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Presentation on Draft Directions on Sale of Loans

Our related research on similar topics can be viewed here –

  1. New regime for securitisation and sale of financial assets;
  2. Originated to transfer- new RBI regime on loan sales permits risk transfers
  3. Comparison of the Draft Securitisation Framework with existing guidelines and committee recommendations;
  4. Comparison of the Draft Framework for sale of loans with existing guidelines and task force recommendations;
  5. Inherent inconsistencies in quantitative conditions for capital relief;
  6. Presentation on Draft Directions on Securitisation of Standard Assets;
  7. YouTube video of the webinar held on June 12, 2020.

Comparison on Draft Framework for sale of loans with existing guidelines and task force recommendations

On 8th June, 2020, RBI issued the Draft Comprehensive Framework for Sale of loan exposures for public comments. This draft framework has brought about major changes in the regulatory framework governing direct assignment. One of the major changes is that the framework has removed MRR requirements in case of DA transactions. The framework covers both Sale of Standard Assets as well as stressed assets in separate chapter. We shall be coming up with a separate detailed analysis of sale of stressed assets under the draft framework.
In continuation of our earlier brief write-up titled Originated to transfer – new RBI regime on loan sales permits risk transfer, here we bring a point by point comparative along with our comments on the changes. Further, we have covered the Draft Directions on sale of loans in a Presentation on Draft Directions Sale of Loans.

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Originated to transfer- new RBI regime on loan sales permits risk transfers

Team, Vinod Kothari Consultants P. Ltd.

finserv@vinodkothari.com

Major changes have been proposed by the RBI in the regime on what has become a major part of the business model of NBFCs and MFIs in the country – direct assignments (DAs). We have separately dealt with the Draft Directions on Securitisation of Standard Assets in a write up titled “New regime for securitisation and sale of financial assets

The term DA is so very typical of the Indian scene – globally, the practice of loan trading, loan sales or so-called whole-loan transfers has largely been out of the regulatory domain. However, in India, the motivation to shift from securitisation to DAs were partly the RBI Guidelines of 2006 which regulated securitisation but did not regulate DAs, and partly, the tax issues on securitisation that began prominent around 2011-12 or so. However, the DA model has, over the years, been a sizeable part of securitisation volumes in India, and is the mainstay of transfer of priority-sector loans from NBFCs to banks. Now that NBFCs have been permitted a major push for MSE lending by several GoI schemes, NBFCs are eagerly looking for another round of DA drive, and therefore, it is important to see whether the proposed regulatory regime for loan sales will facilitate NBFC-originated loans to end up on the books of banks and other investors.

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GOI’s attempt to ease out liquidity stress of NBFCs and HFCs: Ministry of Finance launches Scheme for Partial Credit Guarantee to PSBs for acquisition of financial assets

Abhirup Ghosh  (abhirup@vinodkothari.com)

The Finance Minister, during the Union Budget 2019-20, promised to introduce a partial credit guarantee scheme so as to extend relief to the NBFC during the on-going liquidity crisis. The proposal laid down in the budget was a very broad statement and were subject to several speculations. At last on 13th August, 2019[1], the Ministry of Finance came out with a press release to announce the notification in this regard dated 10th August, 2019, laying down specifics of the scheme.

The scheme will be known by “Partial Credit Guarantee offered by Government of India (GoI) to Public Sector Banks (PSBs) for purchasing high-rated pooled assets from financially sound Non-Banking Financial Companies (NBFCs)/Housing Finance Companies (HFCs)”, however, for the purpose of this write-up we will use the word “Scheme” for reference.

The Scheme is intended to address temporary asset liability mismatch of solvent HFCs/ NBFCs, owing to the ongoing liquidity crisis in the non-banking financial sector, without having to resort to distress sale of their assets.

In this regard, we intend to discuss the various requirements under the Scheme and analyse its probable impact on the financial sector.

Applicability:

The Scheme has been notified with effect from 10th August, 2019 and will remain open for 6 months from or until the period by which the maximum commitment by the Government in the Scheme is fulfilled, whichever is earlier.

Under the Scheme, the Government has promised to extend first loss guarantee for purchase of assets by PSBs aggregating to ₹ 1 lakh crore. The Government will provide first loss guarantee of 10% of the assets purchased by the purchasing bank.

The Scheme is applicable for assignment of assets in the course of direct assignment to PSBs only. It is not applicable on securitisation transactions.

Also, as we know that in case of direct assignment transactions, the originators are required to retain a certain portion of the asset for the purpose of minimum retention requirement; this Scheme however, applies only to the purchasing bank’s share of assets and not on the originators retained portion. Therefore, if due to default, the originator incurs any losses, the same will not be compensated by virtue of this scheme.

Eligible sellers:

The Scheme lays down criteria to check the eligibility of sellers to avail benefits under this Scheme, and the same are follows:

  1. NBFCs registered with the RBI, except Micro Financial Institutions or Core Investment Companies.
  2. HFCs registered with the NHB.
  3. The NBFC/ HFC must have been able to maintain the minimum regulatory capital as on 31st March, 2019, that is –
    • For NBFCs – 15%
    • For HFCs – 12%
  4. The net NPA of the NBFC/HFC must not have exceeded 6% as on 31st March, 2019
  5. The NBFC/ HFC must have reported net profit in at least one out of the last two preceding financial years, that is, FY 2017-18 and FY 2018-19.
  6. The NBFC/ HFC must not have been reported as a Special Mention Account (SMA) by any bank during year prior to 1st August, 2018.

Some observations on the eligibility criteria are:

  1. Asset size of NBFCs for availing benefits under the Scheme: The Scheme does not provide for any asset size requirement for an NBFC to be qualified for this Scheme, however, one of the requirement is that the financial institution must have maintained the minimum regulatory capital requirement as on 31st March, 2019. Here it is important to note that requirement to maintain regulatory capital, that is capital risk adequacy ratio (CRAR), applies only to systemically important NBFCs.

Only those NBFCs whose asset size exceeds Rs. 500 crores singly or jointly with assets of other NBFCs in the group are treated as systemically important NBFCs. Therefore, it is safe to assume that the benefits under this Scheme can be availed only by those NBFCs which – a) are required to maintained CRAR, and b) have maintained the required amount of capital as on 31st March, 2019, subject to the fulfilment of other conditions.

  1. Financial health of originator after 1st August, 2018 – The eligibility criteria for sellers state that the financial institution must not have been reported as SMA by any bank any time during 1 year prior to 1st August, 2018, the apparent question that arises here is what happens if the originator moves into SMA status after the said date. If we go by the letters of the Scheme, if a financial institution satisfies the condition before 1st August, 2018 but becomes SMA thereafter, it will still be eligible as per the Scheme. This makes the situation a little awkward as the whole intention of the Scheme was to facilitate financially sound financial institutions. This seems to be an error on the part of the Government, and it surely must not have meant to situations such as the one discussed above. We can hopefully expect an amendment in this regard from the Government.

Eligible assets

Pool of assets satisfying the following conditions can be assigned under the Scheme:

  1. The asset must have been originated on or before 31st March, 2019.
  2. The asset must be classified as standard in the books of the NBFC/ HFC as on the date of the sale.
  3. The pool of assets should have a minimum rating of “AA” or equivalent at fair value without the credit guarantee from the Government.
  4. Each account under the pooled assets should have been fully disbursed and security charge should have been created in favour of the originating NBFCs/ HFCs.
  5. NBFCs/HFCs can sell up to a maximum of 20% of their standard assets as on 31.3.2019 subject to a cap of Rs. 5,000 crore at fair value. Any additional amount above the cap of Rs. 5,000 crore will be considered on pro ratabasis, subject to availability of headroom.
  6. The individual asset size in the pool must not exceed Rs. 5 crore.
  7. The following types of loans are not eligible for assignment for the purposes of this Scheme:
    1. Revolving credit facilities;
    2. Assets purchased from other entities; and
  • Assets with bullet repayment of both principal and interest

Our observations on the eligibility criteria are as follows:

  1. Rating of the pool: The Scheme states that the pools assigned should be highly rated, that is, should have ratings of AA or equivalent prior to the guarantee. Technically, pool of assets are not rated, it is the security which is rated based on the risks and rewards of the underlying pools. Therefore, it is to be seen how things will unfold. Also, desired rating in the present case is quite high; if an originator is able to secure such a high rating, it might not require the assistance under this Scheme in the first place. And, the fact that the originators will have to pay guarantee commission of 25 bps. Therefore, only where the originators are able to secure a significantly lower cost from the banks for a higher rating, that would also cover the commission paid, will this Scheme be viable; let alone be the challenges of achieving an AA rating of the pool.
  2. Cut-off date of loan origination to be 31st March, 2019: As per the RBI Guidelines on Securitisation and Direct Assignment, the originators have to comply with minimum holding requirements. The said requirement suggests that an asset can be sold off only if it has remained in the books of the originator for at least 6 months. This Scheme has come into force with effect from 10th August, 2019 and will remain open for 6 months from the commencement.

Considering that already 5 months since the cut-off date has already passed, even if we were to assume that the loan is originated on the cut-off date itself, it would mean that closer to the end of the tenure of the Scheme, the loan will be 11 months seasoning. Such high seasoning requirements might not be motivational enough for the originators to avail this Scheme.

  1. Maximum cap on sell down of receivables: The Scheme has put a maximum cap on the amount of assets that can be assigned and that is an amount equal to 20% of the outstanding standard assets as on 31st March, 2019, however, the same is capped to Rs. 5000 crores.

It is pertinent to note that the Scheme also allows additional sell down of loans by the originators, beyond the maximum cap, however, the same shall depend on the available headroom and based on decisions of the Government.

Invocation of guarantee and guarantee commission

Guarantee commission

As already stated earlier, in order to avail benefits under this Scheme, the originator will have to incur a fee of 25 basis points on the amount guaranteed by the Government. However, the payment of the same shall have to be routed through the purchasing bank.

Invocation of guarantee

The guarantee can be invoked any time during the first 24 months from the date of assignment, if the interest/ principal has remained overdue for a period of more than 90 days.

Consequent upon a default, the purchasing bank can invoke the guarantee and recover its entire exposure from the Government. It can continue to recover its losses from the Government, until the upper cap of 10% of the total portfolio is reached. However, the purchasing bank will not be able to recover the losses if – (a) the pooled assets are bought back by the concerned NBFCs/HFCs or (b) sold by the purchasing bank to other entities.

The claims of the purchasing bank will be settled with 5 working days from the date of claim by the Government.

However, if the purchasing bank, by any means, recovers the amount subsequent to the invocation of the guarantee, it will have to refund the amount recovered or the amount received against the guarantee to the Government within 5 working days from the date of recovery. Where the amount recovered is more than amount of received as guarantee, the excess collection will be retained by the purchasing bank.

Other features of the Scheme

  1. Reporting requirement – The Scheme provides for a real-time reporting mechanism for the purchasing banks to understand the remaining headroom for purchase of such pooled assets. The Department of Financial Services (DFS), Ministry of Finance would obtain the requisite information in a prescribed format from the PSBs and send a copy to the budget division of DEA, however, the manner and format of reporting has not been notified yet.
  2. Option to buy-back the loans – The Scheme allows the originator to retain an option to buy back its assets after a specified period of 12 months as a repurchase transaction, on a right of first refusal basis. This however, is contradictory to the RBI Guidelines on Direct Assignment, as the same does not allow any option to repurchase the pool in a DA transaction.
  3. To-do for the NBFCs/ HFCs – In order to avail the benefits under the Scheme, the following actionables have to be undertaken:
    1. The Asset Liability structure should restructured within three months to have positive ALM in each bucket for the first three months and on cumulative basis for the remaining period;
    2. At no time during the period for exercise of the option to buy back the assets, should the CRAR go below the regulatory minimum. The promoters shall have to ensure this by infusing equity, where required.

[1] http://pib.gov.in/newsite/PrintRelease.aspx?relid=192618

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