote most of National Century's bond sales, has written off 83 percent of its holdings of National Century debt. The bank said in November its $258 million of securities were worth $44 million, citing "massive fraud" by National Century.

Ambac Financial Group Inc., has also reportedly written down 80 percent of its $174.5 million investments in National Century bonds, more than the 70 percent figure it announced in November.

Links For earlier news items on National Century, see here. For more in the securitization hall of shame, see our page here.

Taiwan joins ABS fray:
First financial ABS deal approved

Taiwan's Ministry of Finance said Monday it has approved the island's first financial asset-backed securities product, which will be issued by Land Bank of Taiwan and comprise assets from the Industrial Bank of Taiwan. Government-owned Land Bank will issue two tranches of bonds totaling NT$3.65 billion (US$1=NT$34.560), backed by 41 loans belonging to Industrial Bank and the loans' guarantees, the ministry said. The first tranche, totaling NT$2.81 billion, will have a maturity of three years and seven months, and will carry a fixed coupon of 2.8%, while the subordinated tranche is worth about NT$840 million, the ministry said. The bonds will be privately placed and the subordinated tranche will be held by Industrial Bank, the ministry said.

The ABS deal included assets from 13 industries, such as semiconductor, communications, construction, retail, flat panel display and compact disc manufacturing, the ministry said. Each of the industries account for between 0.6% and 25% of the total assets, the ministry said. The ministry said the average annual return on the assets is 4.04%.

Taiwan Ratings Corp. will rate the first tranche of the asset-backed securities. Industrial Bank began working last year with SG to develop products for Taiwan's nascent asset-backed securities market.

CDOs in blunderland?
Investor to sue CDO managers for alleged mismanagment

According to a news item on on portal of Risk Waters, Jersey-registered collateralised bond obligation (CBO) investor Beaford is suing US investment bank Morgan Stanley and French insurer Axa, along with a number of its subsidiaries, for failing to properly manage three CBOs between 1996 and 2002. Morgan Stanley will contest the allegations, in what could prove a landmark case for CBO arrangers and managers.

The CDO landscape is littered with defaults and downgrades of late. Many of these CDOs contained blind portfolios of obligors, or otherwise, the investors had placed a total reliance on the CDO managers' experience and discretion. It is not unlikely that management of CDOs becomes an increasingly contentious issue in the structured finance market.

Beaford's objections significantly predate the more sophisticated managed CDO structuring taking place today. But the issue of how arrangers and CDO managers deal with investors that have seen significant credit events erode the value of their investment pools is still ongoing.

Links For more on cash and synthetic CDOs, see our page here.

Standard and Poor's bullish about 
Spanish securitisation market

The Spanish securitization market is set to show at least 30% growth in the year ahead after an impressive 2002 performance, according to an article by S&P."2002 was by far the most impressive year for the Spanish securitization market to date," the rating agency said. "Volumes were driven by a combination of repeat issuance and new entrants, which bodes well for future growth."

The Spanish securitization market closed 2002 70% higher at $18.4 billion compared with $10.6 billion a year earlier. A total of 27 transactions closed compared with 18 in 2001. Once again, RMBS was the dominant asset class. Year-end 2002 volumes came in at $10.8 billion, more than double the $5.7 billion seen a year earlier, representing 60% of overall Spanish issuance. A total of 16 transactions closed compared with 10 in 2001 and all were executed on a fully funded basis.

Talking of the prospects for this year, the S&P report says: " While mortgage lenders will remain the market's staple over the course of 2003, other institutions are now actively looking at securitization as a financing tool".

Given the importance and recent growth of synthetic transactions in the European market as a whole, in 2003 Standard & Poor's expects developments in the regulatory and legal frameworks for synthetic securitizations for both Spanish originators and domestic investors, the S&P report commented. "There are restrictions on the issuance of these types of transactions and the effect of such deals on financial institutions' capitalization ratios needs to be clarified," it said. "Additionally, some investors are prohibited by the regulatory authorities from investing in this type of security." In 2003, it is expected that that government guarantee program for SME securitizations will be continued, with a funding allocation that at least matches that of last year.

Link For more on securitisation in Spain, see oure page here.

The promise of Promise to cover Europe

German developmental body KfW has declared intents to cover transactions across Europe as it recently launched its first non-German synthetc securitisation deals to cover originations in Austria.

KfW runs program templates called Promise and Provide, wherein it assists German banks to syntheticall securitise RMBS and SME loan deals. The risks are bought from German banks by KfW which in turn transfers the same to capital markets by issue of credit-linked notes. So far, these programs were limited to German banks.

Promise Austria-2002 Plc.was the first non-German issue toward end of last year.

The popularity of the Promise and Provide programs is evident from the surge in their volumes in 2002: 11 transactions adding up to EUR 19 billion have been concluded under the two programmes in 2002, which is more than double the total amount in the two preceding years combined (altogether nearly EUR 9 billion). A KfW press release says: "KfW will focus not only on standard transactions but on the securitisation of portfolios of smaller institutions, that is, it will apply the multi-seller prototype more frequently. In addition, KfW is prepared to make its securitisation platforms available as a standardised instrument to suitable institutions with appropriate loan types in other European countries. As is the case with securitisations in Germany, it could assume the role of a neutral intermediary for European banks as well. "

Links For more on securitisation in Germany, see our page here. For more on synthetic CDOs, see our page here. The Promise transaction is discussed in Vinod Kothari's training courses on CDOs. For details, see here.

FASB's consolidation rules expected shortly

On coming Wednesday, FASB is holding another meeting to resolve some remaining issues relating to the draft of the rules on consolidation of certain special purpose entities. Thereafter, the final rules should follow.

The term "special purpose entities" is NOT used in the draft. Instead, the draft uses the term Variable Interest Entities (VIE).

Entities are separated into two populations: (1) those for which voting interests are used to determine consolidation (this is the most common situation) and (2) those for which variable interests are used to determine consolidation (the subject of this Interpretation).

An entity shall be treated as a VIE and subject to consolidation according to the these rules, if, by design, either of the following conditions exists:

  • The total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support. That is, the equity investment at risk is not greater than the expected losses of the entity. "Equity investment at risk" is not just legal equity carrying voting right but the first loss or residual economic interest class of the enterprise.
  • The equity investors lack any one of the following three characteristics of a controlling finncial interest: 
    (1) The direct or indirect ability to make decisions about an entity's activities through voting rights or similar rights. The investors do not have that ability if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership). 
    (2) The obligation to absorb the expected losses of the entity if they occur. The investor or investors do not have that obligation if they are directly or indirectly protected from the expected losses or are guaranteed a return by the entity itself or by other parties involved with the entity. 
    (3) The right to receive the expected residual returns of the entity if they occur. The investors do not have that right if their return is limited by the entity's governing documents or agreements with other variable interest holders or the entity.

Highlights of the draft of the interpretation are avalable here.

We will continue to report developments as they take place.

Links For more on accounting issues related to securitisation, see our page here

Singapore securitisation market looks forward to more activity

The securitisation market in Singapore is looking forward to increased activity in 2003, says a report by S&P. Until now, the potential for growth in Singapore's securitization market has been restrained because issuers have had access to less expensive funding from Singapore's banking system. Recently, however, the securitization market in Singapore has begun to realize its growth potential, due in part to its innovation, and 2003 could be something of a turning point for the area.

During 2002, Singaporean securitisation market was predominated by CDOs and CMBS deals. Of the 4 deals that S&P rated, there was one global collateralized debt obligation (CDO) transaction managed by United Overseas Bank Ltd. (UOB) Asset Management. The other transactions were property-related and sponsored by the leading Singapore developers, CapitaLand Ltd. and Keppel Land Ltd.

As to the potential of CDO market in Singapore, S&P official says Singapore's asset managers have been quick to realize how CDOs complement their traditional fund management business and form a good platform for expanding and building experience and establishing a track record. Other Asian-based asset managers may follow in their footsteps.

Besides CDOs and CMBS, S&P expects more activity in synthetic RMBS and consumer finance segment as well.

Links: For more on securitisation market in Singapore, see our page here.

US senate committee attacks structured finance

The U.S. Senate Permanent Subcommittee on Investigations : Four Enron Transactions ((Fishtail, Bacchus, Sundance, and Slapshot) Funded and Facilitated by U.S. Financial Institutions has submitted its report on 2 Jan 2003. The report attacks structured finance transactions and has called for penal action against financial intermediaries that help public companies produce misleading financial reports by means of deceptive financial products or transactions.

The transactions in question are Fishtail, Bacchus, Sundance, and Slapshot. These transactions related to Enron’s new business venture in pulp and paper trading, and according to the sub-committee were actively assisted by JPM and Citibank's SSB.

Major recommendations of the sub-committee include a review of structured finance deals by banks. The Federal Reserve, OCC, and SEC should immediately initiate a one-time, joint review of banks and securities firms participating in complex structured finance products with U.S. public companies to identify those structured finance products, transactions, or practices which facilitate a U.S. public company’s use of deceptive accounting in its financial statements or reports. By June 2003, these agencies should issue joint guidance on acceptable and unacceptable structured finance products, transactions and practices. By the end of 2003, the Federal Reserve, OCC and SEC should each take all necessary steps to ensure the financial institutions they oversee have stopped participating in unacceptable structured finance products, transactions, or practices.

It calls for stricter examination of structured finance transactions by bank examiners. It expects routine examiners to evaluate a bank’s structured finance activities to determine whether such activity appears to constitute a violation of the SEC policy and, if so, to declare that activity also constitutes an unsafe and unsound banking practice.

Full text of the 41-page report is available here.

Indian securitisation law passed

The upper house of the Indian Parliament passed the securitisation bill, which has been understood more as a law related to non-performing assets. All discussions in the house related to the non-performing assets part.

Now that the Bill has been cleared by both the houses, the only legal formality is the assent of the President. Normally that should only be a matter of days.

Please see our story below for more details and links.

Bankruptcy of National Century smears more tar on ABS business

Off balance sheet funding was already a dirty word, and now, asset-backed securities might also start straining the eyebrow. National Century Financial Enterprises that filed for bankruptcy recently (see also our story below) undoubtedly puts a question or two on the balance of multi-agency surveillance that ABS transactions work on. After all, it is being alleged that bonds to the extent of more than USD 1 billion were not backed by any assets at all.

After all, all corporate financings are asset-backed at the end of the day – because if the corporate does not have any assets, the liabilities have no meaning. But what has always been, and should continue to be, unique to ABS is the predominant asset backing that the bond investors get. To constantly monitor the asset backing, several independent agencies are brought in – trustees, rating agencies, auditors and so on. But National Century case, like similar cases in the past, must ultimately lead to some of these agencies sharing responsibility.

Thus, US financial press is justified in questioning, as Forbes does, in its article titled Why Wasn't NCFE's Collapse Predicted Sooner? by Seth Lubove, dated Nov 21. The articles contends, as is perhaps a fact, that as recently as in August, Moody's had affirmed its ratings for the securities of National Century.

Bank One, the trustee for the bonds, had alleged National of a "systematic trickery". An article in New York Times says: "Investors in asset-backed securities are still questioning how bonds that had carried a top credit rating could now be worth just a fraction of their face value. Moody's Investors Service rated National Century's bonds AAA until Oct. 25. Credit Suisse First Boston underwrote the bonds, and J. P. Morgan Chase had two bankers on the National Century board, including Hal Pote, head of the audit committee. Deloitte & Touche audited the books. Both Bank One and J. P. Morgan were bond trustees."

A story in Washington Post titled A Mystery Over Missing Funds went into the personal life style of the bosses of National Century.

Links For more sad episodes on asset backed securities, see our page here.

Pakistan central bank issues securitisation regulations

The State Bank of Pakistan has recently formulated reguatory standards for capita lrelief on securitisation deals. The rules dated 14th Nov allow banks and depository financial institutions to securitise assets through SPVs, speling out the requirements, prudential standards and capital relief conditions.

Several safeguards have been put in place which are reflective of the prudential standards in place in most other countries by banking regulators. The originating bnak is not allowed to hold equity in the SPV, nor to make it out that the SPV belongs to the bank.

The guidelines provide that banks can securitize their assets relating to lease financing (with acknowledged assignment of lease rental proceeds), mortgage financing and toll financing (for infrastructure developmental projects). Other assets may be securitized by banks with prior approval of State Bank, on a case to case basis. The regulations further provide that a fixed amount of consideration for the securitized assets must be received not later than the time of the transfer of the assets. This is, in fact, contrary to the market practice whereby banks retain an interest in securitised assets by way of a deferred sale consideration.

The SEC's rules on securitisation have been in place for quite some time, though the level of activity on securitisation is still quite limited.

Links For full text of the Prudential guidelines, click here. For more on securitisation in Pakistan, including a recent article on the state of the market, click here. For text of Pakistan SPV rules, click here

Indian securitisation law makes headway

The combo piece of Indian law on securitisation which combines provisions on enforcement of security interests by bankers has been passed by the lower house of the Parliament, Lok Sabha or house of commons and would most likely be passed soon by the upper house as well. It is, thus, expected that it would become law very soon.

The Indian law is a curious mixture of three unrelated things – securitisation, asset management companies and enforcement of security interests on loan defaults to banks. From the proceedings in the House during the discussion on the bill, much of the debate was centered on the provisions relating to enforcement of security interests. The Press has also generally coloured securitisation bill as a law relating to non-performing assets.

As far as securitisation transactions are concerned, the Bill did not, in its Ordinance form, help or hinder much See our earlier comments/ article on this issue here. Apparently some amendments have been made at the time of its introduction in the Lok Sabha.

Links For proceedings in the Parliament while discussions on the Bill took place, click here. See our India page here. The text of the original Ordinance law is here

Future flows have been safer than corporate finance: S&P

Enriched by experience of recent sovereign problems in Argentina and impact on future flow transactions, rating agency S&P says emerging market future flows are safer than corporate finance.

Future flow structures provide some protection against sovereign- and corporate-related risks particular to emerging markets. However, no future flow structure (with the exception of one benefiting from a full financial guaranty) can completely insulate against all risks, particularly sovereign risks. Ratings assigned to future flow structures are dependent on a company's ability to generate future receivables and the level of sovereign risk mitigation provided by the structure. This dependency creates a linkage with corporate and sovereign ratings that may require rating adjustments that are commensurate with the rating adjustments that occur on the underlying corporate or sovereign rating.

While ratings on future flows are strongly linked with the local currency rating of a corporate, it is the sovereign rating ceilings that future flow transactions seek to pierce.

A lowering of a sovereign foreign currency rating will not automatically result in a lowering of a future flow rating because Standard & Poor's does not view the sovereign foreign currency rating as a direct link to the rating on a cross-border future flow transaction. The decision to lower or affirm a future flow rating following a sovereign rating change requires a review of the factors that led to the sovereign rating change and how these factors affect the probability of sovereign interference in the future flow structure. The decision to adjust a future flow transaction rating will depend on an assessment of two factors: the extent to which the structure protects against direct sovereign risk, and the extent to which the company is able to isolate its operations from direct and indirect sovereign risk.

Links For more on future flows, see our page here.

Health care securitization company's goof up spills: causes bankruptcy

An apparently small issue in one section of the market can snowball into larger issues of due diligence and fiduciary responsibilities at a time when larger bankruptcies have already made it a sensitive issue.

National Century Financial Enterprises, an Ohio-based health care receivables securitization company was recently found wrongly tapping into reserve funds to buy new accounts and was brought to book by due diligence auditors. In response, National Century failed to pay for the health care bills it had securitized. National Financial had arranged more than USD 3 billion of financing for health care companies.

The result is a major chaos that is seeming spilling. So much so that more thant one health care company has already filed for bankruptcy protection. PhyAmerica Physician Corp., the Durham company that runs nearly 200 hospital emergency rooms in 29 states, has filed for Chapter 11 protection.

There were also reports in US press that Med Diversified Inc., a home health-care provider, announced that its Tender Loving Care Health Services Inc. subsidiary had filed for bankruptcy protection. In addition, Med Diversified said it plans to seek a damage award of up to $1 billion in its planned lawsuit against National Century's service providers. The company said it planned to file complaints against Bank One Corp. and J.P. Morgan Chase & Co., trustees of some of National Century's bond funds, as well as National Century auditor Deloitte & Touche LLC.

FASB reaching finality on SPE consolidation standard

After marathon deliberations spanning over several weeks, the US standard setters are finally reaching a stage where the final interpretation on consolidation of SPEs will be issued soon. At the meeting yesterday, the Board instructed the staff to draft the final rule.

According to reliable sources, the following are the main conclusions reached during the discussions:

1. Special purpose entities are more appropriately called variable interest entities, as it is now getting increasingly clear that the consolidation rule will not be limited in application to SPEs only. While applying consolidation rules, it will be necessary to decide whether consolidation will be based on voting interests or variable interests.

2. In case of new variable interest entities, the new Interpretation would be effective immediately. For all existing entites, the Interpretation would be effective as of fiscal periods beginning after June 15, 2003, (i.e. the third quarter of next year for calendar year companies). There will be no grandfathering provisions. Restatement of prior year financial statements would be permitted.

2. In case of QSPEs under FAS 140, it was decided that it would be better for all parties involved in a QSPE to adopt the financial components approach rather than full consolidation of the entity, with the only exception being if a non-transferor had put himself in a position that would have precluded the transferor from achieving sale accounting. In other words, the components approach, which is the general theme of the securitization accounting standard, would continue to apply as a consolidation would go against the very theme. here was a caution from the board chairman that the attributes of a qspe have to be met and that the board would resist any efforts to broaden the definition of a q to accommodate other transactions.

In view of the major immunity granted to QSPEs, the Board would insist that there are no deliberate attempts to broaden the scope of QSPEs over what is contained in FAS 140.

3. In determination of the key question as to whether to apply the variable interest approach, parties should first determine the entity has any identifiable "decision maker". A decision maker is any party that has the authority to purchase OR sell assets or makes other operating decisions that significantly affect the revenues, expenses, gains, and losses of the variable interest entity. If there is a decision maker and that party either holds variable interests that would absorb a majority of the expected losses or holds variable interests that allow the decision maker to obtain a majority of the residual benefits from the entity's operations, that party is the primary beneficiary. If, based on these criteria, the decision maker is not the primary beneficiary, then other parties to variable interest entities should determine whether their variable interests will absorb a majority of the variability, focusing first on expected losses if they were to occur and then on whether they are entitled to a majority of the residual benefit, if any.

The discussions have also made some rules relating to consolidation of conduit entities.

Links For more on accounting for securitisation, see our page here. For more on SPEs, see our page here.

Malaysia sees first primary market CLO

The first primary market CLO was introduced in Malaysia a couple of days ago by Anfin.

While a traditional CLO is made of loans originated by a bank or banks, which are bought and securitised by the CLO, a primary market CLO is one which itself gives loans to borrowers, and funds itself by issuing securities. Primary market CLOs have been operating in Korea for sometime.

Affin Bank and Nomura Advisory Services (M) Sdn Bhd wrapped up a collateralised loan obligation (CLO) deal that would see the 25 companies from 16 different industries get access to RM1bil from the capital market through the sale of new loans to a special purpose vehicle. Technically, under Malaysian SC guidelines, since there has to be a sale of the loans to an SPV, it seems the bank will give the loans and immediately sell them off to the SPV.

There are two remarkable features of the CLO – one, the loans are not seasoned, and two, the level of subordination in the transaction is only 10% whereas earlier CDOs from Malaysia have had far higher levels of subordination.

This is probably due to the ratings of the borrowing companies: the amounts of money borrowed by the 25 companies range between RM25mil and RM45mil and Malaysian Rating Corp Bhd has rated each company. The minimum credit rating of any of the 25 companies involved in the deal is BBB.

Vinod Kothari comments: on the face of it, this is like each of the 25 borrowers going together to the capital market. The role of the SPV and that of the arranger is minimal – that of merely putting up the whole show together. The subordinated investment also, in all likelihood, will be bought up the borrowers themselves, which, in essence, will mean the borrowers get 90% cash funding for what is their loan on paper.

It is not clear from the report whether the loans are secured or unsecured. If the 10% equity in the transaction has not been put up by the arranger, then this type of transaction for unseasoned, unsecured loans opens avenues for subprime lending trough capital market vehicles. That securitisation can be used as a device of promoting lending which banks would hate to keep on their balance sheets is an often-aired criticism of securitisation, and transactions like this give strength to this belief.

The regulators should view this transaction not as a securitisation, but as direct debt issuance by the end borrowers.Besides, subordination is meaningless if it held back by the borrowers themselves. Of course, who will be holding the subordinated investment is not clear from the press report.

Links For more on Malaysia, see our page here. For more on CLOs, see our page here.

Accounting firm to face USD 2 billion claim on securitization accounting issue

US regulators on Friday filed a USD 2 billion suit against accounting firm Ernst and Young for failing to disclose wrong accounting of retained interests of failed thrift Superior Bank that was ordered to be closed last year for securitization accounting lapses.Evidently, this is a big jolt for securitization and securitization accounting, after Enron.

The claim is directly connected with accounting for securitized interest. Superior Bank, which was aggressive in securiitizing subprime loans, continued to report residual interests at inflated numbers, though its first loss in such loans exceeded three its own equity.

A report on Financial Times says a US banking regulator on Friday filed a $2bn suit against Ernst & Young for its role in a bank failure, saying the firm covered up improper accounting work so it could "buy time" for the sale of its consulting arm to Cap Gemini of France. The suit filed by the Federal Deposit Insurance Corporation stems from the failure of Superior Bank, based in the Chicago suburb of Hinsdale, Illlinois, in July 2001. The failure cost the FDIC $750m.

Recently, US investigators had submitted a report on Superior Bank failure.

Links For more on the Superior Bank case, see our page here. For more on securitization accounting,see our page here.


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Government support to Fannie and Freddie should be withdrawn: expert

Wall Street Journal of 17th June 2003 carries an article by Thomas Stanton, who has authored a book titled Government Sponsored Enterprises (GSEs). Freddie Mac, Fannie Mae and Ginnie Mae are GSEs holding the bulk of the US RMBS market. Freedie Mac has recently been in problems – see our news item below.

The author states that the problem with GSEs is that taxpayers and the financial system are at risk, both because of the GSEs' immense size and because of perceived government backing of their obligations and the MBS. Fannie Mae and Freddie Mac together fund over $3 trillion of mortgages in their portfolios and through securitization. Compounding the risk, the government conveys a major benefit to the GSEs by allowing them to maintain significantly lower capital and higher leverage than other firms in the mortgage market.

The author finds no reason as to why GSEs should not be subjected to bank-type capital requirements. Doing so would reduce their leverage. In addition, they should be subjected to full supervision of the SEC, a view which Alan Greenspan seems to support.

"More fundamentally, it is time to begin unwinding the GSE model. Thanks to their government support, the two behemoths double in size every five years. One analyst has projected that the two GSEs could grow their portfolios to a total of $12 trillion by the year 2020, and their mortgage-backed securities by additional trillions of dollars. This creates a growing concentration of financial risk in two highly leveraged companies", says the author.

LinksFor more on the US securitisation market, see our page here.

Are whole business deals turning sour as a whole?

London press is abuzz with stories about Robin Saunders' securitisation deals going sour. Robin, one of the most talked about females in the Citi, isaid to be drawing, in good days, pay packets next after J K Rowling and Madonna, was the head of WestLB's London-based principal finance division, which structured whole business securitisation deals for the bank.

One such deal, Box Clever, went sour contributing heavily to WestLB's near USD 2 billion loss. The result: the 4th largest German bank was reprimanded by German regulators, resulting into the resignation of its CEO. The market expects that Robin might be the next one to resign.

Robin is credited with major whole business deals including Formula 1.

Earlier, we have reported JP Morgan's whole business division being disbanded. Are these isolated cases going bad, or is there a method? Structurally, whole business deals are more like corporate finance than securitisation. The securitisation methods such as liquidity support, SPVs, and structured funding are used in such deals, possibly more to fashion them as regular asset-backed transactions, but in essence, whole business deals are more like securitised LBOs. They depend on the residual value of a business: which is volatile.

At the beginning of the year, Moody's issued a report saying in year 2002, whole business deals were a whopping 28% of European ABS (exclusing MBS and CDOs), adding to Euro 10.4 billion. Moody's was bullish about the 2003 prospects of whole business deals.

However, with revelations about WestLB and the disbanding of JPM's principal finance unit. it is unlikely that whole business deals would continue to remain alluring for investors.

Links For more on whole business deals, see our page here.

US CRE market might get worse before it gets better, warns FDIC article

An article in FDIC newsletter FYI, by Thomas Murray, a Senior Financial Analyst in the Economic Analysis Section of the Division of Insurance and Research, FDIC cautions of the declining occupancy rates in the commercial real estate (CRE) lending in the USA. Notably, about 18% of the CRE exposure is in form of CMBS.

The article explains that the office property segment is undergoing an adversity never seen in the past 20 years: "Performance in most U.S. office markets continues to deteriorate by almost all measures. During eight of the last nine quarters, U.S. office markets have experienced negative net absorption, a situation where the amount of space given up by existing tenants exceeds the amount of space occupied by new tenants. This development is unprecedented in the sense that, prior to 2001, U.S. office markets had never experienced negative net absorption in the 20 years for which comparable data are available".

The problem is not limited to office property alone: vacancies for industrial properties as of first quarter 2003 climbed to 11.3 percent, a record level eclipsing a previous high of 10.7 percent reached in 1992.

While CRE exposure is largest on bank balance sheets, a substantial part of it is in CMBS form. In the CMBS segment, though default rates are increasing, the same have not reached alarming levels as yet. A recent study performed by FitchRatings on fixed-rate CMBS transactions reports on the growing level of CMBS defaults and found that the cumulative default level on mortgage loans securing CMBS pools were 2.66 percent as of year-end 2002. The study noted that the default rate by loan balance "…has increased steadily since year-end 2000, growing from 1.07 percent at the end of 2000, to 1.75 percent as of year-end 2001, to the current 2.66 percent rate at year-end 2002.

Links For more on the CMBS market, see our page here.

FASB issues exposure draft of new QSPE rules

More rules and more rules and yet more rules. The burden of accounting rules on the securitization industry is mounting, and yet again, the FASB issued an exposure draft of proposed QSPE rules. QSPEs are qualifying special purpose entities: if an entity qualifies as QSPE, it escapes consolidation, escapes Variable interest entity rules under FIN 46, and its securities are not treated as a proxy for the assets transferred by the transferor.

The proposed amendments seek to limit the scope of QSPEs, in particular, to deny QSPE-treatment to those entities which survive on liquidity or credit support from the transferor. In case the liquidity support comes in form of acquisition of beneficial interests, it must come from the senior-most security holders, and must not come from the person holding more than a majority of the certificates.

QSPEs are now restrained from holding equity instruments: which would rule out the growing bank of CFOs from being recognised as QSPEs. [for more on CFOs, see our page here.]

The amendments also seek to add a para below Para 83 of FAS 140, whereby it would be necessary for the second SPE in a two-tier transfer [first transfer to a subsidiary, without credit enhancements, second transfer to the issuer SPE, with credit enhancements] to be a QSPE. If not, the condition of Para 9 (b) will be deemed to have been violated. Para 9 (b) requires that the transferee must have the right to re-sell the assets bought by it – this is not required if the transferee is a QSPE.

Links For full text of the exposure draft, click here. For Martin Rosenblatt's comments on the exposure draft, see our page here. For more on accounting issues in securitization, see our page here.

Securitization, or false sense of security?

In an article in CFO magazine, Tim Reason questions the legal robustness of securiitzation structures. Securitization structures rely on bankruptcy remoteness: which are bankruptcy remote except perhaps in the event of bankruptcy – he cites a joke by an industry practitioner.

Though for now the market is concerned mostly with accounting rules such as FIN 46, there might be more basic challenges to the legal framework on which securiitzation relies: one of hiving off of assets into legal vehicles. These legal vehicles, as accounting rules are getting to realise, are seldom independent or real, exposing them to legal challenges.

Apart from true sale related problems which have surfaced in major bankruptcies, each bankruptcy brings its own unique dimensions. In the case of Conseco Finance, which acted as a servicer in some USD 23 billion worth transactions, Conseco threatened to quit as a servicer unless its fees were increased and were made a prior item in the waterfall. Nextcard's bankruptcy brought a new front: when the bank was put into receivership by the Federal Deposit Insurance Corp. Unable to find a buyer for the bank' s credit-card portfolio, the FDIC shut it down. That turned the assets from a revolving pool to an amortizing one and, again, resulted in losses to bondholders.

"The fact that both the market and rating agencies are increasingly uncertain about the stability of asset-backed securities calls into question one of the most commonly cited market benefits of securitization — that is, that it converts illiquid assets into the sorts of safe, highly rated investment vehicles investors crave", says the author.

Links For more on true sale, the core issue raised in this article, see our page here.

Bank of Japan to buy asset backed paper

In a move which does not have a rival elsewhere, Bank of Japan sought to re-inflate its economy by pumping money into the banking sector. BoJ is willing to buy asset backed paper representing the loan assets of Japanese banks, upto a total of Yen 1 trillion.

These securities could have a rating of upto BB. At the least level, therefore, the securiites have a below-investment grade rating.

Bank lending in Japan is constantly coming down – now for 65 months in a row.

Though this decision has made international headlines, market players are not sure about is real impact, in view of the small amount involved. In addition, a securitisation exercise merely contributes to liquidity, which is not a problem in the Japanese economy.

Links For securitisation in Japan, see our page here.

Freddie Mac under potential misconduct probe

Federal prosecutors have opened a criminal investigation into possible misconduct at Freddie Mac. Federal Home Loan Mortgage Corporation or Freddie Mac is one of the 3 government-sponsored enterprises (GSEs) which are engaged in securitisation of residential mortgage loans in the USA. Freddie is the second largest, after Fannie Mae.

Freddie Mac's accounting is already under a probe relating to its accounting practices. The probe was launched when Freddie wanted to re-state its earnings for past 3 years due to derivatives-related valuation. This was expected to increase its earnings, but render more volatility. The Office of Federal Housing Enterprise Oversight (OFHEO) has deputed an oversight representative to review the re-audit. On 9th June, the company announces it fired President and Chief Operating Officer David Glenn, 59, for failing to cooperate with its board's audit committee counsel in a review of its earnings. It says Chairman and Chief Executive Leland Brendsel, 61, retired and Chief Financial Officer Vaughn Clarke, 48, resigned.

A day later, Alan Greenspan reportedly stated that the securities of Freddie should be registered with the SEC.

The present probe has further thickened the mystery over Freddie. The diaries of David Glenn, the company's president who was fired on Monday, are drawing interest. Wednesday's news of the criminal inquiry came two days after the government-sponsored company shook up its top leadership because of accounting problems, jolting the stock market and raising concern about a possible impact on the housing market. "The U.S. Attorney's Office in the Eastern District of Virginia has initiated an investigation involving Freddie Mac," U.S. Attorney Paul McNulty said.

Links For more on the US GSEs relating to RMBS market, see our page here.

Private equity CFOs boom as AIG raises USD 250million

Couple of years ago, securitisation of private equity investments seemed like an outlandish idea, but now it seems this market is booming. American International Group (AIG) recently raised USD 1 billion by way of collateralized financial obligations (CFOs) and there are suggestions that there are more deals in the pipeline.

CFOs are a device similar to CDOs or CLOs, with the difference that the collateral here is not a pool of debts or bonds but investments in private equity, hedge funds or similar venture financings.

AIG raised USD 250 million backed by revenues from a USD 1billion investment in private equity. It is for the first time that without an insurance wrap, the deal has been given a AAA rating. It is reported that the collateral consists of 64 private equity firms representing 910 underlying investments The AIG deal was structured by Swiss investment bank CapitalDynamics, which also was involved in one of the few previous private equity securitizations called Prime Edge.

Links For more on CFOs, see our page here.

JPM disbands whole business securitisation team

As per a news that made headlines on financial press World over, JP Morgan London office has disbanded its whole team that looked after operating revenues or whole business securitisation. The exact implications of this move or the reasons that prompted it are not clear.

According to press reports, JP Morgan said Tamara Adler, who was head of corporate structured finance, and two other managing directors, Richard Tray and Jeff May, have been redeployed elsewhere in the bank, though it declined to say if they had been offered specific roles.

Whole business securitisation emerged as an idea around 1997 when LBOs were converted into securiites by investment bankers. Guy Hands was often cited as the leading proponent of this idea. Over recent times, some of the whole business deals in the past have suffered downgrades, but overall, it is difficult to say whether the idea has flopped. Rating agencies have always seen whole business securitisation as closer to corporate finance than to securitisation. There were also fears that bankruptcy law reforms in the UK as also rulings of the House of Lords in Brumark and Cosslett have reduced the strength of the floating charges on while whole business securitisation was essentially based.

It is not clear as to whether the JPM move is at all associated with any difficulties in the whole business sphere or is just an organisational restructuring.

Links For more on whole business securitisation, see here.

OCC may consider capital relief for FIN 46

At a recent structured finance forum organised by Standard and Poor's, Greg Coleman of the Office of the Comptroller of the Currency, participating as a panelists, acknowledged that his agency and other regulatory bodies are likely going to put together a proposal during the next month outlining their plan to supply temporary capital relief to U.S. banks impacted by FIN 46. The regulatory capital relief would last either through year-end or through March 2004, Coleman said. Mr. Coleman also indicated that the existing regulatory treatment of banks' leverage ratios is unlikely to change, however.

This would be a short-term approach to how the OCC will address the issue of regulatory capital associated with the FIN 46 rule. According to Coleman, the regulatory bodies' long-term strategy will be a "risk-sensitive approach," seeking out risk-sensitive alternatives for asset-backed commercial paper conduits.

At this panel discussion dedicated to FIN 46, it was clear that the market was desperately looking for solutions to FIN 46. According to the panelists, the leading solution being proposed by members of the structured finance market for both ABCP and CDOs is the creation of an "expected loss tranche" that will be sold to a single entity, who will be exposed to the losses of the VIE. Other possible solutions for ABCP conduits include the formation of joint ventures, whereby each participating bank shares some of the risk, and the conversion of multiseller CP conduits to Qualified Special Purpose Entities (QSPEs).

For the CDO market, panelists agreed that the simplest solution would be for a collateral manager to find a willing buyer of the majority of the equity class of the CDO, who would then consolidate. While such a strategy is rare nowadays, there is an added incentive to find such a buyer now that consolidation under FIN 46 is mandatory, panelists said.

Links For more on FIN 46, see our page on accounting issues. Also see Vinod Kothari's article on FIN 46 here. There are more materials on FIN 46 in our premium section –click here to join. There are more FIN4-related news items below.

FASB reconsiders QSPE amendments

There is a partial reconsideration of earlier FASB decisions on amending the QSPE conditions and some other provisions of FAS 140. See the earlier news item below.

As per FASB Action alert of May 7, the FASB reaffirmed its decision to issue an Exposure Draft that would amend FAS 140, but changed its decisions about certain of the provisions that Exposure Draft. The Board decided that the comment period for the Exposure Draft would end on July 31, 2003, based on an expectation that the Exposure Draft will be issued by early June, and decided to hold public roundtable meeting or meetings shortly thereafter.

The Board reversed its earlier decisions about commitments to provide assets to make payments to beneficial interest holders and parties that made decisions about reissuing beneficial interests and decided replace them with the following:

  • A qualifying special-purpose entity (SPE) would be prohibited from being a party to a swap with the transferor (or its affiliates or agents) if such a swap transfers substantially all of the types of risks inherent in the assets back to the transferor. The apparent reference is to a total rate of return swap. For more on total rate of return swaps, see our site on credit derivatives.
  • A qualifying SPE would be prohibited from holding commitments from the transferor and its related parties to provide cash or other assets to make payments due to beneficial interest holders. Obviously, this is not to deny the servicer advances from the transferor who is also a servicer, but the idea is a liquidity or other firm commitmnet. Also excluded, apparently, is the initial credit enhancement provided by the transferor. The FASB also intends to put other limits on provision on liquidity facility in case the term of the securities is shorter than the term of the assets.

Links For more on accounting issues, see our page here.

Basle II issues third consultative paper

On 29th April, the BIS came out with its Third, and presumably the last consultative paper before the new capital standards are finalised. The consultative paper gives 3 months for comments, and it is expected that the new standard will be finalised by the end of the calendar year, to be implemented by year-end 2006.

Despite vehement opposition by the industry and rating agencies, the BIS contiues to provide for higher capital for unrated and low-rated securitisation tranches as compared to direct credit exposures. The consultative paper says: "One noteworthy point is the difference in treatment of lower quality and unrated securitisations vis-à-vis comparable corporate exposures. In a securitisation, such positions are generally designed to absorb all losses on the underlying pool of exposures up to a certain level. Accordingly, the Committee believes this concentration of risk warrants higher capital requirements. In particular, for banks using the standardised approach, unrated securitisation positions must be deducted from capital."

Another notable change in CP3 is in relation to liquidity facilities for ABCP conduitsl Changes have been made to the securitisation framework concerning the treatment of liquidity facilities. Criteria for recognising eligible liquidity facilities have been amended. A further change to the capital treatment has been introduced for IRB banks. Such bank providers of liquidity facilities are required to calculate KIRB for exposures in the underlying pool on an ongoing basis.

Where a deduction from capital is required under the norms, the deduction is split 50:50 between Tier I and Tier II capital.

For more details of the new consultative paper, see our page here.

Delinquencies mount up in US CMBS; 
investor interest still strong

US CMBS segment is suffering from delinquencies and negative rating actions, but investor interest still continues to be strong.

Rating agency S&P released its first quarter 2003 review of US CMBS showing increasing delinquencies and declining property values. Continuing job losses, travel curtailment, and uncertainty regarding the economy's direction in the aftermath of the Iraq war are all factors influencing property performance and contributing to higher delinquency levels. Although not all property sectors and markets are feeling the stress equally, the overall decline is broad based.

During the first quarter, the delinquency rate in rated CMBS deals was 1.56%, 5 bps higher than that in the previous quarter. While the delinquencies were broad-based, the U.S. CMBS office delinquency rate remained at low levels despite the problems in the sector. The current rate, 0.70%, although an increase of 20% from last quarter, is the lowest delinquency rate of all property classes.

Inspite of the above, investors are still showing strong interest in CMBS. A recent survey by Barron's/John B. Levy & Company indicated that CMBS issuance was close to the levels seen in the go-go year of 1998. The first-quarter collateralized mortgage-backed securities volume was just short of $18 billion, up from $14.7 billion during the same period last year

Link: For more on CMBS, see our page here.

Italy sits on a massive pipeline in 2003

The Italian market is expected to be the centerpiece of securitisation activity in Europe in 2003, says a report in Reuters dated May 1.

The first quarter numbers reveal Italy occupies second place in Europe with a total securitisation volume of USD 10.7 billion (including synthetic deals), behind the UK with USD 26.6 billion. The 2003 remaining pipeline includes a whole lot of RMBS deals, deals from the Government, and a variety of other asset classes.

As for issues in the Government sector, there was a recent deal on April 28 of Euro 683 million, backed by water and water disposal and water transport assets. This 4-tranche deal is the 11th publicly rated asset-backed deal from government utilities.

U.S. investors have been actively investing in European ABS issues this year. This is good news for Italy, whose banks want to recapitalise and whose government would like to reduce its exposure to public sector assets

Links For more on securitisation markets in Italy, see our country page here.

FASB proposes amendments to QSPE conditions

It is the FASB in action again. The Board has now decided, unanimously, to amend the conditions relating to QSPEs and make them a bit more elaborate. The FASB affirmed these amendments on 30th April, which will be in form of an amendment to FAS 140. According to Martin Rosenblatt of Deloitte, these amendments are likely to be issued in Exposure Draft form by end of May or early June, with a comment period to expire in next 30 days or so.

The proposed changes are as follows:

  • Paragraph 35.c. of FAS 140 which lists the types of assets, derivatives and guarantees that a QSPE may hold would be expanded to say that in transactions where reissuance of beneficial interests is required, a QSPE may only hold a financial asset such as a liquidity commitment that supports the repayment of the beneficial interests if such commitment is provided by parties OTHER THAN

    • (1) the transferor, its affiliates or its agents;
    • (2) parties who are responsible for making decisions regarding the reissuance of beneficial interests; and
    • (3) holders of subordinated classes of beneficial interests who would have a vested interest in whether the refinancing goes well or goes poorly.
  • Further, no single eligible party would be allowed to provide more than 50% of such a financial arrangement (eg liquidity commitment) to the entity.
  • The board also decided that a QSPE could not be a party to a swap with the transferor (or its affiliates or agents), if such swap transferred [substantially] all of the [types of] risks inherent in the assets back to the transferor. they referred to total return swaps, but will try to avoid using that term in the exposure draft.
  • A qualifying SPE may not hold assets without contractual maturities or with contractual maturities extending beyond the end of the planned life of the entity unless the governing documents include a prespecified date of sale within the entity's planned life. .
  • Paragraph 9(a) of Statement 140 will be amended to clarify that derecognition of transferred assets is appropriate only if the assets would be beyond the reach of a bankruptcy trustee or other receiver for the transferor or any other consolidated affiliate of the transferor that is not an SPE designed to make remote the possibility that it would enter bankruptcy or other receivership. .

Links For more on accounting issues, see our page here.

FASB staff positions on FIN 46

Call them interpretations on the interpretation – FASB has come out with 6 FSPs on FIN 46. An FSP is the position that the FASB staff takes on a matter which is expected to be contentious. FIN 46 is the interpretation issued by FASB that relates to consolidation of certain SPVs based on variable interests, and not based on voting interests as is the common rule in case of consolidation.

The first of the FSPs is clarificatory – that a non-for-profit entity, usually exempt from FIN 46, would be subjected to the interpretation if it is used for running a business transaction.

The FASB staff also clarifies that the term "expected losses" as a criteria for identification of variable interest is not necessarily related to "losses" in financial accounting sense, but every loss of profit, that is, unfavourable variability of the results or asset values of the enterprise.

Another interpretation clarifies that where the variable interest that would absorb the expected losses of the enterprise can be identified, it would not be necessary to identify the beneficiary of the residual returns.

On a question to whether a group of assets withint a variable entity should be reported as a separate sub-entity, if such assets and related liabilities are isolated from other assets/liabilities of the entity, the FASB staff clarifies that that would be required only if the assets are "effectively separate", which should mean something similar to a protected cell company.

We have reported elsewhere that the structured finance community is already intrigued by FIN 46 and sees this more as an evil.

Links Full text of the FASB FSPs is here. On the premium section of our site, we have several presentations/ articles on FIN 46. The premium section is accessible to subscribers to the premium list, which only requires a nominal contribution.

India's central bank announces securitisation guidelines

A set of 6 notifications brought into force the securitisation guidelines in India on 23rd April, nearly 11 months after the promulgation of the law. These guidelines will regulate what in Indian jargon is called "securitisatio and asset reconstruction companies" (SARCs) (gladly different from either SARS, or even sharks).

A SARC under the Indian framework is supposed to be engaged in both securitisation and asset reconstruction – the latter term refers to concerted efforts at realisation of non-performing loans of banks. It is evident that the combined infrastructure would most likely be used for asset reconstruction rather than for securitisation of performing assets.

By look and structure, these guidelines have no semblance to bank regulatory guidelines anywhere else in the World – as the minds of the regulator was largely pre-occupied with the asset reconstruction activity.

An SARC can conduct securitisation activities by setting up trusts – this imparts a great deal of flexibility particularly for securitisation. The SARC itself needs a capital base of 15% of its risk weighted assets, or Rs 2 crores at least, but the trusts are exempted from such requirement. So, obviously, real-life transactions would be routed through the umbrella body SARC, which will act as a trustee to various trusts each of which will be an SPV.

The real difficulty created by the guidelines is for the transferring banks which must be paid for the assets transferred to the SARC either in cash, or in non-contingent securities such as bonds/debentures. The guidelines have at various places talked about paying for the consideration in form of pass-through certificates, but since it clearly prescribes an unconditional undertaking on the part of the SARC to pay for the same, it is evident that the transferring bank cannot be part-paid in form of junior securities. The consequence of this is that the transferring bank will suffer a write off, both in regulatory capital, as also in financial books, for the subordinated stake it holds in the SARC, as the only way the subordinated stake could be held under the guidelines is in form of profit-sharing.

Links For full text of the Guidelines, as also a dedicated page on SARC, see http://india-financing.com/arc/, or http://india-accounting.com/arc/. For a detailed comment by Vinod Kothari, see http://www.india-financing.com/ Vinod Kothari's book on securitisation and asset reconstruction discusses the Indian law at length – see here for details

KfW to steer Germany's largest multi-seller CLO

Under the aegis of KfW, 5 of the top German banks will pool a huge amount of their performing loans and come out with asset-backed securities. It is a plan that has made international headlines.

The banks that will participate in this "joint venture" are Deutsche Bank, Dresdner Bank, Commerzbank, HVB Group, and DZ Bank. All of these have participated in KfW's Promise or Provide programs earlier. However, the proposed multi-seller CLO is different. Here, these banks will initially raise a funding of some USD 5 billion, but over a period of time, the target is for USD 50 billion worth assets to go off the books of the transferring banks.

KfW, it may be noted, has the status of a sovereign in German law, and is rated AAA. The securities, though backed by the loans transferred by the banks, will bear the stamp of KfW which will increase their market acceptability. On the other hands, the transferring banks lighten their balance sheets with USD 50 billion worth assets over a period of time.

The move comes at a time when the health of German banking is at an all time since World War II.

Soon after the announcement of the move, there were signals from the European Commission that the Commission might be opposed to any kind of implicit or explicit guarantee put in by KfW for the securities. Some people also felt that the multi-seller conduit was the replica of the "bad bank" that German bankers were envisaging for a while – a bank that will pool bad loans of German banks.

The present transaction has drawn quick headlines all over the World. The BBC said German banks are huddling together for warmth.

In the meantime, some tax law changes making SPVs tax neutral are also reportedly in the offing – see our country page on Germany

Links KfW's synthetic deals have been discussed off and on on this site as also on our credit derivatives site. Use search to browse. For more on securitization in Germany, click here.

First Quarter 2003: rating downgrades decline, but certain sectors still in the woods: S&P

Rating agency S&P has come out with its quarterly round up of rating actions for 1st Quarter of 2003 and says that while negative rating activity decreased somewhat in the U.S. ABS and European ABS markets during the first quarter, there was no shortage of downgrades, as a few specific asset types continue to bear the brunt of a sluggish economy.

Of the sectors seemingly badly affected in the MBS segment, US and Canadian CMBS reported a total of 21 upgrades and 49 downgrades in the first quarter, which is the higest downgrade to upgrade ratio in the recent past.

In all, there were 133 downgrades in US ABS transactions. However, S&P draws comfort from an emerging trend: with 279 downgrades in Q3, 2002, lower to 176 downgrades in Q4, 2002 and is further lowered at 133 downgrades in Q1 of 2003.

In the ABS segment, the leader of the pack was CDOs with a total of 56 downgrades, comprised mainly of high yield cashflow CDOs with 41 downgrades.

Manufactured housing was another weak spot with 31 downgrades. There were 27 downgrades in the synthetic segment.

There were 18 ABS defaults from 4 issues during the quarter. This, again, is awesome if one looks at the past where there were only 12 defaults over all the years together before 2001, and 18 defaults during the whole of 2001. Larger part of these defaults (16) relate to subordinated tranches of Conseco's originations.

In Europe, 20 asset classes were downgraded. CDOs contributed to 11 downgrades, and of these, 10 were synthetic CDOs.

FIN 46 frustrates securitization professionals

If they could just borrow some strong words from a stronger personality, they would call it "weapons of mass destruction". We are referring to what the securitization industry thinks about the recent US accounting rules regarding SPE consolidation. Exaggeration? Okay, let us use better words, and quote S&P: "the majority of securitization professionals worldwide report that they are overwhelmingly frustrated, skeptical and confused by the new set of rules for off-balance-sheet financing, characterizing it as an unnecessary and costly burden on an otherwise healthy market."

FIN 46 is an accounting interpretation from the FASB that requires consolidation of certain SPEs on a basis other than voting control – which the normal basis for consolidation of subsidiaries. The structured finance world, which uses SPEs in almost every securitization deal, feels these rules are confusing, confused and would cloud out the purpose for which they were made. The purpose, unarguably, was to search for the real beneficiary of SPEs formed with thin capital where the voting control did not indicate the true ownership. So, the securitization world calls it "wrong solution for a right problem".

So strong is the concern of the structured finance industry, that Iraq is only a much smaller issue. The S&P survey indicates that more than two-thirds of participants consider the FASB proposals/rules to be the most significant current concern in the market, more important than rating transitions (32%), the role of servicers (21%), the impact of the war in Iraq (19%) and the role of trustees (16%).

When asked how well they understood the ramifications of FIN 46 for ABCP conduits, CDOs, and ABS, it was notable that there is still a distinct lack of clarity for the CDO sector: 60% of survey participants did not yet understand the exact impact of FIN 46 on CDOs, while 55% had an understanding of how ABCP would be affected. The level of comprehension for the ABS market was roughly split down the middle.

Links For more stories on FIN46, see below. Also see our page on accounting issuesThere is a detailed presentation on FIN 46 on the premium section of our website- click here to join as a premium member. For more on SPEs, click here.

Indonesia sees some securitisation deals

Indonesia is really nowhere in the Asian securitisation map, but if some recent deals are of any indication, it could be a welcome addition to the league of Asian nations that are going gung-ho on securitisation.

Rob Davies of Financeasia.com reports that news has emerged from Jakarta of two potential transactions by state-owned organisations. Pertamina, the oil and gas giant, and Bank Negara Indonesia (BNI), the largest publicly traded bank in Indonesia, have both held roadshows for potential ABS deals in the last couple of months, where both foreign and local houses have been invited to pitch in.

These deals will be the first one over the last 5 years or so. One of the first Indonesian ABS deals was when PT Astra International in August 1996 securitised auto loans with a $200 million issue backed via Barclays Capital. The currency crisis of 1997 punctured the Indonesian economy and so also the securitisation activity which has never picked up since then, except for the relieving news above.

Links For more on Indonesia, see our country page here.

FIN 46 forcing US firms to restructure SPEs

As major US financial and non-financial firms make disclosures about the possible impact of the new accounting interpretation on consolidation of SPEs, SPE structures seem to be heading for changes which will possibly prevent their consolidation with their putative parents.

For instance, JP Morgan Chase is associated with several SPEs for traditional asset-backed and mortgage backed securities, which, it holds, will not require consolidation since they are structured as QSPEs under FAS 140. However, the multiseller ABCP conduits do not so quality, and may be regarded as variable interest entities. "The Firm is analyzing restructuring options for the multi-seller conduits". Similarly Citigroup has entities which may be regarded as variable interest entities and their consolidation could bring back on the balance sheet as much as USD 55 billion of assets – but it is considering restructuring options.

At least some of them, like General Electric, are holding the view that "The complexity of the new consolidation rules and their evolving clarification make forecasting [their] effect impracticable." Even GE sees the restructuring possibility: "It is also clear that many alternative structures for sales of financial assets would continue to be reported as sales under FIN 46 with the assets qualifying for sale not consolidated. We are evaluating whether characteristics of those structures can cost-beneficially be applied to our arrangements before the July 1 effective date. "

Links For more on accounting for SPEs, see our page here. For more on SPEs, see our page here.

Canadian ruling affirms securitization true sale

In an extremely well-reasoned ruling, the Supreme Court of Justice of Ontario, Canada has given a ruling on the truth of the sale of receivables in a securitization transaction. The significance of the ruling lies in the fact that the Court had benefited itself from leading cases on both sides of the Atlantic. This ruling might be the reference point for future disputes on true sale all over the World.

The ruling in a case called BC Tel has analysed various factors such as the extent of recourse, retention of risks/rewards by the originator, continuation of servicing by the originator etc. The ruling concluded that if the intent of the transaction is visibly a transfer of assets by the originator, the transaction would be treated as such.

The ruling reviews caselaw in USA as well as UK.

Links For more on true sale, see our page here.