RBI granted moratorium on term loans: Impact on securitisation and direct assignment transactions

Abhirup Ghosh

abhirup@vinodkothari.com

In response to the stress caused due to the pandemic COVID-19, the regulatory authorities around the world have been coming out relaxations and bailout packages. Reserve Bank of India, being the apex financial institution of the country, came out a flurry of measures as a part of its Seventh Bi-Monthly Policy[1][2], to tackle the crisis in hand.

One of the measure, which aims to pass on immediate relief to the borrowers, is extension of moratorium on term loans extended by banks and financial institutions.  We have in a separate write-up[3] discussed the impact of this measure, however, in this write-up we have tried to examine its impact on the securitisation and direct assignment transactions.

Securitisation and direct assignment transactions have been happening extensively since the liquidity crisis after the failure of ILFS and DHFL, as it allowed the investors to take exposure on the underlying assets, without having to take any direct exposure on the financial intermediaries (NBFCs and HFCs). However, this measure has opened up various ambiguities in the structured finance industry regarding the fate of the securitisation or direct assignment transactions in light of this measure.

Originators’ right to extend moratorium

The originators, will be expected to extend this moratorium to the borrowers, even for the cases which have been sold the under securitisation. The question is, do they have sufficient right to extend moratorium in the first place? The answer is no. The moment an originator sells off the assets, all its rights over the assets stands relinquished. However, after the sale, it assumes the role of a servicer. Legally, a servicer does not have any right to confer any relaxation of the terms to the borrowers or restructure the facility.

Therefore, if at all the originator/ servicer wishes to extend moratorium to the borrowers, it will have to first seek the consent of the investors or the trustees to the transaction, depending upon the terms of the assignment agreement.

On the other hand, in case of the direct assignment transactions, the originators retain only 10% of the cash flows. The question here is, will the originator, with 10% share, be able to grant moratorium? The answer again is no. With just 10% share in the cash flows, the originator cannot alone grant moratorium, approval of the assignee has to be obtained.

Investors’ rights

As discussed above, extension of moratorium in case of account sold under direct assignment or securitisation transactions, will be possible only with the consent of the investors. Once the approval is placed, what will happen to the transactions, as very clearly there will be a deferral of cash flows for a period of 3 months? Will this lead to a deterioration in the quality of the securitised paper, ultimately leading to a rating downgrade? Will this lead to the accounts being classified as NPAs in the books of the assignee, in case of direct assignment transactions?

Before discussing this question, it is important to understand that the intention behind this measure is to extend relief to the end borrowers from the financial stress due to this on-going pandemic. The relief is not being granted in light of any credit weakness in the accounts. In a securitisation or a direct assignment, the transaction mirrors the quality of the underlying pool. If the credit quality of the loans remain intact, then there is no question of the securitisation or the direct assignment transaction going bad. Similarly, we do not see any reason for rating downgrade as well.

The next question that arises here is: what about the loss of interest due to the deferment of cash flows? The RBI’s notification states that the financial institutions may provide a moratorium of 3 months, which basically means a payment holiday. This, however, does not mean that the interest accrual will also be suspended during this period. As per our understanding, despite the payment suspension, the lenders will still be accruing the interest on the loans during these 3 months – which will be either collected from the borrower towards the end of the transaction or by re-computing the EMIs. If the lenders adopt such practices, then it should also pass on the benefits to the investors, and the expected cash flows of the PTCs or under the direct assignment transactions should also be recomputed and rescheduled so as to compensate the investors for the losses due to deferment of cash flows.

Another question that arises is – can the investors or the trustee in a securitisation transaction, instead of agreeing to a rescheduling of cash flows, use the credit enhancement to recover the dues during this period? Here it is important to note that credit enhancements are utilised usually when there is a shortfall due to credit weakness of the underlying borrower(s). Using credit enhancements in this case, will reduce the extent of support, weaken the structure of the transaction and may lead to rating downgrade. Therefore, this is not advisable.

We were to imagine an extreme situation – can the investors force the originators to buy back the PTCs or the pool from the assignee, in case of a direct assignment transaction? In case of securitisation transactions, there are special guidelines for exercise of clean up calls on PTCs by the originators, therefore, such a situation will have to be examined in light of the applicable provisions of Securitisation Guidelines. For any other cases, including direct assignment transactions, such a situation could lead up to a larger question on whether the original transaction was itself a true sale or not, because, a buy-back of the pool, defies the basic principles of true sale. Hence, this is not advisable.

[1]https://rbidocs.rbi.org.in/rdocs/Content/PDFs/GOVERNORSTATEMENT5DDD70F6A35D4D70B49174897BE39D9F.PDF

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11835&Mode=0

[3] http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

Moratorium on loans due to Covid-19 disruption

Team Financial Services, Vinod Kothari Consultants P Ltd. 

finserv@vinodkothari.com 

This version dated 14th April, 2020. We shall continue to develop this further based on the text of notification and the clarifications, if any, issued by the RBI.

We are also gratefully obliged to see that the page has received attention and comments from several borrowers. We submit, humbly, that the page is primarily for guidance of lenders.]

To address the stress in the financial sector caused by COVID-19, several measures have been taken by the RBI as a part of its Seventh Bi-monthly Policy[1]. Further, the RBI has come up with a Notification titled COVID 19 package[2]. These measures are intended to mitigate the burden on debt-servicing caused due to disruptions on account of COVID-19 pandemic. These measures include moratorium on term loans, deferring interest payments on working capital and easing of working capital financing. We have tried to provide our analysis of the measures taken by RBI in form of the following FAQs.

Further, in this regard the Ministry of Finance has also issued FAQs on RBI’s scheme for a 3-month moratorium on loan repayment.

Legal/contractual nature of the Moratorium

1.     Has the RBI granted a compulsory moratorium?

No, the lending institutions have been permitted to allow a moratorium of three months. This is a relaxation offered by RBI to the lending institutions. Neither is it a guidance by the RBI to the lenders, nor is it a leeway granted by the RBI to the borrowers to delay or defer the repayment of the loans. Hence, the moratorium will actually have to be granted by the lending institution to the borrowers. The RBI has simply permitted the lenders to grant such moratorium.

2.     Who are the lending institutions covered by the moratorium requirement?

All commercial banks (including regional rural banks, small finance banks and local area banks), co-operative banks, all-India Financial Institutions, and NBFCs (including housing finance companies and micro-finance institutions) have been permitted to allow the moratorium relaxation to its borrowers.

3A.     Is this the first time such a moratorium or relaxation has been granted by the RBI?

During the demonetisation phase in November 2016, a 60 day relaxation was offered to small borrowers accounts for recognition of an asset as sub-standard. Our detailed analysis on the same can be viewed here- http://vinodkothari.com/wp-content/uploads/2017/03/Interpreting_the_2_months_relaxation_for_asset_classification.pdf

3B.      Has there been similar relaxation provided by other jurisdictions across the globe?

India is not the only country to grant a moratorium during this time of crisis. Several other countries have granted a moratorium in varying terms. A table showing the details of moratoriums granted globally may be read here http://vinodkothari.com/2020/04/the-great-lockdown-standstill-on-asset-classification/ 

4.     What is meant by moratorium on term loan?

Moratorium is a sort of granting of a ’holiday’- it is a repayment holiday where the borrower is granted an option to not pay during the moratorium period. It is a restructuring of the terms of the loan with the mutual consent of the lender and the borrower. The consent of the lender will be in the form the lender’s circular or notice – see below. The consent of the borrower may be obtained by a “deemed consent unless declined” option.

For example, in case the instalment falls due on April 01, 2020, and the lender has granted a moratorium of 3 months from a specific date, say April 1, 2020,  then the revised due date for repayment shall be July 1, 2020.

Scope and implementation of the moratorium

5.     From what date can the moratorium be granted?

The lenders are permitted to grant a moratorium of three months on payment of all instalments falling due between March 1, 2020 and May 31, 2020. The intention is to shift the repayment dates by three months. Therefore, the moratorium should start from the due date, falling immediately after 1st March, 2020, against which the payment has not been made by the borrower.

For example, if an instalment was due on 15th March, 2020, but has remained unpaid so far, the lender can impose the moratorium from 15th March, 2020 and in that case, revised due date shall be 15th June, 2020

6.     Will the moratorium be applicable in case of new loans sanctioned after March 1, 2020 during the lockdown period?

Technically, new loans sanctioned after March 1, 2020 are not covered under the press release since it mentioned about loans outstanding as on March 1, 2020. However, based on the RBI circular it can be inferred that the Lending Institution may at its own discretion extend the benefit to such borrowers in case the loan instalments of such new loans are falling due between March 1, 2020 and May 31, 2020.

7.     Is the moratorium on principal or interest or both?

The repayment schedule and all subsequent due dates, as also the tenor for loans may be shifted by three months (or the period of moratorium granted by the lending institution). Instalments will include payments falling due from March 1, 2020 to May 31, 2020 in the form of-

(i) principal and/or interest components;

(ii) bullet repayments;

(iii) Equated Monthly instalments;

(iv) credit card dues.

8A.     What shall be the moratorium period?

Lending Institutions may use their discretion to allow a moratorium of upto three months. It is not necessary to provide a compulsory moratorium of three months- it can be less than three months as well. Practically, we envisage that all lenders shall grant a moratorium to all borrowers across board for 3 months.

However, a moratorium beyond three months shall be considered as restructuring of loan.

8B.   Can NBFCs grant extensions for loans where the last EMI falls due after May 31st?

The Covid-19 Regulatory Package issued by RBI has allowed the grant of moratorium to only those instalments that are falling due between March 1, 2020 and May 31, 2020. However, considering the disruption caused across the globe, the Company may consider extension of the EMI dates for installments falling due after May 31, 2020.
The reason for granting such relaxation is not related to any specific borrower’s financial difficulty because of any economic or legal reasons. The reason for such relaxation would be the disruption caused across an entire class of borrower and not any individual borrower. Hence, this would not be considered as restructuring and will not require any asset classification downgrade.

9.     Reading the language of the RBI Notification strictly, it says: “lending institutions” are permitted to grant a moratorium of three months on payment of all instalments1 falling due between March 1, 2020 and May 31, 2020. [Para 2]. The notification nowhere refers to the payments which had already fallen due before March 1. Therefore, will those payments continue to age during the moratorium period? For example, will something which is 30 DPD will become 120 DPD?

As per the contents of the letter dated March 31, 2020 written by RBI to IBA, any amount which was overdue on 29th Feb, 2020, there is no moratorium with respect to those amounts, and therefore, the existing IRAC norms will continue to apply. The RBI contends that there was no disruption in February, and therefore, one cannot bring disruption as the basis for not paying what had fallen due before March 1.

However, in our view, such an interpretation will be completely counter-intuitive. The whole intent behind the moratorium is the disruption in the system due to an externality. If the borrower had an instalment which was 30 days past due on 1st March, it cannot be contended that he will have difficulty in paying his current dues but will have no difficulty in paying what had already become due. But for the systemic disruption, it could well have been that the borrower would have cleared all his dues.

The meaning of the moratorium is that payments do not fall due during the period of the moratorium – whether current or past. Therefore, the moratorium period cannot result into ageing of the past dues. Of course, if the past dues are an overdue rate, the overdue rate may continue. But for the purpose of counting DPD, the moratorium period will have to be excluded.

Taking any other interpretation will frustrate the very purpose of the moratorium. By rules of appropriation, whatever the borrower pays between March 1 and May 31 would have first gone towards clearing his overdues. Hence, a moratorium on the current dues should apply to the existing dues as well.

There has been a ruling of the Delhi High court in Anantraj Limited vs Yes Bank order dated 6th April, 2020 in response to a writ petition, where the court has also stated that there will be no transformation of a standard account into an NPA, since before an account becomes an NPA, it has to pass through SMA 1 and SMA 2, and as per RBI’s own admission, there will be no downgradation  of the status due to the moratorium. In essence, the Delhi High court seems to be holding the same view as expressed by us above. Our analysis of the judgement can be read here- http://vinodkothari.com/2020/04/moratorium-on-asset-classification-of-past-due-accounts/

10. How will the moratorium impact the existing loan tenure?

In case a moratorium is granted, the RBI circular states that the repayment schedule for such loans as also the residual tenure, will be shifted across by three months after the moratorium period.

However, in certain cases of long tenure loans (say, home loans), the additional burden on the borrower due to the accrued interest (and interest on such interest) would cause the amount to swell so much that paying the accumulated interest in one go may not be feasible. This may require the lender to convert the accrued interest also into instalments. Converting such accrued interest into manageable instalments is the lender’s prudential call, and should not be taken as a case of restructuring, since the total tenure is going beyond 3 months over the original term.

11. Will the interest accrue during the moratorium period?

Yes, the moratorium is a ‘payment holiday’ however, the interest will definitely accrue. The accrual will not stop.

12. Will there be delayed payment charges for the missing instalments during the moratorium period?

Overdue interest is charged in case of default in payment. However, during the moratorium, the payment itself is contractually stopped. If there is no payment due, there is no question of a default. Therefore, there will be no overdue interest or delayed payment charges to be levied.

13. Which all loans shall be considered eligible for the relaxation?

All term loans outstanding as on March 1, 2020 are eligible to claim the relaxation. Also, there may be a deferment of interest in case of working capital facilities sanctioned in the form of cash credit/overdraft and outstanding as on March 1, 2020.

14. Is the moratorium applicable to the following:

(a)  Personal loans

The moratorium is applicable to all term loans and working capital facilities (refer para 5 and 6 of the Statement on Developmental and Regulatory Policies). Therefore, the lender may extend the benefit of the moratorium or deferment of interest to lending facilities in the nature of term loans as well as revolving lines of credit, a.k.a. working capital facilities, as the case may be.

(b)  Overdraft facilities

Overdraft facilities allow the account-holder to withdraw more money than what is held in the account. It is a kind of short-term loan facility, which the account-holder shall be required to repay within a specified period of time or at once, depending on the terms of arrangement with the bank. Thus, in case repayment is to be made within a specified tenure , the same qualifies to be term-loan and moratorium shall be applicable on EMIs of such overdraft facility.

(c) An unsecured personal loan extended by a lender through prepaid cards for making payments at partner merchant PoS

Such unsecured personal loans may be repayable in the form of EMIs or a bullet repayment. As discussed above, if repayment is made over a period of time, moratorium is applicable. In case of bullet repayments as well, moratorium may be granted.

(d) Invoice financing

Invoice financing can be of 2 types- (a) Factoring and (b) Asset-based invoice financing.

In case of factoring, the factor purchases the receivables of an entity and pays the amount of receivables reduced by a certain percentage (factoring fee) to the entity. Thereafter, the factor is responsible to recover the money from the debtor of such entity. There is no moratorium in case of commercial invoices.

Another device commonly used is invoice financing i.e. asset-based invoice financing, which  allows a vendor to avail a credit facility  against the security of receivables. Since the underlying here is the commercial receivable, for which there is no moratorium, the same is not covered by the moratorium as being discussed.

(e) Payday loans

Payday loans are unsecured personal credit facilities obtained by salaried individuals against their upcoming pay-cheques. The amount of such facilities is usually limited to a certain part of the borrower’s upcoming salary.

In case of such loans, the repayment term, though very short, is pre-determined and is payable from out of the salary of the individual. As there is no deferral of salary payments, we are of the view that there is no case of disruption here.

(f) Loan against turnover

These loans are extended by the lenders on the basis of expected turnover of a merchant, mostly on e-commerce websites. The intent is to finance the day-to-day business needs of the borrower in order to attain the expected turnover. Thus, such loans are essentially working capital loans. As already discussed, moratorium may be allowed on working capital loans.

(g) Long-term loans

These kinds of loans have a pre-specified term, which is usually greater than 3 years. Needless, to say, being term loans, moratorium shall be allowed on such loans. Such loans are usually secured and may cover the following kinds of loans:

  • Housing loans
  • Equipment finance loans
  • Personal loans
  • Two-wheeler loans
  • Auto-finance loans

(h) Gold loans

The applicability of the Notification to gold loans is quite interesting. Most gold loans have a bullet repayment term. In addition, some gold loans induce a customer to make payment of interest on a regular basis, and offer a concessional rate of interest should the customer pay interest on a regular basis. The following situations may explain the applicability of the Notification to gold loans:

  • If the bullet repayment is due during the Moratorium period, the loan will be eligible for the moratorium, and the borrower may make the bullet repayment at the end of the moratorium period.
  • If the bullet repayment is due after the Moratorium period, the moratorium has no impact on the loan. There is no question of any extension of the loan term, as there were no payments due during the disruption period.
  • If there is interest payment during the moratorium period, and the customer has opted for the same, the customer will get holiday from the interest payment during the moratorium period, and the customer will still be eligible for the lower rate of interest.

15. How will the moratorium be effective in case of working capital facilities?

The working capital facilities have been allowed a deferment of three months on payment of interest in respect of all such facilities outstanding as on March 1, 2020. The accumulated interest for the period will be paid after the expiry of the deferment period.

16. Is it possible for the Lender to not provide a moratorium?

Technically, certainly yes. However, borrowers may take advantage of the Ministry of Law circular that the COVID disruption is a case of “force majeure” and FMC does not result in a contractual breach. Hence, lenders will be virtually forced into granting the same.

17. Is the lending institution required to grant the moratorium to all categories of borrowers?

Since the grant of the moratorium is completely discretionary, the lending institution may grant different moratoriums to different classes of borrowers based on the degree of disruption on a particular category of borrowers. However, the grant of the moratorium to different classes of borrowers should be making an intelligible distinction, and should not be discriminatory.

18. Can the lender revise the interest rate while granting extension under the moratorium?

The intent of the moratorium is to ensure relaxation to the borrower due to the disruption caused. However, increase in interest rate is not a relief granted and hence should not be practised as such.

19. Can the moratorium period be different for different loans of the same type? For example, a lender grants a moratorium of 3 months for all loans which are 60-89 DPD, and a moratorium of 2 months for all loans which are 30 -59 DPD as on the effective date.

The moratorium is essentially granted to help the borrowers to tide over a liquidity crisis caused by the corona disruption. In the above example, the scheme seems to be to get over a potential NPA characterisation, which could not be the intent of the relaxation.

20. Will the grant of different moratorium periods be regarded as discrimination by the NBFC?

An NBFC may assess where the disruption is likely to adversely impact the repayment capacity of the borrower and take a call based on such assessment. For example in case of farm sector borrowers and daily wage earners, the disruption will be maximum. However, a salaried employee may not be facing any impact on their repayment capacity.

21. Can a borrower prevail upon a lending institution to grant the moratorium, in case the same has not been granted the lending institution?

The grant of the moratorium is a contractual matter between the lender and the borrower. There is no regulatory intervention in that contract.

22. Can the borrower pay in between the moratorium period?

It is a relief granted to the borrower due to disruption caused by the sudden lockdown. However, the option lies with the borrower to either repay the loan during this moratorium as per the actual due dates or avail the benefit of the moratorium.

23. Will such payment be considered as prepayment?

This will not be considered as prepayment and there will not be any prepayment penalty on the same.

24. Is the moratorium applicable to financial lease transactions?

Financial leases are akin to loan transactions and have rental payouts similar to EMIs in case of a term loan. Hence, lessors under a financial lease may confer the benefit of the moratorium under the RBI circular.

25. Is the moratorium applicable to operating lease transactions?

Operating leases are not considered as financial transactions and hence, they shall not be covered under the RBI circular for granting moratorium. However, lessors may, in their wisdom, grant the benefit of moratorium. Note that the NPA treatment in case of operating leases is not the same as in case of loans.

Refer to our various articles on leasing here.

26. A loan was in default already as on 1st March, 2020. The lender has various security interests – say a mortgage, or a pledge. Will the lender be precluded from exercising security interest during the holiday period?

The moratorium is only for what instalments/payments were due from 1st March 2020 upto the period of moratorium conferred by the lender (so, 31st May, in case of a 3 month moratorium). The same does not affect payment obligations that have already fallen due before 1st March. Hence, if there was a default, and there were remedies available to the lender as on 1st March already, the same will not be affected.

 

However, note that for using the powers under the SARFAESI Act, the facility has to be characterised as non-performing. Unless the facility was already a non-performing loan, the intervening holiday will defer the NPA categorisation. In that case, the use of SARFAESI powers will be deferred until NPA categorisation happens.

Modus operandi for giving effect to the moratorium

27. What are the actionables required to be taken by the lending institution to grant the moratorium?

The RBI Notification dated 27th March, 2020, para 8 mentions about a board-approved policy. Accordingly, the lending institution may put in place a policy. The Policy should provide maximum facility to the concerned authority centre in the hierarchy of decision-making so that everything does not become rigid. For instance, the extent of moratorium to be granted, the types of asset classes where the moratorium is to be granted, etc., may be left to the relevant asset managers.

Further, the instructions in the notification must be properly communicated to the staff to ensure its implementation.

You may refer to the list of actionables here.

28. The RBI has mentioned about a Board-approved policy. Obviously, under the present scenario, calling of any Board-meeting is not possible. Hence, how does one implement the moratorium?

Please refer to our article here as to how to use technology for calling board meetings.

29. In case the lender intends to extend a moratorium, will it require consent of the borrower and confirmation on the revised repayment schedule?

Based on the policy adopted by the lending institution, the moratorium may be extended to all borrowers or only those who approach the lender in this regard. However, the revised terms must be communicated to the borrower and the acceptance must be recorded.

An option may be provided to the borrower for opting the moratorium. In case the borrower fails to respond or remains silent, it may be considered as deemed confirmation on the moratorium. In case of acceptance by the borrower to opt for moratorium, including deemed acceptance, the revised terms shall be shared which should be accepted by the borrower- either electronically or such other means as per the respective lending practice. Further, the PDC or NACH should not be presented for encashment as per the existing terms.

However, in case the borrower has not opted for the moratorium by his action or otherwise has expressly denied the option, the PDC and NACH shall be encashed as per the existing terms and necessary action can be initiated by the lender in case of dishonour.

30. Is the lender required to obtain fresh PDCs and NACH debit mandates from the borrowers?

An option may be provided to the borrower for opting the moratorium. In case the borrower fails to respond or remains silent, it may be considered as deemed confirmation on the moratorium. In such a case the PDC or NACH should not be presented for encashment as per the existing terms.

However, in case the borrower has not opted for the moratorium by his action or otherwise has expressly denied the option, the PDC and NACH shall be encashed as per the existing terms and necessary action can be initiated by the lender in case of dishonour.

31. In case the payment has been made by a borrower for the installment due for the month of March 2020, does the lender need to refund the same?

The payments already received may not be considered for the purpose of passing the moratorium relaxation. The lenders have their discretion, but appropriately, these payments may either be regarded as payment of principal as on 1st March, 2020, duly discounted for the time lag between 1st March and the actual repayment date, or the payment already made by the borrower may just be excluded from the moratorium. For example, if the payments fell due on 7th March, and by 15th March, 80% of the payments have already been made, the same may just be excluded from the holiday, thereby granting holiday only for the  payments due on 15th April and 15th May.

NPA classification and restructuring

32. What will be the impact on the NPA classification on the following loans:

  1. Standard as on March 1, 2020
  2. NPA as on March 1, 2020
  3. Showing signs of distress as on March 1, 2020

In case of standard loan, the moratorium period will not be considered for computing default and hence, it will not result in asset classification downgrade. Our views in this regard have been discussed elaborately above.

As per the FAQs issued by the MoF, it is clear that the benefit of moratorium is available to all such accounts, which are standard assets as on 1st March 2020. Hence, loans already classified as NPA shall continue with further asset classification deterioration during the moratorium period in case of non-payment.

In case of assets showing signs of distress as on March 1, 2020, the moratorium may still be extended since they are classified as standard asset. Further, the asset classification of account which has been classified as SMA should not further be classified as a NPA in case the installment is not paid during the moratorium period and the classification as SMA should be maintained. [Refer our detailed response in Q9 above]

33. Effectively, are we saying the grant of the moratorium is also a stoppage of NPA classification?

The RBI contends that there was no disruption in February, and therefore, one cannot bring disruption as the basis for not paying what had fallen due before March 1. The benefit of the moratorium is not applicable for the amounts which were already past due before March 01, 2020..

34. Is grant of moratorium a type of restructuring of loans?

The moratorium/deferment is being provided specifically to enable the borrowers to tide over the economic fallout from COVID-19. Hence, the same will not be treated as change in terms and conditions of loan agreements due to financial difficulty of the borrowers.

35. What will be the impact on the loan tenure and the EMI due to the moratorium?

Effectively, it would amount to extension of tenure. For example, if a term loan was granted for  a period of 36 months on 1st Jan 2020, and the lender grants a 3 months’ moratorium, the tenure effectively stands extended by 3 months – so it becomes 39 months how.

Since there is an accrual of interest during the period of moratorium, the lender will have to either increase the EMIs (that means, recompute the EMI on the accreted amount of outstanding principal for the remaining number of months), or change the last EMI so as to compensate for the accrual of interest during the period of the moratorium. Since changing of EMIs have practical difficulties (PDCs, standing instructions, etc.), it seems that the latter approach will be mostly used.

36. How will the deferment of interest in the case of working capital facilities impact the asset classification?

Recalculating the drawing power by reducing margins and/or by reassessing the working capital cycle for the borrowers will not result in asset classification downgrade.

The asset classification of term loans which are granted relief shall be determined on the basis of revised due dates and the revised repayment schedule.

37. Will the delayed payment by the borrower due to the moratorium have an impact on its CIBIL score?

The moratorium on term loans, the deferring of interest payments on working capital and the easing of working capital financing will not qualify as a default for the purposes of supervisory reporting and reporting to credit information companies (CICs) by the lending institutions. Hence, there will be no adverse impact on the credit history of the beneficiaries.

Impact of moratorium on corporate borrowers

37A. What will be the impact of the moratorium on the corporate borrowers? If the corporate borrower is having a secured loan with the bank, and due to the moratorium, the tenure gets extended, is it a case of modification requiring “modification of charge” within the meaning of the Companies Act? 

Answer should be in the negative, for the following reasons:

  1. 79 provides for “modification in the terms or conditions or the extent or operation of any charge”. There is no modification in the terms of the charge, or the extent or operation of the charge. The charge is on the same property; the exposure amount also does not change by the very fact of the moratorium.
  2. The modification is not a result of a unique transaction between the lender and the borrower, which needs to be publicly intimated. The moratorium is the result of an external event, which the public at large is expected to be aware of.
  3. The moratorium is not a case of restructuring of the debt that requires any kind of regulatory reporting by the borrower. The moratorium is the result of a force majeure event.

Taking the view that the resulting extension of tenure is a case of moratorium will make thousands of borrowers file modification, which is both perfunctory and unnecessary.

37B. Under Part A of Schedule III of LODR Regulations, a corporate debt restructuring is to be deemed to be a material event requiring reporting to the stock exchanges. Is the moratorium-related restructuring a case of corporate debt restructuring? 

Answer should be negative once again. This restructuring is not a result of a credit event. It is result of a force majeure.

Impact of the Moratorium on accounting under IndAS 109

38. Where there are no repayments during the moratorium period, is it proper to say that the loan will be taken to have “defaulted” or there will be credit deterioration, for the purposes of ECL computation?

The provisions of para 5.5.12 of the IndAS 109 are quite clear on this. If there has been a modification of the contractual terms of a loan, then, in order to see whether there has been a significant increase in credit risk, the entity shall compare the credit risk before the modification, and the credit risk after the modification. Sure enough, the restructuring under the disruption scenario is not indicative of any increase in the probability of default.

39. There are presumptions in para B 5.5.19 and 20 about “past due” leading to rebuttable presumption about credit deterioration. What impact does the moratorium have on the same?

The very meaning of “past due” is something which is not paid when due. The moratorium amends the payment schedule. What is not due cannot be past due.

40. Will the effective interest rate (EIR) for the loan be recomputed on account of the modification of tenure?

The whole idea of the modification is to compute the interest for the deferment of EMIs due to moratorium, and to compensate the lender fully for the same. The IRR for the loan after restructuring should, in principle, be the same as that before restructuring. Hence, there should be no impact on the EIR.

41. What will be the impact of the moratorium for accounting for income during the holiday period?

As the EIR remains constant, there will be recognition of income for the entire Holiday period. For example, for the month of March, 2020, interest will be accrued. The carrying value of the asset (POS) will stand increased to the extent of such interest recognised. In essence, the P/L will not be impacted.

42. If the moratorium is a case of “modification of the financial asset”, is there a case for computing modification gain/loss?

As the EIR remains constant, the question of any modification gain or loss does not arise.

43. Does the “modification of the financial asset”call for impairment testing?

The contractual modification is not the result of a credit event. Hence, the question of any impairment for this reason does not arise.

Impact in case of securitisation transactions

44. There may be securitisation transactions where there are investors who have acquired the PTCs. The servicing is with the originator. Can the originator, as the servicer, grant the benefit of the moratorium? Any consent/concurrence of the trustees will be required? PTC holders’ sanction is required?

Servicer is simply a servicer – that is, someone who enforces the terms of the existing contracts, collects cashflows and remits the same to the investors. Servicer does not have any right to confer any relaxation of terms to the borrowers or restructure the facility.

While the moratorium may not amount to restructuring but there is certainly an active grant of a discretionary benefit to the borrowers. In our view, the servicer by himself does not have that right. The right may be exercised only with appropriate sanction as provided in the deed of assignment/trust deed – either the consent of the trustees, or investor’ consent.

45. Irrespective of whether the moratorium is granted with the requisite consent or not, there may be some missing instalments or substantial shortfall in collections in the months of April, May and June. Is the trustee bound to use the credit enhancements (excess spread, over-collateralisation, cash collateral or subordination) to recover these amounts?

As we have mentioned above, the grant of the moratorium by the servicer will have to require investor concurrence or trustee consent (if the trustee is so empowered under the trust deed/servicing agreement). Assuming that the investors have given the requisite consent (say, with 75% consent), the investors’ consent may also contain a clause that during the period of the moratorium, the investors’ payouts will be deemed “paid-in-kind” or reinvested, such that the expected payments for the remaining months are commensurately increased.

This will be a fair solution. Technically, one may argue that the credit enhancements may be exploited to meet the deficiency in the payments, but utilisation of credit enhancements will only reduce the size of the support, and may cause the rating of the transaction to suffer. Therefore, investors’ consent may be the right solution.

Impact in case of direct assignment transactions

46. There may be direct assignment transactions where there is an assignee with 90% share, and the assignor has a 10% retained interest. Can the assignor/originator, also having the servicer role, grant the benefit of the moratorium? Any consent/concurrence of the assignee will be required?

In our view, the 10% retained interest holder cannot grant the benefit without the concurrence of the 90% interest holder.

47. What will be the impact of the moratorium on the assignee?

Once again, as in case of securitisation transactions, if the grant of the moratorium takes place with assignee consent, the assignee may agree to give the benefit to the borrowers. In that case, the assignee does not have to treat the loans as NPAs merely because of non-payment during the period of the moratorium.

Impact in case of co-lending transactions

48. In case of a co-lending arrangement, can the co-lenders grant differential benefit of the moratorium?

Since the grant of moratorium is discretionary, the co-lenders may intend to grant different moratorium periods to the same borrower. However, that could lead to several complications with respect to servicing, asset classification etc. Hence, it is recommended that all the parties to the co-lending arrangement should be in sync.

 

 

[1] https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR21302E204AFFBB614305B56DD6B843A520DB.PDF

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11835&Mode=0


Our other write-ups relating to covid-19 disruption can be read here- http://vinodkothari.com/covid-19-incorporated-responses/

Other write-ups on NBFCs can be read here- http://vinodkothari.com/nbfcs/

Is capital relief allowed for on-balance sheet securitisations?

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Non-Banking Financial Companies (NBFCs) have been actively involved in the securitisation market, being one of its major participants at the originating as well as investing front. One of the key motivation of a securitisation transaction is its ability to take the loans off the books of the originator, thereby extending capital relief.

Until the implementation of IFRS or Ind AS in the Indian financial sector, the de-recognition of financial assets from the books of financial institutions was pretty simple; however, with complex conditions for de-recognition under Ind AS 109, almost all securitisation transactions now fail to qualify for de-recognition.

This leads to the key question of whether capital relief will still be available, despite the transactions failing de-recognition test under Ind AS. Through this write-up we intend to explore and address this question.

Situation prior to Ind-AS

Prior to the implementation of Ind-AS, there was no accounting guidance with respect to de-recognition of the financial assets from the books of the financial institutions. However, it was a generally accepted accounting principle that if the transaction fulfilled the true sale condition, then the assets were eligible to go off the books.

The true sale condition came from the RBI Guidelines on Securitisation[1]. The off-balance sheet treatment of the assets led to capital relief for the financial institutions. However, the Guidelines requires knock off, to the extent of credit enhancement provided, from the capital (Tier 1 and Tier 2) of the financial institution.

Post Ind-AS scenario

One of the key highlights of the IFRS 9 or Ind AS 109 is the introduction of the de-recognition criteria for financial instruments. Under Ind AS, a financial asset can be put off the books, only when there is a transfer of substantially all risks and rewards arising out of the assets. This, however, is difficult to prove for the transactions that take place in India because most of the structures practiced in India have high level of first loss credit support from the originators, therefore, evidencing high level of risk retention in the hands of the originator.

As a result, the transactions fail to satisfy the de-recognition test and the financial assets do not go off the books of the financial institutions.

This raises another concern with respect to maintenance of regulatory capital, since the assets are not de-recognized as per accounting standards, although backed by a legal true sale opinion. The apprehension here is whether capital relief would still be available in case the assets are retained on the books as per accounting norms. Capital relief would mean not having to assign any risk weight to or maintain capital for these assets.

RBI guidance on implementation

In the absence of any clarity on the question of capital relief to be availed by NBFCs, the whole idea for securitization was getting frustrated. However, RBI has on March 13, 2020 issued guidance for NBFCs and Asset Reconstruction Companies for implementation of Ind-AS[2].

It has now been clarified by RBI that securitised assets not qualifying for de-recognition under Ind-AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. This implies that the originating NBFC will not be required to maintain any capital against the securitised portfolio of assets. However, the originator shall still be required to make 50% deduction from Tier 1 and 50% from Tier 2 capital.

The relevant extract of RBI notification states as follows-

vii) Securitised assets not qualifying for de-recognition under Ind AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. However, the NBFC shall reduce 50 per cent of the amount of credit enhancement given from Tier I capital and the balance from Tier II capital.

Accordingly, the fact that a transaction does not qualify for off-balance sheet treatment shall not be relevant for capital adequacy computation. As long as a securitisation transaction satisfies the conditions laid down in the relevant Securitsation Guidelines the fact that whether it has been de-recognised or not for accounting purposes will not make a difference.

Read our related write ups here –

Securitisation accounting under Ind-AS

Securitisation accounting: disconnects between RBI Guidelines and Ind-AS

Accounting for DA under Ind-AS

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=2723

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11818&Mode=0#AN1

Securitisation of performing assets: meaning of “homogenous pools”

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Standard asset securitisation in India is governed by the RBI securitisation guidelines of 2006[1] and 2012[2]. As one of the essential pre-requisites of a securitisation transaction, the underlying assets should represent the debt obligations of a ‘homogeneous pool’ of obligors. Subject to this condition of homogeneity, all on-balance sheet standard assets (except certain assets prescribed under the guidelines) are eligible for securitisation.

The question, then, arises as to what is the criteria for determining whether a pool of assets is homogeneous? In this write up we analyse the homogeneity criteria in the context of a securitisation transaction based on global understanding.

How is homogeneity assessed?

Basel III norms on Simple Transparent and Comparable (‘STC’) Securitisation transactions[3] lays down factors to be kept in mind while determining homogeneity as follows –

  • In simple, transparent and comparable securitisations, the assets underlying the securitisation should be credit claims or receivables that are homogeneous.
  • In assessing homogeneity, consideration should be given to –
    • Asset type,
    • Jurisdiction,
    • Legal system; and
    • Currency.
  • The nature of assets should be such that investors would not need to analyse and assess materially different legal and/or credit risk factors and risk profiles when carrying out risk analysis and due diligence checks.
  • Homogeneity should be assessed on the basis of common risk drivers, including similar risk factors and risk profiles.
  • Credit claims or receivables included in the securitisation should have standard obligations, in terms of rights to payments and/or income from assets and that result in a periodic and well-defined stream of payments to investors. Credit card facilities should be deemed to result in a periodic and well-defined stream of payments to investors for the purposes of this criterion.
  • Repayment of note-holders should mainly rely on the principal and interest proceeds from the securitised assets. Partial reliance on refinancing or re-sale of the asset securing the exposure may occur provided that re-financing is sufficiently distributed within the pool and the residual values on which the transaction relies are sufficiently low and that the reliance on refinancing is thus not substantial.

The basic intent behind a securitisation transaction is the tranching of risk. In order to tranche the risk, there must be similarity in terms of the risk attributes of the pool. If the risk is not homogeneous across different attributes of the pool the tranching of risk becomes difficult and defeats the intent of the transaction.

Further, the nature of assets in the pool must be homogenous. This means that the assets in the pool should be covered by similar legal risks or credit risks so that the investors need not analyse and assess materially different assets in a pool.

The EU Simple, Transparent and Standardised (‘STS’) securitisation Regulations[4] states the following–

“To ensure that investors perform robust due diligence and to facilitate the assessment of underlying risks, it is important that securitisation transactions are backed by pools of exposures that are homogenous in asset type, such as pools of residential loans, or pools of corporate loans, business property loans, leases and credit facilities to undertakings of the same category, or pools of auto loans and leases, or pools of credit facilities to individuals for personal, family or household consumption purposes.”

“The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type. The underlying exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors.”

Illustrations of a homogeneous pool

Whether a pool of comprising of commercial vehicles, trucks and tractors can be called homogeneous?

Prima facie the pool might appear to be homogeneous, however it is not so. The assets in this pool are different in terms of legal and credit risks. For instance, the credit risk arising out of a commercial vehicle loan and a tractor loan is far from similar, given the nature of the asset, value of assets and repayment power of the borrower of the asset, type of usage to which the asset.

Whether a pool of personal loans, business loans and loans against property can be called homogeneous?

The pool of loans would have to each be analysed individually given the material differences in their nature. Further the nature of collateral in each of these loans may be different leading to different risk attributes. Further it would have to be seen whether these loans have well defined stream of payments as well. Ultimately it is unlikely that this pool can be called homogeneous.

Conclusion

Homogeneity should be assessed from the viewpoint of risk attributes. There must be similarity in the nature of assets as well as collateral to ascertain homogeneity in terms of credit risks. Legal risks must also be analysed and should be homogeneous. These factors ultimately help investors in the due diligence process (while also making the transaction simple, transparent and comparable compliant) as well as make tranching of risks easier.

Read our related write ups on the subject of securitisation –

Basel III requirements for Simple Transparent and Comparable (STC) Securitisation –

http://vinodkothari.com/2020/01/basel-iii-requirements-for-simple-transparent-and-comparable-stc-securitisation/

 

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=2723

[2] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/C170RG21082012.pdf

[3] https://www.bis.org/bcbs/publ/d374.pdf

[4] https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R2402&from=en

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

Basel III requirements for Simple Transparent and Comparable (STC) Securitisation

Vinod Kothari Consultants P Ltd

finserv@vinodkothari.com

Having a simple, transparent and comparable (STC) label for a securitisation transaction is a very important factor, particularly for investors’ acceptability of the transaction. Securitisation transactions are structured finance transactions –the structure may be fairly complicated. The transaction may be bespoke – created with a particular investor in mind; hence, the transaction may not be standard. Also, the transaction terms may not have requisite transparency.

Absence of simplicity, transparency and comparability limit the ability of investors to understand and interpret the transaction structure and evaluate the underlying risks.

Basel III Securitisation Standard has a complete annexure [Annex 2] dedicated to the STC requirements. We are itemising these requirements below in the form of a checklist, such that one may verify the adherence of a transaction to the STC norms.

Basel III Norms Notes
A.     Asset Risk –
A1. Nature of Asset –
1)      Assets underlying securitisation should be –  
·         Credit claims or receivables; AND In a standard transaction, the receivables typically arise from credit contracts.
·         These credit claims or receivables must be homogenous.  
2)      In assessing homogeneity, consideration should be given to – Homogeneity is assessed from the viewpoint of risk attributes. Each of the following indicate risk attributes. Therefore, it appears that these conditions are cumulative
·         Asset type;  
·         Jurisdiction;  
·         Legal system;  
·         Currency.  
3)      Homogeneity should be assessed taking into account the following principles –  
·         The nature of assets should be such that investors would not need to analyse and assess materially different legal and/or credit risk factors and risk profiles when carrying out risk analysis and due diligence checks. This means that the assets in the pool questions are covered by similar legal risks and credit risks, and the analysis can be done portfolio-wide.
·         Homogeneity should be assessed on the basis of common risk drivers, including similar risk factors and risk profiles. The major credit risk drivers – for example, the purpose of the loan, nature of the collateral, should be similar, so that the pool can be subjected to a pool-wide credit risk assessment
·         Credit claims or receivables included in the securitisation should have standard obligations, in terms of rights to payments and/or income from assets and that result in a periodic and well- defined stream of payments to investors. Credit card facilities should be deemed to result in a periodic and well-defined stream of payments to investors for the purposes of this criterion. The receivables should be consisting of periodic and well-defined contractual stream. That is, expected cashflows or future flows may not qualify this condition.
·         Repayment of noteholders should mainly rely on the principal and interest proceeds from the securitised assets. In standard transactions, the receivables should generally consist of rentals, principal, interest or principal plus interest.
·         Partial reliance on refinancing or re-sale of the asset securing the exposure may occur provided that re-financing is sufficiently distributed within the pool and the residual values on which the transaction relies are sufficiently low and that the reliance on refinancing is thus not substantial. Transaction structures sometimes rely on refinancing of the collateral to make the final repayment. This is mostly so in case of CMBS transactions. Managed CDOs also depend on liquidation of the underlying loans/bonds for repaying investors. In such cases, STC rules require that the refinancing risk is minimal. No specific percentage is laid down.
4)      As more exotic asset classes require more complex and deeper analysis, credit claims or receivables should have contractually identified periodic payment streams relating to –  
·         Rental; This includes both financial and operating leases.
·         Principal; For example, in a PO strip, the cashflows will consist of principal only
·         Interest, or; For example, in an IO strip, the cashflows consist of interest only
·         Principal and Interest payments.  
5)      Any referenced interest payments or discount rates should be based on -commonly encountered market interest rates but should not reference complex or complicated formulae or exotic derivatives. The meaning of referenced interest payments is – where interest is not an absolute rate, but a floating rate linked with a reference rate. LIBOR, Treasuries, etc are examples. Similarly, discounting rates may be linked with reference rates.
“Commonly encountered market interest rates” may include –  
·         Rates reflective of a lender’s cost of funds, to the extent that sufficient data are provided to investors to allow them to assess their relation to other market rates. In many cases, interest rates on loans are linked with lender’s cost of funds. For example, a commonplace practice in India is MCLR – marginal cost of fund-based lending rate. However, the question will be – is this rate, in turn, based on market rates? Typically, MCLR is itself based on the policy rates of the RBI. Therefore, if the interrelationship between the external rates the banks’ own cost of funds is visible, the same will qualify as “market interest rate”.
·         Sectoral rates reflective of a lender’s cost of funds, such as internal interest rates that directly reflect the market costs of a bank’s funding or that of a subset of institutions. See discussion above on MCLR, for example
·         Interest rate caps and/or floors would not automatically be considered exotic derivatives. While cashflows which are based on exotic derivatives do not qualify under the STC condition, the fact that there are interest rate floors or caps by itself does not imply a breach of the STC condition.
A2. Asset Performance History  
1)      In order to provide investors with sufficient information on an asset class –  
·         To conduct appropriate due diligence, and;  
·         Access to a sufficiently rich data set to enable a more accurate calculation of expected loss in different stress scenarios, This clause is intended to provide data dump for similar assets as those in the final pool, with such parameters as to enable the investor to carry out stress testing and compute expected losses
verifiable loss performance data, such as delinquency and default data Delinquency data as well as default data matter- the former for the risk of missing payments, and the latter for bad assets
should be available for credit claims and receivables, with substantially similar risk characteristics to those being securitised, This is referring to the statistical pool, which has risk attributes similar to the assets to go into the final pool. Since the statistical pool will have past history for a sufficiently long period, this may actually be the assets that may have either been securitised, or stayed on the books in the past.
for a time period long enough to permit meaningful evaluation by investors. The data should be for a reasonably long time period. Once again, what is the time period in question is subjective, but it is with this data that the investor will be able to compute standard deviation and volatility of the parameters. Hence, the time period should be long enough to eliminate the impact of periodic spikes.
2)      Sources of and access to data and the basis for claiming similarity to credit claims or receivables being securitised should be clearly disclosed to all market participants.  
3)      Additional consideration (not forming part of STC criteria but may form part of investors’ due diligence):  
(i)                 In addition to the history of the asset class within a jurisdiction, investors should consider whether the – This criteria gets into the track record of the originator, original lender and other counterparties to the transaction. As the Basel document seeks to explain, the idea is not to discourage/restrict new entrants. However, investors should be able to track not only the performance of the asset, but also that of the parties.
–          Originator  
–          Sponsor Sponsor, being distinct from the originator, may be there in conduits, or CLOs/CDOs. Also, in many cases, the originator may not be the original lender but may be aggregator.
–          Servicer and  
–          Other parties with a fiduciary responsibility to the securitisation  
have an established performance history for substantially similar credit claims or receivables to those being securitised, and for an appropriately long period of time. As to what is this “long period of time”, the guidance given in the Basel document is (a) 7 years in case of non-retail exposures; (b) 5 years in case of retail exposures
A3. Payment Status  
1)      Non-performing credit claims and receivables are likely to require more complex and heightened analysis. In order to ensure that only performing credit claims and receivables are assigned to a securitisation, credit claims or receivables being transferred to the securitisation may not, at the time of inclusion in the pool, include obligations that are –  
–          in default;  
–          or delinquent;  
–          or obligations for which the transferor (e.g. Originator or sponsor); This and the next requirement is possibly a declaration from the originator and the servicer that the declarant is not aware of any material increase in expected losses or of enforcement actions.
2)      Additional requirement for capital purposes  
To prevent credit claims or receivables arising from credit-impaired borrowers from being transferred to the securitisation, the originator or sponsor should verify that the credit claims or receivables meet the following conditions : These conditions below are to be assessed as of a date not longer than 45 days before the closing date
(a)   the obligor has not been the subject of an insolvency or debt restructuring process due to financial difficulties within three years prior to the date of origination[1]; and,  
(b)   the obligor is not recorded on a public credit registry of persons with an adverse credit history; and,  
(c)    the obligor does not have a credit assessment by an ECAI or a credit score indicating a significant risk of default; and  
(d)   the credit claim or receivable is not subject to a dispute between the obligor and the original lender.  
3)      Additionally, at the time of this assessment, there should to the best knowledge of the originator or sponsor be no evidence indicating likely deterioration in the performance status of the credit claim or receivable.  
4)      Additionally, at the time of their inclusion in the pool, at least one payment should have been made on the underlying exposures, except in the case of revolving asset trust structures such as those for credit card receivables, trade receivables, and other exposures payable in a single instalment, at maturity.  
A4. Consistency of Underwriting
1)      Investor analysis is simple and straightforward where the securitisation is of credit claims or receivables that satisfy materially non-deteriorating origination standards. To ensure that the quality of the securitised credit claims and receivables is not affected by changes in underwriting standards, the originator should demonstrate to investors that any credit claims or receivables being transferred to the securitisation have been originated in the ordinary course of the originator’s business to materially non-deteriorating underwriting standards.  
2)      Where underwriting standards change, the originator should disclose the timing and purpose of such changes.  
   
3)      Underwriting standards should not be less stringent than those applied to credit claims and receivables retained on the balance sheet.  
4)      These should be credit claims or receivables which have satisfied the following: In case where the originator has acquired the assets from third parties, the assessment of non-deterioration of underwriting standards and whether assessment of volition and ability of obligors has been done by the third party, must be done by the originator.
(i)                 materially non-deteriorating underwriting criteria  
(ii)               for which the obligors have been assessed as having the ability and volition to make timely payments on obligations or  
(iii)             on granular pools of obligors  
(iv)              originated in the ordinary course of the originator’s business  
(v)                where expected cash flows have been modelled to meet stated obligations of the securitisation under prudently stressed loan loss scenarios.  
A5. Asset selection and transfer  
1)      Whilst recognising that credit claims or receivables transferred to a securitisation will be subject to defined criteria, e.g. the size of the obligation, the age of the borrower or the LTV (loan-to-value) of the property, DTI (debt-to-income) and/or DSC (debt service coverage) ratios, the performance of the securitisation should not rely upon the ongoing selection of assets through active management on a discretionary basis of the securitisation’s underlying portfolio. The condition lays down the rule against cherry picking. Assets may be selected by laying down criteria and not by active selection. Addition of assets in case of revolving transactions, and substitution of assets on account of some of the loans not meeting the representations and warranties is not regarded as a breach of this condition.
2)      Credit claims or receivables transferred to a securitisation should satisfy clearly defined eligibility criteria.  
3)      Credit claims or receivables transferred to a securitisation after the closing date may not be –  
–          Actively selected  
–          Actively managed  
–          Or otherwise cherry-picked  
4)      Investors should be able to assess the credit risk of the asset pool prior to their investment decisions.  
5)      In order to meet the principle of true sale, the securitisation should effect true sale such that the underlying credit claims or receivables:  
(a)   are enforceable against the obligor and their enforceability is included in the representations and warranties of the securitisation;  
(b)   are beyond the reach of the seller, its creditors or liquidators and are not subject to material re-characterisation or clawback risks;  
(c)    are not effected through credit default swaps, derivatives or guarantees, but by a transfer of the credit claims or the receivables to the securitisation; and  
(d)   demonstrate effective recourse to the ultimate obligation for the underlying credit claims or receivables and are not a securitisation of other securitisations.  
Additional requirement for capital purposes – An independent third-party legal opinion must support the claim that the true sale and the transfer of assets under the applicable laws comply with points (a) through (d).  
To avoid conflicts of interest, the legal opinion should be provided by an independent third party. That is say, the transaction counsel should not generally be the counsel giving the true sale opinion.
6)      In applicable jurisdictions, securitisations employing transfers of credit claims or receivables by other means should demonstrate the existence of material obstacles preventing true sale at issuance (E.g. the immediate realisation of transfer tax or the requirement to notify all obligors of the transfer.) and; That is, if clear true sale structure is not used, but say a loan or similar structures are used, it should be possible to see that a true sale would have been impractical
should clearly demonstrate the method of recourse to ultimate obligors (E.g. equitable assignment, perfected contingent transfer.) In that case, the ability of being able to enforce the collection from the obligors, independent of the originator, should be demonstrated.
7)      In such jurisdictions, any conditions where the transfer of the credit claims or receivable is –  
–          Delayed, or;  
–          Contingent upon specific events  
And any factors affecting timely perfection of claims by the securitisation should be clearly disclosed.  
8)      The originator should provide representations and warranties that the credit claims or receivables being transferred to the securitisation are not subject to any condition or encumbrance that can be foreseen to adversely affect enforceability in respect of collections due.  
A6. Initial and ongoing Data
1)      To assist investors in conducting appropriate due diligence prior to investing in a new offering,  
sufficient loan-level data in accordance with applicable laws, or  
in the case of granular pools, summary stratification data on the relevant risk characteristics of the underlying pool  
should be available to potential investors before pricing of a securitisation.  
2)      To assist investors in conducting appropriate and ongoing monitoring of their investments’ performance and so that investors that wish to purchase a securitisation in the secondary market have sufficient information to conduct appropriate due diligence,  
–          timely loan-level data in accordance with applicable laws, or  
–          or granular pool stratification data on the risk characteristics of the underlying pool and standardised investor reports  
should be readily available to  
–          current and potential investors  
at least quarterly throughout the life of the securitisation.  
3)      Cut-off dates of the loan-level or granular pool stratification data should be aligned with those used for investor reporting.  
4)      To provide a level of assurance that the reporting of the underlying credit claims or receivables is accurate and that the underlying credit claims or receivables meet the eligibility requirements, the initial portfolio should be reviewed for conformity with the eligibility requirements by an appropriate legally accountable and independent third party The examples of such independent third party given in the Basel framework are independent accounting practitioners, calculation agent, or management company for securitisation
–          The review should confirm that the credit claims or receivables transferred to the securitisation meet the portfolio eligibility requirements.  
–          The review could, for example, be undertaken on a representative sample of the initial portfolio, with the application of a minimum confidence level.  
–          The verification report need not be provided but its results, including any material exceptions, should be disclosed in the initial offering documentation.  
B.      Structural Risk  
B7. Redemption cash flows  
1)      Liabilities subject to the refinancing risk of the underlying credit claims or receivables are likely to require more complex and heightened analysis. To help ensure that the underlying credit claims or receivables do not need to be refinanced over a short period of time, there should not be a reliance on the sale or refinancing of the underlying credit claims or receivables in order to repay the liabilities, unless the underlying pool of credit claims or receivables is sufficiently granular and has sufficiently distributed repayment profiles. Except in case of granular pools (say RMBS pools), the reliance on refinancing should not be substantial.
2)      Rights to receive income from the assets specified to support redemption payments should be considered as eligible credit claims or receivables in this regard. Sometimes, temporary reinvestment of cashflows may be done. The Basel document gives an example of associated savings plans designed to repay principal at maturity. This does not breach the preceding condition.
B8. Currency and interest  
1)      To reduce the payment risk arising from the interest rate or currency mismatches, and to improve investors’ ability to model cash flows, interest rate and foreign currency risks should be appropriately mitigated at all times, “Appropriate mitigation” of the interest rate and currency risk has been explained further. This is not requiring a perfect hedge. The appropriateness of the mitigation of interest rate and foreign currency through the life of the transaction must be demonstrated by making available to potential investors, in a timely and regular manner, quantitative information including the fraction of notional amounts that are hedged, as well as sensitivity analysis that illustrates the effectiveness of the hedge under extreme but plausible scenarios.
and if any hedging transaction is executed the transaction should be documented according to industry-standard master agreements.  
2)      Only derivatives used for genuine hedging of asset and liability mismatches of interest rate and / or currency should be allowed.  
If hedges are not performed through derivatives, then those risk-mitigating measures are only permitted if they are specifically created and used for the purpose of hedging an individual and specific risk, and not multiple risks at the same time (such as credit and interest rate risks).  
Non-derivative risk mitigation measures must be fully funded and available at all times.  
B9. Payment Priorities and observability  
1)      To prevent investors being subjected to unexpected repayment profiles during the life of a securitisation, the priorities of payments for all liabilities in all circumstances should be clearly defined at the time of securitisation  
and appropriate legal comfort regarding their enforceability should be provided.  
2)      To ensure that junior noteholders do not have inappropriate payment preference over senior noteholders that are due and payable, throughout the life of a securitisation, or,  
–          where there are multiple securitisations backed by the same pool of credit claims or receivables, throughout the life of the securitisation programme,  
junior liabilities should not have payment preference over senior liabilities which are due and payable.  
3)      The securitisation should not be structured as a “reverse” cash flow waterfall such that junior liabilities are paid where due and payable senior liabilities have not been paid.  
4)      To help provide investors with full transparency over any changes to the cash flow waterfall, payment profile or priority of payments that might affect a securitisation,  
all triggers affecting the cash flow waterfall, payment profile or priority of payments of the securitisation should be clearly and fully disclosed both in  
–          offering documents  
–          and in investor reports,  
with information in the investor report that clearly identifies the breach status,  
the ability for the breach to be reversed and  
the consequences of the breach.  
5)      Investor reports should contain information that allows investors to monitor the evolution over time of the indicators that are subject to triggers.  
6)      Any triggers breached between payment dates should be  disclosed to investors on a timely basis in accordance with the terms and conditions of all underlying transaction documents.  
7)      Securitisations featuring a revolving period should include provisions for  
–          appropriate early amortisation events and/or  
–          triggers of termination of the revolving period, This requires proper disclosure of all early amortisation triggers
–          including notably:  
(i)   deterioration in the credit quality of the underlying exposures;  
(ii) a failure to acquire sufficient new underlying exposures of similar credit quality; and  
(iii)    the occurrence of an insolvency-related event with regard to the originator or the servicer.  
8)      Following the occurrence of  
–          a performance-related trigger,  
–          an event of default or  
–          an acceleration event,  
the securitisation positions should be repaid in accordance with a sequential amortisation priority of payments, in order of tranche seniority, and  
there should not be provisions requiring immediate liquidation of the underlying assets at market value.  
9)      To assist investors in their ability to appropriately model the cash flow waterfall of the securitisation, the originator or the sponsor should make available to investors, both  
–          Before pricing of the securitisation and  
–          On an ongoing basis,  
o   a liability cash flow model, or  
o   information on the cash flow provisions allowing appropriate modelling of the securitisation cash flow waterfall.  
10)  To ensure that the following can be clearly identified: The objective of the following is to enable investors to identify debt forgiveness, forbearance, payment holidays, restructuring and other asset performance remedies on an ongoing basis.
–          debt forgiveness,  
–          forbearance  
–          payment holidays and  
–          other asset performance remedies  
To ensure that there are clear and consistent terms for the following:  
–          policies and procedures,  
–          definitions,  
–          remedies  
–          and actions relating to delinquency,  
–          default  
–          or restructuring of underlying debtors  
B10. Voting and Enforcement Rights  
1)      To help ensure clarity for securitisation note holders of their rights and ability to control and enforce on the underlying credit claims or receivables, upon insolvency of the originator or sponsor, all voting and enforcement rights related to the credit claims or receivables should be transferred to the securitisation.  
2)      Investors’ rights in the securitisation should be clearly defined in all circumstances, including the rights of senior versus junior note holders.  
B11. Documentation Disclosure and legal review  
1)      The documentation for initial offering (E.g. draft offering circular, draft offering memorandum, draft offering document or draft prospectus, such as a “red herring”.) should help investors to fully understand the  
–          Terms and conditions  
–          Legal and  
–          Commercial information  
Ensure that this information is set out in a clear and effective manner for all programmes and offerings,  
2)      Each of the following legal documentation (as may be relevant) should be provided to investors: If these are not available immediately, they should be made available within a reasonably sufficient period of time prior to pricing, or when legally permissible.
–          Asset sale agreement, assignment, novation or transfer agreement; servicing, backup servicing, administration and cash management agreements; trust/management deed, security deed, agency agreement, account bank agreement, guaranteed investment contract, incorporated terms or master trust framework or master definitions agreement as applicable; any relevant inter-creditor agreements, swap or derivative documentation, subordinated loan agreements, start-up loan agreements and liquidity facility agreements; and any other relevant underlying documentation, including legal opinions  
3)      Final offering documents should be available from the closing date and all final underlying transaction documents shortly thereafter. These should be composed such that readers can readily find, understand and use relevant information.
4)      To ensure that all the securitisation’s underlying documentation has been subject to appropriate review prior to publication, the terms and documentation of the securitisation should be reviewed by an appropriately experienced third party legal practice, such as a legal counsel already instructed by one of the transaction parties, eg by the arranger or the trustee.  
5)      Investors should be notified in a timely fashion of any changes in such documents that have an impact on the structural risks in the securitisation.  
B12. Alignment of Interest  
1)      In order to align the interests of those responsible for the underwriting of the credit claims or receivables with those of investors, the originator or sponsor of the credit claims or receivables  
should retain a material net economic exposure, and  
demonstrate a financial incentive in the performance of these assets following their securitisation.  
C.      Fiduciary and servicer risk  
C13. Fiduciary and Contractual Responsibilities  
1)      Servicer should be able to demonstrate expertise in the servicing of the underlying credit claims or receivables, by the following:  
extensive workout expertise,  
thorough legal and collateral knowledge, and  
a proven track record in loss mitigation,  
supported by a management team with extensive industry experience.  
2)      The servicer should at all times act in accordance with reasonable and prudent standards.  
3)      Policies, procedures and risk management controls should be well documented and adhere to good market practices and relevant regulatory regimes.  
4)      There should be strong systems and reporting capabilities in place.  
5)      The party or parties with fiduciary responsibility should act on a timely basis in the best interests of the securitisation note holders, and both the initial offering and all underlying documentation should contain provisions facilitating the timely resolution of conflicts between different classes of note holders by the trustees, to the extent permitted by applicable law.  
6)      The party or parties with fiduciary responsibility to the securitisation and to investors should be able to demonstrate –  
–          Sufficient skills and  
–          Resources to comply with their duties of care in the administration of the securitisation vehicle.  
7)      To increase the likelihood that those identified as having a fiduciary responsibility towards investors as well as the servicer execute their duties in full on a timely basis,  
remuneration should be such that these parties are incentivised and able to meet their responsibilities in full and on a timely basis. This is an important requirement about adequacy of the servicer remuneration. The same must be arms’ length.
8)      Additional Guidance for capital purposes  
In assessing whether “strong systems and reporting capabilities are in place”, well documented policies, procedures and risk management controls, as well as strong systems and reporting capabilities, may be substantiated by a third-party review for non-banking entities.  
C14. Transparency to investors  
1)      To help provide full transparency to investors, assist investors in the conduct of their due diligence and to prevent investors being subject to unexpected disruptions in cash flow collections and servicing,  
the contractual obligations, duties and responsibilities of all key parties to the securitisation, both those with  
–          a fiduciary responsibility  
–          and of the ancillary service providers,  
should be defined clearly both in the initial offering and all underlying documentation.  
2)      Provisions should be documented for the replacement of  
–          Servicers,  
–          Bank account providers,  
–          derivatives counterparties and  
–          liquidity providers  
in the event of  
–          Failure or  
–          non-performance or  
–          insolvency or  
–          other deterioration of creditworthiness of any such counterparty to the securitisation.  
3)      To enhance transparency and visibility over all receipts, payments and ledger entries at all times, the performance reports to investors should distinguish and report the securitisation’s income and disbursements, such as  
 
o   scheduled principal,  
o   redemption principal,  
o   scheduled interest,  
o   prepaid principal,  
o   past due interest and fees and charges,  
o   delinquent,  
o   defaulted and restructured amounts under debt forgiveness and payment holidays,  
o   including accurate accounting for amounts attributable to principal and interest deficiency ledgers.  
D.     Additional Criteria for capital purposes  
D15. Credit risk of underlying exposures  
1)      At the portfolio cut-off date the underlying exposures have to meet the conditions under the Standardised Approach for credit risk, and after taking into account any eligible credit risk mitigation, for being assigned a risk weight equal to or smaller than: The Basel document provides that the criterion based on regulatory risk weights under the Standardised Approach has the merit of using globally consistent regulatory risk measures. Hence, if, after considering any credit risk mitigations, the risk weights are coming lower than tabulated below, the conditions under the Standardised Approach have to be satisfied. It also provides the benefit of applying a filter to ensure higher-risk underlying exposures are not granted an alternative capital treatment as STC-compliant transactions.
·         [40%] on a value-weighted average exposure basis for the portfolio where the exposures are loans secured by residential mortgages or fully guaranteed residential loans;  
·         [50%] on an individual exposure basis where the exposure is a loan secured by a commercial mortgage;  
·         [75%] on an individual exposure basis where the exposure is a retail exposure; or  
·         [100%] on an individual exposure basis for any other exposure.  
A  
D16. Granularity of the pool  
1)      At the portfolio cut-off date, the aggregated value of all exposures to a single obligor shall not exceed 1% of the aggregated outstanding exposure value of all exposures in the portfolio.  
In jurisdictions with structurally concentrated corporate loan markets available for securitisation subject to ex ante supervisory approval and only for corporate exposures, the applicable maximum concentration threshold could be increased to 2% if the originator or sponsor retains subordinated tranche(s) that form loss absorbing credit enhancement, as defined in paragraph 55 of the December 2014 framework, and which cover at least the first 10% of losses. These tranche(s) retained by the originator or sponsor shall not be eligible for the STC capital treatment.  

 

[1] This condition would not apply to borrowers that previously had credit incidents but were subsequently removed from credit registries as a result of the borrower cleaning their records. This is the case in jurisdictions in which borrowers have the “right to be forgotten”.

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