Why India's first CDO failed
ICICI was trying to market India's first CDO, called ICCDO, that finally failed. A failure once is not a failure always, but we surely need to learn from failures. That is what we do here:
Market data reported upto 31st Dec 2002
Click here for a PDF file (courtesy Sanjay Aggarwal and Mayank Kaul of Citibank) containing 2002 data of issuance in India
Updated on 9th Oct., 2001
On our news page, we report the recent flurry of activity -see here.
Updated on 13th March 2001
Everyone would agree that the Indian securitization market was like a giant waiting to wake up. In early 2001, the portents clearly point out that the giant is waking up indeed.
There have been several notable transactions over the past couple of months or so. These deals have been reported on Securitization news pages on this site – in particular, refer to this page and this page.
The notable deals in the recent past are:
- The second RMBS transaction through the agency of NHB
- HUDCO's securitisation
- Mega securitisation by Jet Airways
- ILFS-sponsored securitisation of receivables by Varun Shipping.
Late breaking additions : 10 Feb. 2000:
Task force on Infrastructure has finalised a proposal to securitise cess on petrol and diesel to fund infrastructure projects – click here.
With a vast banking and financial sector and generally forward-looking economy, India is a promising market for securitisation, but transactions have taken a very long time to happen. However, with the ice having been broken by the NHB-HDFC securitisation deal in August, 2000, it appears that there would be a spate of securitisation issues in time to come, as investors' appetite for debt offers distinctively improves.
A number of quasi-securitisation transactions have been going on for quite some time – these are essentially portfolio purchases, basically by larger NBFCs. GE Capital, Birla Global, etc. are financial companies aggressively buying portfolios under agreements styled as securitisations, though there is no SPV or security creation in such cases.
The first securitisation in true sense was the Citibank's Peoples' Financial Services where Citibank securitised its own auto loan transactions through a financial company acting as an SPV. This transaction used pass through certificates, which were listed on the second-tier exchange National Stock Exchange, though no deals ever took place till the near-maturity of the transaction.
In the RMBS segment, the first transaction, that dragged along for quite some time, recently took place – securitisation of mortgage loan receivables originated by HDFC, securitised by National Housing Bank.
The NHB-HDFC RMBS transaction
This Rs 597 million (approx. USD 13 million) transaction is the first RMBS transaction in India. RMBS securitisation was dogged by several controversies – stamp duties, tax credits for the borrowers, etc. Not all these controversies have been resolved as the Information Memorandum mentions a number of these unresolved issues. However, NHB dared to securitise the receivables originated by HDFC.
8330 housing loans granted by HDFC were pooled in this transaction with an aggregate principal outstanding of Rs. 883 million. This also the amount paid by the SPV as purchase consideration, broken into Class A notes of Rs 597 million and class B notes of the balance, which have been retained by HDFC. During the first 84 months, class A will be serviced at the stipulated coupon rate and principal amortisation as actually collected, and the residual cashflows will belong to class B. Class B will come for amortisation only after 84 months whereas class A is to amortised by the principal collections for first 84 months.
From the way class B is structured, it is quite likely that class B will be taken akin to equity interest.
Besides, the transaction is supported by corporate guarantee of the originator. The corporate guarantee has been structured as a liquidity facility, such that any shortfall in the scheduled payments on principal will be drawn out of HDFC's liquidity facility, and any surplus remaining for any month will be first used to defray HDFC for the amount extended in pursuance of this guarantee. The guarantee is limited to an amount of Rs. 11 million.
The extent of class B interest plus corporate guarantee provided would mean a substantial risk retention by HDFC. If capital adequacy norms as suggested by BIS come into force, HDFC will suffer a much higher capital erosion than would have been the case if the receivables stayed on HDFC's books.
Potential for bank loan securitisation in India:
Bankers must seriously consider the potential for bank loan securitisation. As per capital adequacy norms recently enforced by the RBI whereby staff advances are to be given 100% risk weightage, many banks will be starved of capital. Securitisation can provide much needed capital relief.
India is a common law country: there are no specific securitisation laws but the usual common law procedure for securitisation is applicable. Accordingly:
- Transfer of receivables, in order to be effective, requires a written conveyance.
- Conveyance involves stamping. Stamp rates vary from state to state, but the rates are prohibitive in most of the States barring those which have announced special duties for securitisation transactions. For such notifications, see our page here.
- Notice to obligors is not required, but an obligor paying in absence of notice gets a valid discharge.
- Assignment of future receivables may be possible only as a future transaction, not a present transfer.
Mortgage foreclosure: amendments to NHB law
The enactment relating to the apex housing finance institution, National Housing Bank (NHB) was amended in 2000 to provide for a speedier quasi-judicial recovery mechanism. According to these amendments, if a bank or housing finance company has given a housing loan for a residential house which has been refinanced or securitised by the NHB, on a failure in repayment of the loan, the lender can seek recovery through a loan recovery officer appointed by the NHB. The recovery offices will work as institutional quasi-judicial authorities to force recoveries, failing which will be authorised to foreclose a mortgage.
The required regulations to put this scheme into effect are yet to be passed.
Tax laws do not contain any specific provision about securitisation. Based on understanding of general tax principles, the following are the three possible taxation scenarios as far as taxing the SPV is concerned:
- Pass through status where the SPV is not taxed at all.
- Representative tax status, where the SPV is taxed on behalf of the investors.
- Entity level taxation, where the SPV is taxed as a normal tax-paying entity.
The Institute of Chartered Accountants of India is working on a guidance note or standard. As for present, most securitisations are being treated as off balance sheet without making any provision for the retained interests, even though most cases carry substantial recourse obligations.
The Reserve Bank of India constituted a working group to report on securitisation in India. The report was presented November last year- see our news item here. No action has been taken as yet on any of the recommendations in the report.