Securitisation: Indian market grows amidst global volume contraction

Timothy Lopes, Manager

finserv@vinodkothari.com

Global Securitisation Volumes, 2022

The global securitisation market in 2022[1] saw a decline in volumes as compared to record issuance volumes seen in the year 2021. The decline was mainly driven by 24% year-on-year decline in volumes in the United States, obviously because of inflation, general economic conditions and low level of business confidence,  coupled with supply chain disruptions and uncertainty caused by the Russia-Ukraine conflict[2].

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Resurgence of synthetic securitisations: Capital-relief driven transactions scale new peaks

Resurgence of synthetic securitisations: Capital-relief driven transactions scale new peaks – Vinod Kothari | vinod@vinodkothari.com [Revised March 2022] Balance sheet synthetic securitisations, apparently aimed at capital relief and economic capital management, have scaled new peaks in the European market. In the US market, credit risk transfer transactions have registered substantial traction in the RMBS space. […]

Global Securitisation Markets in 2021: A Robust Year for Structured Finance

-Subhojit Shome, Executive | finserv@vinodkothari.com

Overview

The structured finance space exhibited robust growth during 2021, as the world entered the COVID-19 endemic period. This growth was largely driven by supportive regulatory and policy initiatives aimed at overcoming the negative economic effects of the pandemic, the emergence of green finance initiatives and a general rise in economic activity.

Figure 1: Snapshot of Global Structured Finance Issuance[1]
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15th Securitisation School

Register your interests today! – https://forms.gle/iXbCWFJDAkQ3HJuW7

We are also organising the 10th edition of the Securitisation Summit, an annual coming together of stakeholders in structured finance industry in India. The event will be held in physical as well as virtual mode on 27th May, 2022.
Read more: https://vinodkothari.com/secsummit/


Further, we are also organising a Pre-Summit Workshop on Securitisation and Transfer of Loans in Mumbai, a day before the Summit i.e. on 26th May, 2022. The workshop is intended to act as a refresher on the securitisation market in India.
Read more: https://vinodkothari.com/2022/02/pre-summit-workshop/

Our resources on the topic:

After 15 years: New Securitisation regulatory framework takes effect

-Financial Services Division (finserv@vinodkothari.com)

[This version dated 24th September, 2021. We are continuing to develop the write-up further – please do come back]

On September 24, 2021, the RBI released Master Direction – Reserve Bank of India Securitisation of Standard Assets) Directions, 2021 (‘Directions’)[1]. The same has been released after almost 15 months of the comment period on the draft framework issued on June 08, 2020[2]. This culminates the process that started with Dr. Harsh Vardhan committee report in 2019[3].

It is said that capital markets are fast changing, and regulations aim to capture a dynamic market which quite often leads the regulation than follow it. However, the just-repealed Guidelines continued to shape and support the securitisation market in the country for a good 15 years, with the 2012 supplements mainly incorporating the response to the Global Financial Crisis (GFC). Read more

Global securitization enroute to pre-Covid heights

– Abhirup Ghosh (abhirup@vinodkothari.com)

The pandemic disrupted life economies across the globe, and so did it to securitization transactions. However, increase in vaccinations across the globe has had a positive impact on the most of the structured finance markets world-wide, but potential new variants continue to be a threat.

This write-up reviews the performance of securitization across the major jurisdictions.

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EASE OF RECOVERY FOR NBFCS?

–  Ministry of Finance relaxes the criteria for NBFCs to be eligible for enforcing security interest under SARFAESI

-Richa Saraf (richa@vinodkothari.com)

 

The Ministry of Finance has, vide notification[1] dated 24.02.2020 (“Notification”), specified that non- banking financial companies (NBFCs), having assets worth Rs. 100 crore and above, shall be entitled for enforcement of security interest in secured debts of Rs. 50 lakhs and above, as financial institutions for the purposes of the said Act.

BACKGROUND:

RBI has, in its Financial Stability Report (FSR)[2], reported that the gross NPA ratio of the NBFC sector has increased from 6.1% as at end-March 2019 to 6.3% as at end September 2019, and has projected a further increase in NPAs till September 2020. The FSR further states that as at end September 2019, the CRAR of the NBFC sector stood at 19.5% (which is lower than 20% as at end-March 2019).

To ensure quicker recovery of dues and maintenance of liquidity, the Finance Minister had, in the Budget Speech, announced that the limit for NBFCs to be eligible for debt recovery under the SARFAESI is proposed to be reduced from Rs. 500 crores to asset size of Rs. 100 crores or loan size from existing Rs. 1 crore to Rs. 50 lakhs[3]. The Notification has been brought as a fall out of the Budget.

Our budget booklet can be accessed from the link below:

http://vinodkothari.com/wp-content/uploads/2020/02/Budget-Booklet-2020.pdf

ELIGIBILITY FOR INITIATING ACTION UNDER SARFAESI

To determine the test for eligible NBFCs, it is first pertinent to understand the terms used in the Notification.

The Notification provides that NBFCs shall be entitled for enforcement of security interest in “secured debts”. Now, the term “secured debt” has been defined under Section 2(ze) of SARFAESI to mean a debt which is secured by any security interest, and “debt” has been defined under Section 2(ha) as follows:

(ha) “debt” shall have the meaning assigned to it in clause (g) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993) and includes-

(i) unpaid portion of the purchase price of any tangible asset given on hire or financial lease or conditional sale or under any other contract;

(ii) any right, title or interest on any intangible asset or licence or assignment of such intangible asset, which secures the obligation to pay any unpaid portion of the purchase price of such intangible asset or an obligation incurred or credit otherwise extended to enable any borrower to acquire the intangible asset or obtain licence of such asset.

Further, Section 2(g) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, provides that the term “debt” means “any liability (inclusive of interest) which is claimed as due from any person by a bank or a financial institution or by a consortium of banks or financial institutions during the course of any business activity undertaken by the bank or the financial institution or the consortium under any law for the time being in force, in cash or otherwise, whether secured or unsecured, or assigned, or whether payable under a decree or order of any civil court or any arbitration award or otherwise or under a mortgage and subsisting on, and legally recoverable on, the date of the application and includes any liability towards debt securities which remains unpaid in full or part after notice of ninety days served upon the borrower by the debenture trustee or any other authority in whose favour security interest is created for the benefit of holders of debt securities.”

Therefore, NBFCs having asset size of Rs. 100 crores and above as per their last audited balance sheet will have the right to proceed under SARFAESI if:

  • The debt (including principal and interest) amounts to Rs. 50 lakhs or more; and
  • The debt is secured by way of security interest[4].

EFFECT OF NOTIFICATION:

An article of Economic Times[5] dated 07.02.2020 states that:

“Not many non-bank lenders are expected to use the SARFAESI Act provisions to recover debt despite the Union budget making this route accessible to more such lenders due to time-consuming administrative hurdles as well as high loan ticket limit.”

As one may understand, SARFAESI is one of the many recourses available to the NBFCs, and with the commencement of the Insolvency and Bankruptcy Code, the NBFCs are either arriving at a compromise with the debtors or expecting recovery through insolvency/ liquidation proceedings of the debtor. The primary reasons are as follows:

  • SARFAESI provisions will apply only when there is a security interest;
  • NBFCs usually provide small ticket loans to a large number of borrowers, but even though their aggregate exposure, on which borrowers have defaulted, is substantially high, they will not able to find recourse under SARFAESI;
  • For using the SARFAESI option, the lender will have to wait for 90 days’ time for the debt to turn NPA. Then there is a mandatory 60 days’ notice before any repossession action and a mandatory 30 days’ time before sale. Also, the debtor may file an appeal before Debt Recovery Tribunal, and the lengthy court procedures further delay the recovery.

While the notification seems to include a larger chunk of NBFCs under SARFAESI, a significant question that arises here is whether NBFCs will actually utilise the SARFAESI route for recovery?

 

[1] http://egazette.nic.in/WriteReadData/2020/216392.pdf

[2] https://m.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=952

[3] https://www.indiabudget.gov.in/doc/Budget_Speech.pdf

[4] Section 2(zf) “security interest” means right, title or interest of any kind, other than those specified in section 31, upon property created in favour of any secured creditor and includes-

(i) any mortgage, charge, hypothecation, assignment or any right, title or interest of any kind, on tangible asset, retained by the secured creditor as an owner of the property, given on hire or financial lease or conditional sale or under any other contract which secures the obligation to pay any unpaid portion of the purchase price of the asset or an obligation incurred or credit provided to enable the borrower to acquire the tangible asset; or

(ii) such right, title or interest in any intangible asset or assignment or licence of such intangible asset which secures the obligation to pay any unpaid portion of the purchase price of the intangible asset or the obligation incurred or any credit provided to enable the borrower to acquire the intangible asset or licence of intangible asset.

[5] https://economictimes.indiatimes.com/industry/banking/finance/banking/not-many-nbfcs-may-use-sarfaesi-act-to-recover-loan/articleshow/74012648.cms

Sale assailed: NBFC crisis may put Indian securitisation transactions to trial

-By Vinod Kothari (vinod@vinodkothari.com)

Securitisation is all about bankruptcy remoteness, and the common saying about bankruptcy remoteness is that it works as long as the entities are not in bankruptcy! The fact that any major bankruptcy has put bankruptcy remoteness to challenge is known world-over. In fact, the Global Financial Crisis itself put several never-before questions to legality of securitisation, some of them going into the very basics of insolvency law[1]. There have been spate of rulings in the USA pertaining to transfer of mortgages, disclosures in offer documents, law suits against trustee, etc.

The Indian securitisation market has faced taxation challenges, regulatory changes, etc. However, it has so far been immune from any questions at the very basics of either securitisability of assets, or the structure of securitisation transactions, or issues such as commingling of cashflows, servicer transition, etc. However, sitting at the very doorstep of defaults by some major originators, and facing the spectrum of serious servicer downgrades, the Indian securitisation market clearly faces the risk of being shaken at its basics, in not too distant future.

Before we get into these challenges, it may be useful to note that the Indian securitisation market saw an over-100% growth in FY 2019 with volumes catapulting to INR 1000 billion. In terms of global market statistics, Indian market may now be regarded as 2nd largest in ex-Japan Asia, only after China.

Since the blowing up of the ILFS crisis in the month of September 2018, securitisation has been almost the only way of liquidity for NBFCs. Based on the Budget proposal, the Govt of India launched, in Partial Credit Guarantee Scheme, a scheme for partial sovereign guarantee for AA-rated NBFC pools. That scheme seems to be going very well as a liquidity breather for NBFCs. Excluding the volumes under the partial credit enhancement scheme, securitisation volumes in first half of the year have already crossed INR 1000 billion.

In the midst of these fast rising volumes, the challenges on the horizon seem multiple, and some of them really very very hard. This write up looks at some of these emerging developments.

Sale of assets to securitisation trusts questioned

In an interim order of the Bombay High court in Edelweiss AMC vs Dewan Housing Finance Corporation Limited[2], the Bombay High court has made certain observations that may hit at the very securitisability of receivables.  Based on an issue being raised by the plaintiff, the High Court has directed the company DHFL to provide under affidavit details of all those securitisation transactions where receivables subject to pari passu charge of the debentureholders have been assigned, whether with or without the sanction of the trustee for the debentureholders.

The practice of pari passu floating charge on receivables is quite commonly used for securing issuance of debentures. Usually, the charge of the trustees is on a blanket, unspecific common pool, based on which multiple issuances of debentures are covered. The charge is usually all pervasive, covering all the receivables of the company. In that sense, the charge is what is classically called a “floating charge”.

These are the very receivables that are sold or assigned when a securitisation transaction is done. The issue is, given the floating nature of the charge, a receivable originated automatically becomes subject to the floating charge, and a receivable realised or sold automatically goes out of the purview of the charge. The charge document typically requires a no-objection confirmation of the chargeholder for transactions which are not in ordinary course of business. But for an NBFC or an HFC, a securitisation transaction is a mode of take-out and very much a part of ordinary course of business, as realisation of receivables is.

If the chargeholder’s asset cover is still sufficient, is it open for the chargeholder to refuse to give the no-objection confirmation to another mode of financing? If that was the case, any chargeholder may just bring the business of an NBFC to a grinding halt by refusing to give a no-objection.

The whole concept of a floating charge and its priority in the event of bankruptcy has been subject matter of intensive discussion in several UK rulings[3]. There have been discussions on whether the floating charge concept, a judge-made product of UK courts, can be eliminated altogether from the insolvency law[4].

In India, the so-called security interest on receivables is not really intended to be a security device – it is merely a regulatory compliance with company law rules under which unsecured debentures are treated as “deposits”[5]. The real intent of the so-called debenture trust document is maintenance of an asset cover, which may be expressed as a covenant, even otherwise, in case of an unsecured debenture issuance. The fact is that over the years, the Indian bond issuance market has not been able to come out of the clutches of this practice of secured debenture issuance.

While bond issuance practices surely need re-examination, the burning issue for securitisation transactions is – if the DHFL interim ruling results into some final observations of the court about need for the bond trustee’s NOC for every securitisation transaction, all existing securitisation transactions may also face similar challenges.

Servicer-related downgrades

Rating agencies have recently downgraded two notches from AAA ratings several pass-through certificate transactions of a leading NBFC. The rationale given in the downgrade action, among other things, cites servicer risks, on the ground that the originator has not been able to obtain continuous funding support from banks. While absence of continuing funding support may affect new business by an NBFC, how does it affect servicing capabilities of existing transactions, is a curious question. However, it seems that in addition to the liquidity issue, which is all pervasive, the rating action in the present case may have been inspired by some internal scheme of arrangement proposed by the NBFC in question.

This particular downgrades may, therefore, not have a sectoral relevance. However, what is important is that the downgrades are muddying the transition history of securitisation ratings. From the classic notion that securitisation ratings are not susceptible to originator-ratings, the dependence of securitisation transactions to pure originator entity risks such as internal funding strengths or scheme of arrangement puts a risk which is usually not considered by securitisation investors. In fact, the flight to securitisation and direct assignments after ILFS crisis was based on the general notion that entity risks are escaped by securitisation transactions.

Servicer transitions

The biggest jolt may be a forced servicer transition. In something like RMBS transactions, outsourcing of collection function is still easy, and, in many cases, several activities are indeed outsourced. However, if it comes to more complicated assets requiring country-wide presence, borrower franchise and regular interaction, if servicer transition has to be forced, the transaction will be worse than originator bankruptcy.

Questions on true sale

The market has been leaning substantially on the “direct assignment” route. Most of the direct assignments are seen by the investors are look-alikes and feel-alikes of a loan to the originator, save and except for the true-sale opinion. Investors have been linking their rates of return to their MCLR. Investors have been viewing the excess spread as a virtual credit support, which is actually not allowed as per RBI regulations. Pari-passu sharing of principal and interest is rarely followed by the market transactions.

If the truth of the sale in most of the direct assignment transactions is questioned in cases such as those before the Bombay High court, it will not be surprising to see the court recharacterise the so-called direct assignments as nothing but disguised loans. If that was to happen in one case of a failed NBFC, not only will the investors lose the very bankruptcy-remoteness they were hoping for, the RBI will be chasing the originators for flouting the norms of direct assignment which may have hitherto been ignored by the supervisor. The irony is – supervisors become super stringent in stressful times, which is exactly where supervisor’s understanding is required more than reprimand.

Conclusion

NBFCs are passing through a very strenuous time. Delicate handling of the situation with deep understanding and sense of support is required from all stakeholders. Any abrupt strong action may exacerbate the problem beyond proportion and make it completely out of control. As for securitisation practitioners, it is high time to strengthen practices and realise that the truth of the sale is not in merely getting a true sale opinion.

Other Related Articles:


[1] For example, in a Lehman-related UK litigation called Perpetual Trustees vs BNY Corporate Trustee Services, the typical clause in a synthetic securitisation diverting the benefit of funding from the protection buyer (originator – who is now in bankruptcy) to the investors, was challenged under the anti-deprivation rule of insolvency law. Ultimately, UK Supreme Court ruled in favour of securitisation transactions.

[2] https://www.livelaw.in/pdf_upload/pdf_upload-365465.pdf. Similar observations have been made by the same court in Reliance Nippon Life AMC vs  DHFL.

[3] One of the leading UK rulings is Spectrum Plus Limited, https://www.bailii.org/uk/cases/UKHL/2005/41.html. This ruling reviews whole lot of UK rulings on floating charges and their priorities.

[4] See, for example, R M Goode, The Case for Abolition of the Floating Charge, in Fundamental Concepts of Commercial Law (50 years of Reflection, by Goode)

[5] Or partly, the device may involve creation of a mortgage on a queer inconsequential piece of land to qualify as “mortgage debentures” and therefore, avail of stamp duty relaxation.

Partial Credit Guarantee Scheme

A Business Conclave on  “Partial Credit Guarantee Scheme” was organised by Indian Securitisation Foundation jointly with Edelweiss on September 16,2019 in Mumbai.

On this occasion, the presentation used by Mr. Vinod Kothari is being given here:

http://vinodkothari.com/wp-content/uploads/2019/09/partial-credit-enhancement-scheme-.pdf

 

We have authored few articles on the topic that one might want to give a read. The links to such related articles are provided below: