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Covered Bonds with NHB- Intermediation coming


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26th October, 2012:

The NBH group report has suggested a unique structure for introduction of covered bonds in India and these may be a reality very soon

A Group appointed by the National Housing Bank (NHB) to suggest capital market measures for residential mortgage lending submitted its report recently. The report was released by Securities and Exchange Board of India (SEBI) chairman UK Sinha in Mumbai on 17 October 2012.

The group has suggested a unique, NHB-intermediated structured for introduction of covered bonds in India. NHB will act in the role of a special purpose vehicle (special purpose vehicle) to hold the collateral pool, and to assure repayments to bond investors from out of the proceeds of the collateral pool. 

Covered bonds are an instrument for funding residential mortgages that have been gaining increasing popularity of late, particularly after the sub-prime crisis. Covered bonds were the mainstay of continental Europe, its usage outside of Europe has been a recent phenomenon. Covered bonds are bonds issued by a mortgage originator that are full recourse obligations of the issuer, but provide investors with a bankruptcy-protected claim on a pool of residential mortgages. The pool, called "cover pool" is a dynamic pool that also carries the credit enhancement necessary to provide strength to the bonds. 

The bankruptcy-protected right over the cover pool comes mainly in two ways, either by way of a special legislation as in case of several European countries, or by way of a special structure. The former structure is called legislative structure, and the latter is called structured covered bond structure. The principal followers of the structured covered bond structures include UK, USA, Canada, New Zealand, Australia, etc. 

The NHB Group considered the legislation option for introduction of covered bonds in India, but favored the structured covered bond option, for the flexibility it offers. Even in case of structured covered bonds, the Group has discussed two options - NHB-intermediated structures, and self-intermediated structures. In the self-intermediated structure, the issuer will transfer the legal title in a dynamic collateral pool to an SPV which acts a guarantor for the repayment of the bonds. In case the issuer defaults, the SPV uses the legal title over the pool to repay bonds it has guaranteed.

The NHB-intermediated structure, strongly recommended by the Group, will be a unique blend of the flexibility of a structured covered issuance, as also the backing of an apex regulatory body. Here, the transfer of legal title over the collateral pool happens by virtue of operation of the law. The Group has suggested a minor amendment to Section 16B of the NHB Act to allow for a statutory vesting of title in the NHB. With title over the pool, the housing regulator assures that NHB will use the proceeds from the collateral pool to repay investors in case of a default by the bond issuer. NHB has several statutory powers under the NHB Act, including power to take over management of the issuer, etc. The Group felt that the presence of NHB in the structure will go a great way in ensuring investor comfort. NHB's position may also help in notching up the rating of the bonds over the above the rating of the collateral pool and the attendant credit enhancement.

Covered bonds do not imply a recourse against NHB, hence, they are not a guarantee by NHB. As is the globally understood feature of covered bonds, they imply dual recourse - primary recourse against the issuer, and secondary recourse against the collateral pool. It is the secondary recourse that is bankruptcy-protected.

The Group, led by Ananta Barua, executive director of SEBI, had this writer also as a member. The Group included representatives from ministry of finance, Reserve Bank of India (RBI), leading mortgage originators, rating agencies, banks, etc.

NHB is reportedly interested in fast-tracking the issuance of covered bonds in India. The Group has given a draft of Covered Bond Regulations that NHB may promulgate. If the needed amendment of law can be passed without any delay, covered bonds in India may be a reality very soon.

In addition to covered bonds, the Group has made recommendations about residential mortgage backed securities too. The Group feels that there will be intensive demand among Indian banks for residential mortgage backed securities, as the priority-sector treatment has been denied in case of loans to housing finance companies (except in case of loans of small sizes). 


[Reported by: Vinod Kothari]

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