Timothy Lopes, Executive, Vinod Kothari Consultants
Standard asset securitisation in India is governed by the RBI securitisation guidelines of 2006 and 2012. 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 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,
- Legal system; and
- 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 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.
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 –