Posts

Meta-morphed: A corporate bond that puts $27 billion off-the-balance-sheet

/0 Comments/in , , , /by
Meta structures a data center investment funding with cash flows linked with rentals and guarantees

– Vinod Kothari | finserv@vinodkothari.com

In India, we often say: upar wala sab dekhta hai (God sees it all). However, if I could do things which God the almighty does not or cannot see, I will be most happy to do those. Doing things off-the-balance-sheet is always equally tempting; structurers of Frankenstein financial instruments have already tried to bring ingenuity to explore gaps in accounting standards to create such funding structures where the asset or the relevant liability does not show on the books. Recently, a $ 27 billion bond issuance by an SPV called Beignet Investor, LLC may have the ultimate effect of keeping the massive investment done at the instance of Meta group  kept off-the-balance-sheet. 

Structural Features

Essentially, the deal involves issuance of  bonds to the investors, the servicing of which is through the cash flows generated from the lease payments. Further, a residual value guarantee has been provided by the group entity which has again led to a rating upliftment for the bonds issued. 

The essential structure of the transaction involves a combination of project finance, lease payments and a residual value guarantee to shelter investors from project-related risks, and use of an operating lease structure, apparently designed to keep the funding off the balance sheet of Meta group. It is a special purpose joint venture which keeps the funding liability on its balance sheet.

Let us understand the transaction structure:

  • Meta intends to do a huge capex to build a massive 2.064-GW data center campus in Richland Parish, LA. The cost of this investment is estimated at $27 billion in total development costs for the buildings and long-lived power, cooling, and connectivity infrastructure at the campus. The massive facility will take until 2029 to finish.
  • The expense will be incurred by a joint venture, formed for the purpose, where Meta (or its group entities) will hold a 20% stake, and the 80% stake will come from Blue Owl Capital. The two of them together form the JV called Beignet Investor, LLC (issuer of the bonds).
  • The JV Co owns an entity called Laidley LLC, which will be the lessor of the data center facilities.
  • The lessee is a 100% Meta subsidiary, called Pelican Leap LLC, which enters into 4 year leases for each of the 11 data centers. Each lease will have a one-sided renewal option with 4 years’ term each, that is to say, a total term at the discretion of the lessee adding to 20 years. The leases are so-called triple-net (which is a term very commonly used in the leasing industry, implying that the lessor does not take any obligations of maintenance, repairs, or insurance). 
  • The 20-year right of use, though in tranches of  4 years at a time, will mean the rentals are payable over as many years. This is made to coincide with the term of amortisation of the bonds issued by the Issuer, as the bonds mature in 2049 (2026-2029 – the development period, followed by 20 years of amortisation).
  • If the lease renewal is at the option of the lessee, then, how is it that the lease payments for 20 years are guaranteed to amortise the bonds? This is where the so-called “residual value guarantee” (RVG) comes in. RVG is also quite a common feature of lease structures. In the present case, from whatever information is available on public domain, it appears that the RVG is an amount payable by Meta Platforms under a so-called Residual Value Guarantee agreement. The RVG on each renewal date (gaps of 4 years) guarantees to make a payment sufficient to take care of the debt servicing of the bonds, and is significantly lower than the estimated fair value of the data center establishment on each such date. 

The diagram below by provides for the transaction structure: 

Off-balance sheet: Gap in the GAAP?

Of course, as one would have expected, the rating agency Standard and Poor’s that was the sole rating agency having given rating for the bonds, its report does not say the structure is off-the-balance sheet for the lessee, a Meta group entity. However, various analysts and commentators have referred to this funding as off-the-balance sheet. For example, Bloomberg report  says “The SPV structure helps tech companies avoid placing large amounts of debt on their balance sheets”. Another report says that the huge debt of $ 27 billion will be on the balance sheet of Beignet, the JV, rather than on the books of Meta. An  FT report says that bond was priced much higher than Meta’s balance sheet bonds, at a coupon of 6.58%, as a compensation for the off-balance sheet treatment it affords. A write up on Fortune also refers to this funding as off-the-balance sheet. 

In fact, Meta itself, on its website, gives a clear indication that the deal was struck in a way to ensure that the funding is not on the balance sheet of Meta or its affiliates. Here is what Meta says: 

“Meta entered into operating lease agreements with the joint venture for use of all of the facilities of the campus once construction is complete. These lease agreements will have a four-year initial term with options to extend, providing Meta with long-term strategic flexibility.

To balance this optionality in a cost-efficient manner, Meta also provided the joint venture with a residual value guarantee for the first 16 years of operations whereby Meta would make a capped cash payment to the joint venture based on the then-current value of the campus if certain conditions are met following a non-renewal or termination of a lease.”

Here, two points are important to understand – first, the operating lease/financial lease distinction, and second, the so-called residual value guarantee – what it means, and why it is opposite in the present case.

The distinction between financial and operating leases, the key to the off-balance sheet treatment of operating leases, was the product of age-old accounting standards, dating back to the 1960s. In 2019, most countries in the world decided to chuck these accounting standards, and move to a new IFRS 16, which eliminates the distinction between financial and operating leases, at least from the lessee perspective. According to this standard, every lease will be put on the balance sheet, with a value assigned to the obligation to pay lease rentals over the non-cancellable lease term.

However, USA has not aligned completely with IFRS 16, and decided to adopt its own version called ASC 842 for lease accounting. The US accounting approach recognises the difference between operating leases and financial leases, and if the lease qualifies to be an operating lease, it permits the lessee to only bring an amount equal to the “lease liability”, that is, the discounted value of lease rentals as applicable for the lease term.

As to whether the lease qualifies to be an operating lease, or financial lease, one will apply the classic tests of present value of “lease payments” [note IFRS uses the expression “minimum lease payments”], length of lease term vis-a-vis the economic life of the asset, existence of any bargain purchase option, etc. “Lease payments” are defined to include not just the rentals payable by a lessee, but also the minimum residual value. This is coming from para 842-10-25-2(d). The reading of this para is sufficiently complicated, as it makes cross references to another para referring to a “probable payment” under “residual value guarantees”. The reference to para 842-10-55-34 may not be needed in the present case, as the residual value agreed to be paid by the lessee is included in “lease payment” for financial lease determination by virtue of the very definition of financial lease. Therefore, it remains open to interpretation whether the leases in the present case are indeed operating leases.

Considering that the residual value guarantee from the parent company in the present case may not meet the requirements for its inclusion in “lease payments”, it is unlikely that the lease payments over any of the 4 year terms will meet the present value test, to characterise the lease as a financial lease. Also, the economic life of the commercial property in form of the data centers may be significantly longer than the 20 year lease period, including the option to renew. Hence, the lease may quite likely qualify as an operating lease.

Residual value guarantee: Rationale and Implications

In lease contracts, a residual value guarantee by the lessee is understandable as a conjoined obligation with fair use and reasonable wear and tear of assets. In the present case, if the lessee is a tenant for only 4 years, and the renewal thereafter is at the option of the lessee. If the lessee chooses not to renew the lease, the lessee is exercising its uncontrolled discretion available under the lease. So, what could be the justification for the parent company being called to make a payment for the residual value of the property? After all, the property reverts to the lessor, and whatever is the value of the property then is the asset of the lessor. 

In the present case, it seems that the RVG comes under a separate agreement – whether that agreement is linked with the leases is not sure. However, for the holistic understanding of any complicated transaction, one always needs to connect all the dots together to get a a complete understanding of the transaction. If the lessee or a related party is paying for future rentals, it transpires that the understanding between the parties was a non-cancelable lease, and the RVG is a compensation for the loss of future rentals to the lessor. If that is the overall picture, then the lease may well be characterised as a financial lease.

Is the lessee’s balance sheet immune from the bond payment liability?

A liability is what one is obligated to pay; a commitment to pay. The $ 27 billion liability for the bonds in the present case sits on the balance of the JV Company. However, the question is, ultimately, what is it that will ensure the repayment of these bonds? Quite clearly, the payment for the bonds is made to match with the underlying lease payments, with a target debt service coverage. In totality, it is the lease payments that discharge the bond obligation; there is nothing else with the JV company to retire or redeem the bonds. From this perspective as well, an off-balance-sheet treatment at the lessee or at the group level seems tough.

However, off-balance-sheet may not be the objective really. What matters is, does the structure insulate Meta group from the risks of the payments from the data center. From the available data, it appears that the project related risks, from delays in completion to non-renewal, are all taken by Meta. Therefore, even from the viewpoint of project-related risks, there do not seem to be sufficient reasons for any off-balance sheet treatment.

Disclaimer: The analysis in the write-up above is limited to the reading that could be done from write-ups/materials in public domain.  

Other Resources:

Old Rules, New Book: RBI consolidates Regulatory Framework

/1 Comment/in , , , /by

Team Finserv | finserv@vinodkothari.com

RBI Consolidation of Circulars (1)Download

Read our related resources:

RBI’s Regulatory Shelf gets a Pre-Diwali Dusting  

A matter of scale in securitisation

/0 Comments/in , /by

Qasim Saif, Vice President and Yuvraj Kundargi, Executive | finserv@vinodkothari.com

Background

The previous financial year witnessed Indian banks entering the securitisation market as originators, marking a positive step towards large-volume transactions. Their participation also raised expectations that non-lending institutions could increasingly come in as investors in such instruments.

Midway through this year, the Reliance group announced a landmark transaction, raising funds through securitisation of loan receivables of its group entities. These loans are proposed to be repaid from the receivables from usage of digital telecommunication infrastructure by Reliance group companies.

Issuances were made by three trusts: Radhakrishna Securitisation Trust, Shivshakti Securitisation Trust, and Siddhivinayak Securitisation Trust with maturities of approximately three, four and five years respectively, and carrying an average coupon of 7.75%.

This transaction represents the largest securitisation issuance in India to date. It is marked by a unique structure where the transaction is not supported by credit enhancements from the originator. Instead, the obligors’ rating, supported by a guarantee from Reliance Industries Ltd., enabled the securities to achieve a AAA rating.

This article discusses the structure of the transaction, its elements, and the flow of funds.

Read more: A matter of scale in securitisation

Understanding the Structure

1. Loan by Originator

The originators, Sikka Ports & Terminals Limited (SPTL) and Jamnagar Utilities & Power Private Limited (JUPL), provided a long-tenure loan to the obligor, Digital Fibre Infrastructure Trust (DFIT). 

However, the maturity of the loan’s principal extends far beyond the tenure of the pass-through certificates (PTCs) issued under the securitisation structure. Out of a total sanction amount of ₹33131 crore, ₹25000 crore was lent out by the originators for a period of 30 years. An additional loan amounting to ₹8131 crore was also extended, but is not being securitised in this transaction.

2. Put Option with Originator

Parallely, the originator entered into a put option agreement with five Reliance group entities, namely, Reliance Industries Holding Pvt. Ltd., Srichakra Commercials LLP, Karuna Commercials LLP, Devarshi Commercials LLP, and Tattvam Enterprises LLP. The put option gave the originator the right to sell the loan receivables to these entities. Since the maturity of the underlying loan is significantly longer than the tenure of PTCs, the trustee would exercise the put option with the group entities and proceeds from sale of the loan receivables would be used for principal repayment.

Section 19A of the SDI Regulations, which specifies the conditions governing securitisation, mandates that no obligor shall have more than 25% in the asset pool at the time of securitisation. This serves to reduce credit concentration by specifying a minimum number of obligors. Entering into an option agreement with five separate entities fulfills these diversification requirements, ensuring compliance with the SDI regulations.

3. Assignment of Receivables to the Securitisation Trust

The originator assigned the loan receivables, along with the receivables under the put option agreement, to the securitisation trusts. Three trusts were involved in this deal: Siddhivinayak, Shivshakti, and Radhakrishna. SPTL assigned its loans to the first two trusts, while JUPL assigned its loan to Radhakrishna. Reliance Industries Holding Pvt. Ltd., one of the option counterparties, is not a part of the structure of the first trust; Siddhivinayak only has four option counterparties.

(all values in ₹ crore) 

Structure of the deal
TrustsSiddhivinayakShivshaktiRadhakrishna
Value of Receivables6780.346943.364461.71
Assignor of ReceivablesSTPLJUPLJUPL
Value of PTCs8000.008000.005000.00
Value of Options1615.931339.92870.24
Number of Option Counterparties455
Principal Repayment from Options6463.726699.624351.22
Principal Repayment from DFIT1536.281300.38648.78
Yield on PTCs7.80%7.73%7.66%
Tenure of PTCs in years543
4. Issuance of Securitised Notes

The trusts issued securitised notes to investors, backed by loan receivables. These notes, or pass-through certificates (PTCs), have varying tenures of five, four, and three years respectively. They also have different yields, as the table above highlights. The notes were rated by two independent agencies, Crisil and Care Edge, and all three issuances were given a AAA rating.           

5. Investor Participation

Roughly three-fourths of the issuance has been subscribed by the country’s leading asset managers, including Aditya Birla Sun Life AMC, HDFC AMC, ICICI Prudential AMC, Nippon Life India AMC, and SBI Funds Management Ltd.

6. Servicing of Securitised Notes
  • Interest payments: Serviced from the interest on the underlying loan by DFIT .
  • Principal repayments: Since the maturity of the underlying loan is significantly longer than the PTCs, the trustee would exercise the put option with the group entities. The proceeds from the sale of the loan under this option were then used to repay the principal to the securitised noteholders.

Read our other articles:

Securitisation Resource Centre

Key Takeaways – 13th Securitisation Summit, 2025

/0 Comments/in , /by
Loader Loading…
EAD Logo Taking too long?

Reload Reload document
| Open Open in new tab

Download as PDF [9.16 MB]

Access our Publication launched during the 13th Securitisation Summit here.

SEBI Securitisation Regulations: Track Record, Risk retention and Investment size among several new requirements

/0 Comments/in , , , , /by

– Dayita Kanodia (finserv@vinodkothari.com)

Requirements to apply to all listed issuances, from financial and non-financial issuers

Below are the major highlights of the SDI amendment regulations:

SEBI on May 5, 2025 has issued the SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) (Amendment) Regulations. 2025. It may be noted that the SDI Regulations, was first notified on 26th May, 2008, after public consultation on the proposed regulatory structure with respect to public offer and listing of SDIs, following the amendments made in the SCRA. The Regulations, originally referred to as the SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008, were subsequently renamed as SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008, w.e.f. 26th June, 2018.

In order to ensure that the regulatory framework remains in accordance with the  recent developments in the securitisation market, a working group chaired by Mr. Vinod Kothari was formed to suggest changes to the 2008 SDI regulations. Based on the suggestions of the working group and deliberations of SEBI with RBI, the amendment has been issued. The amendment primarily aims to align the SEBI norms for Securitised Debt Instruments (SDIs) with that of the RBI SSA Directions which only applies in case of securitisations undertaken by RBI regulated entities.

It can be said that these amendments are not in conflict with the SSA Directions and therefore for financial sector entities while there may be some additional compliance requirements if the securitisation notes are listed, there are as such no pain points which discourages such entities to go for listing. Further, certain requirements such as MRR, MHP, minimum ticket size have only been mandated for public issue of SDIs and therefore are not applicable in case of privately placed SDIs.

This article discusses the major amendments in the SDI Framework.

Major Changes

Definition of debt

The amendment makes the following changes to the definition of debt:

  1. All financial assets now covered – In order to align the SDI Regulations with the RBI SSA Directions, the definition of ‘debt’ has been amended to cover all financial assets as permitted to be originated by an RBI regulated originator. Further, this is subject to the such classes of assets and receivables as are permissible under the RBI Directions. Note that the RBI SSA Directions does not provide a definition of ‘debt’ or ‘receivables’, however, provides a negative list of assets that cannot be securitised under Para 6(d) of the RBI SSA Directions.
  2. Equipment leasing receivables, rental receivables now covered under the definition of debt.
  3. Listed debt securities – The explicit mention of ‘listed’ debt securities may remove the ambiguity with regard to whether SDIs can be issued backed by underlying unlisted debt securities, and limits the same to only listed debt securities. The second proviso to the definition further clarifies that unlisted debt securities are not permitted as an underlying for the SDIs.
  4. Trade receivables (arising from bills or invoices duly accepted by the obligors) – As regards securitisation of trade receivables, acceptance of bills or invoices is a pre-condition for eligibility of the same as a debt under the SDI Regulations.

‘Acceptance’, in literal terms, would mean acknowledgement of the existence of receivables. Under the Negotiable Instruments Act, 1881, ‘acceptance’ is not defined, however, ‘acceptor’ is defined to mean the drawee of a bill having signed his assent upon the bill, and delivered the same, or given notice of such signing to the holder or to some person on his behalf.

Note that a bill or invoice may either be a hard copy or in digital form. In the context of digital bill, acceptance through signature is not possible; therefore, existence of no disputes indicating a non-acceptance, should be considered as a valid acceptance.

  1. Such Debt/ receivable including sustainable SDIs as may be notified by SEBI – In addition to the forms of debts covered under the SDI Regulations, powers have been reserved with SEBI to specify other forms or nature of debt/ receivable as may be covered under the aforesaid definition. Further, the clause explicitly refers to sustainable SDIs, for which a consultation had been initiated by SEBI in August 2024[1].

Conditions governing securitisation

SEBI has mandated the following conditions to be met for securitisation under the SDI Framework:

  1. No single obligor to constitute more than 25% of the asset pool – This condition has been mandated with a view to ensure appropriate diversification of the asset pool so that risk is not concentrated with only a few obligors. However, it may be noted here that the RBI regulations does not currently prescribe any such obligor concentration condition. Only in case of Simple, Transparent and Comparable securitisation transactions, there is a mandate requiring a maximum concentration of 2% of the pool for each obligor.

However, SEBI has retained the power to relax this condition. In our view, this may be relaxed by SEBI for RBI regulated entities considering that RBI does not prescribe for any such condition.

  1. All assets to be homogenous – This is yet another provision which is only required by RBI in case of STC transactions. However, even in the context of RBI regulations, what exactly constitutes a homogenous asset is mostly a subjective test. SEBI has defined homogenous to mean same or similar risk or return profile arising from the proposed underlying for a securitised debt instrument. This has made the test of homogeneity even more subjective. For the purpose of determining homogeneity, reference can be made to the homogeneity parameters laid out by RBI in case of Simple, Transparent and Comparable securitization transactions.
  2. SDIs will need to be fully paid up-  The SDIs will need to be fully paid up, i.e., partly paid up SDIs cannot be securitised. 
  3. Originators to have a track record of 3 financial years: Originators should be in the same business of originating the receivables being securitised for a period of at least three financial years. This restricts new entities from securitising their receivables. However, this condition in our view should only apply to business entities other than business entities, complying with this condition does not seem feasible. 
  4. Obligors to have a track record of 3 financial years– The intent behind this seems to to reduce the risk associated with the transaction as the obligors having a track record in the same operations which resulted in the creation of receivables being securitized. However, this condition cannot be met in most types of future flow securitisation transactions such as toll road receivables and receivables from music royalties.

SEBI has made it clear that the last two conditions of maintenance of track record of 3 years for originators and obligors will not apply in case of transactions where the originators is an RBI regulated entity.

Amendments only applicable in case of public issue of SDIs

The following amendments will only be applicable if the SDIs are issued to the public. Here, it may be noted that the maximum number of investors in case of private placement of SDIs is limited to 50.

Minimum Ticket Size

The Erstwhile SDI Regulations did not provide for any minimum ticket size. However, with a view to align the SDI regulations with that of RBI’s SSA Direction, a minimum ticket size of Rs. 1 crore has been mandated in case of originators which are RBI regulated as well as of non-RBI regulated entities. It may however be noted that the minimum ticket size requirement has only been introduced in case of public offer of SDIs. Further, in cases with SDIs having listed securities as underlying, the minimum ticket size shall be the face value of such listed security.

Securitisation is generally perceived as a sophisticated and complex structure and therefore the regulators are not comfortable in making the same available to the retail investors. Accordingly, a minimum ticket size  of Rs. 1 Crore has been mandated for public issue of SDIs. In case of privately placed SDIs, the issuer will therefore have the discretion to decide on the minimum ticket size. However, since the RBI also mandates a minimum ticket size of Rs. 1 Crore, financial sector entities will need to adhere to the same.

Here, it is also important to note that in case of public issue of SDIs with respect to originators not regulated by RBI, SEBI has made it clear that the minimum ticket size of Rs. 1 Crore should be seen both at initial subscription as well as at the time of subsequent transfers of SDIs. However, nothing has been said for subsequent transfers in cases where the originator is a RBI regulated entity. The RBI SSA Directions also requires such minimum ticket size of Rs. 1 Crore to be seen only at the time of initial subscription. This in many cases led to the securitisation notes being broken down into smaller amounts in the secondary market.

In the absence of anything mentioned for RBI regulated entities, it can be said that there is no change with respect to the ticket size for RBI regulated entities even in the case of publicly issued SDIs which should be seen only at the time of initial subscription.

It is worth mentioning that under the SSA Directions of RBI requires that in case of transactions carried out outside of the SSA Directions (the transactions undertaken by non-RBI regulated entities), the investors which are regulated by RBI have to maintain full capital charge. This therefore discourages Banks from investing in securitisation transactions which are carried out outside the ambit of the SSA Directions.  Therefore, both retail investors as well RBI regulated entities will not be the investors which will hinder liquidity and overall growth of the SDI market.

Minimum Risk Retention

Aligning with RBI’s SSA Direction, a Minimum Risk Retention (MRR) requirement for public issue of SDIs has been mandated requiring retention by the originator of a minimum of

  1. 5% in case the residual maturity of the underlying loans is upto 24 months and
  2. 10% in case residual maturity is more than 24 months

Further, in case of RMBS transactions, the MRR has been kept at 5% irrespective of the original tenure.

SEBI has aligned the entire MRR conditions with that of the RBI SSA Directions, including the quantum and form of maintenance of MRR. Accordingly, for financial sector entities, there is no change with respect to MRR.

By introducing MRR in the SDI Regulations, non-financial sector entities will be held to similar standards of accountability, skin-in-the-game, reducing the risks associated with the originate-to-sell model and aligning their practices with those of financial sector originators. This will strengthen investor confidence across the board and mitigate risks of moral hazard or lax underwriting standards.

It may however be noted here that in case of non financial originators, there could be situations where retention is being maintained in some form (for example in leasing transactions, the residual value of the leased assets continues to be held by the originator) and therefore such originators will be required to hold MRR in addition to the retention maintained.

Minimum Holding Period

SEBI has aligned the MHP conditions as prescribed under the SSA directions for all RBI regulated entities. Accordingly, there is no additional compliance requirement for RBI regulated entities. For receivables other than loans, the MHP condition will be specified by SEBI.

Exercise of Clean up Call option by the originator

The provisions for the exercise of the clean up call option has been aligned with those prescribed under the SSA Directions. These provisions have been introduced under the chapter applicable in case of public offer of SDIs. However, the SDI Regulations always provided for the exercise of clean up call option and what has been now introduced in simply the manner in which such an option has to be exercised.

In case of private placement of SDIs, can the clean up call option be exercised at a threshold exceeding 10% ?

Although the provisions for the exercise of clean up call options has been made a part of chapter applicable in case of public offers, it should however be noted that these provisions are also a part of the RBI SSA Directions. Accordingly, financial sector originators are bound by such conditions even if they go for private placement of SDIs. Further, even in the case of the non-financial sector originator, clean up call is simply the clean up of the leftovers when they serve no economic purpose. Therefore, in our view, exercising clean up calls at a higher threshold should not arise.

Other Amendments

  1. Norms for liquidity facility aligned with that of RBI regulations
  2. All references to the Companies Act 1956 has been changed to Companies Act 2013
  3. Chapter on registration of trustees has been removed and reference has been made to SEBI (Debenture Trustees) Regulations, 1993
  4. Disclosure requirements for the originator and the SPDE have been prescribed; however the disclosure formats are yet to be issued by SEBI.
  5. Public offer of SDIs to remain open for a minimum period of 2 working days and upto a maximum of 10 working days.

Amendments proposed in the SEBI(LODR) Regulations

There are primarily two regulations which govern the listing of SDIs:

  1. SEBI SDI Regulations
  2. SEBI LODR Regulations

The following amendments have been proposed in the LODR regulations:

  1. SCORES registration to be taken at the trustee level
  2. Outstanding litigations, any material developments in relation to the originator or servicer or any other party to the transaction which could be prejudicial to the interests of the investors to be disclosed on an annual basis.
  3. Servicing related defaults to be disclosed on an annual basis.

[1] Read an article on the concept of sustainable SDIs at – https://vinodkothari.com/2024/09/sustainable-securitisation-the-next-in-filling-sustainable-finance-gap-in-india

Securitisation of Stressed Assets (SOSTRA)

/0 Comments/in , , , /by

Team Finserv | finserv@vinodkothari.com

Loader Loading…
EAD Logo Taking too long?

Reload Reload document
| Open Open in new tab

Download as PDF [592.82 KB]

NBFC Regulatory Refresher

/0 Comments/in , , , /by

RBI Updates for NBFCs- A rerun of the regulatory changes introduced during FY 24-25

– Team Finserv (finserv@vinodkothari.com)

Watch our youtube video: https://youtu.be/Vg4vFrWfzsw

Loader Loading…
EAD Logo Taking too long?

Reload Reload document
| Open Open in new tab

Download as PDF [712.35 KB]

Read more:

Bond Credit Enhancement Framework: Competitive, rational, reasonable

Balancing between Bling & Business: RBI proposes new Gold Lending rules

Unified framework for Non-fund based facilities, by banks and NBFCs

SOSTRA: The New shastra of liquidating Non-performing loans

Webinar on 4 new major regulations on NPL Securitisation, Co-lending, Gold lending and NFB facilities

/0 Comments/in , , /by

Register here: https://forms.gle/TUZLiAfjhsBfoyfn6

Loader Loading…
EAD Logo Taking too long?

Reload Reload document
| Open Open in new tab

Download as PDF [772.95 KB]

Read More:

SOSTRA: The New shastra of liquidating Non-performing loans

/0 Comments/in , , /by

-Team Finserv (finserv@vinodkothari.com)

“Only the few know the sweetness of the twisted apples” – Sherwood Anderson

If securitisation of stressed assets abbreviates as SOSTRA, here is the new shastra (tool) for NPA clean-up from the financial system. On January 11, 2024, while speaking at the Centre for Advanced Financial Learning (CAFRAL)[1], then RBI Governor Shaktikanta Das announced that the RBI is in the process of formulating a framework for the securitisation of stressed assets based on the public comments received on the Discussion Paper on Securitisation of Stressed Assets Framework, released by the RBI on January, 2023.

Based on the comments received on the above mentioned discussion paper and as  proposed in the Statement on Developmental and Regulatory Policies dated April 09, 2025, the RBI has now released a draft framework for securitisation of non-performing assets. This is a major improvisation over the draft originally released in January 2023.

Some of the highlights of the new Draft Directions are:

  • Banks as well as NBFCs may securitise pool of NPAs;
  • The pool shall consist entirely of stressed loans, but upto 10% of the pool may be assets which are standard (that is, more than 1 but upto 89 DPD). That is, originators may add a deal-sweetener. However, re-performing loans (that is, those that earned the tag of an NPA due to past default history, which is not completely washed out) may be securitised;
  • To ensure that the pool does not have a significant concentricity, the Herfindahl Index of the loan pool should be within 0.3;
  • The originator may optionally engage the services of a resolution manager fulfilling such eligibility criteria as mentioned under the Draft Directions;
  • The originator may retain upto 20% exposure in the pool (that is, first loss piece, plus 10%, not exceeding 20% in total);
  • Securitisation notes acquired by the buyer will get a standard status to begin with, but will be subject to valuation and provisioning requirements. The provisioning requirement is based on a linear amortisation of 20% each year, and aims at splitting the total provision to the tranches in the ratio of risk weights. Highest provisioning will be taken by the equity tranche, and lowest by the senior tranche.
  • The SPV needs to ensure that the investors are not related parties of the borrower or disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016
  • For the purpose of ticket size the Directions have referred to the SSA Directions hence the minimum ticket size for issuance of securitisation notes shall be Rs. 1 crore.

Team VKC notes: In the 2023 draft, team VKC submitted clause-wise comments to the RBI and also gave a presentation to the RBI’s team. Many of our recommendations have been accepted by the RBI.

In our view, the proposed draft Directions provide an effective solution to clean up the NPA clogs, particularly in case of retail loans.

The key highlights of the proposed framework are illustrated below:

Existing framework:

At present, in India, there exists a framework for securitisation of standard assets only which are regulated through the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021’ (‘SSA Directions’), which deals with standard asset securitisation. Under the SSA Directions, the definition of standard assets does not include non-performing loans, i.e., only those assets with a delinquency up to 89 days, would qualify for securitisation under the SSA directions.

On the other hand, in case of stressed loans, the TLE  framework has always been permissive. That is, stressed loans may be sold by way of bilateral transactions.

Now, the present draft directions, Reserve Bank of India (Securitisation of Stressed Assets) Directions, 2025 (‘Draft Directions’) has been issued to facilitate securitisation of assets with a delinquency of more than 89 days, i.e stressed loans. The RBI proposed to introduce a framework for the purpose of securitisation of stressed loans back in 2023. The RBI had published a discussion paper for public consultation titled  Discussion Paper on Securitisation of Stressed Assets Framework, whereunder the paper discussed the mechanism of securitisation of stressed assets. Vide the Statement on Developmental and Regulatory Policies the RBI announced its intention to come out with a draft framework for Securitisation of Stressed Assets and accordingly the draft framework for public consultation towards the same has been published on 09 April 2025, with comment period upto 12th May, 2025.

Comparative Analysis – SOSTRA, ARC and SSFs

BasisSOSTRAAsset Reconstruction CompaniesSpecial Situation Funds
Global contextSecuritisation of NPLs happens all over the world; in some cases (home loans in particular), with State support. Globally, AMCs were envisaged, normally with a sunset, to tide over a crisis. Essentially for resolving systemic generation of NPLsFor driving investments into stressed loans, essentially with a view to the underlying collateral; mostly with significant upside opportunities
Indian contextSecuritisation is currently allowed for standard assets only; draft Directions now permit securitisation of NPLs, including, within a limit of 10%, stressed but standard assets27 ARCs exist; however, most of them focus on asset aggregation, IBC resolution etc. Relatively less active in retail loan spaceCumulative Data as at Dec 31, 2024: Commitments raised-2048 cr.; Funds Raised- 1531 cr; Investment made-1510 crComparatively less popular
Economic driversUnlocking the inherent value of NPLs, particularly those which are still giving regular cashflows. Pertinent in case of retail poolsResolution abilities of the ARC, in particular, sec 8 and 13 of the SARFAESI Act, legal powers and IBCInvestment returns based on the underlying collateral
Minimum Ticket Size For investment- min. ₹1 crore per investor  (similar to SSA Directions)No statutory ticket size, but given limited number of investors, mostly aligned with the deal size.Min. Investment by an Investor Rs 10 crores.
Nature of the investmentCredit-enhanced, mostly rated investment in securitisation notes, backed by cashflows expected from the pool of securitised loans. Distributions happen on a waterfall mechanismInvestment in security receipts; no credit enhancements. Distributions happen as and when collections are done.Pooled investment by investors into a fund, which in turn buys multiple stressed loans. Subordination structures currently not permitted.
Skin-in-game for the originatorNo originator risk retention stipulated; however, tranching/ credit-enhancement call for originator risk retention. Maximum originator retention 20%.No minimum originator retention; ARC investment minimum 15% of originator’s share, or 2.5% of total SRs, w.e.h. SRs are pari passu – hence, subordination is not common/permittedDirection acquisition of NPLs by the fund does not seem possible under the structure, except under Clause 58 of TLE Directions (resolution plans or JLF decision)
Potential InvestorsAny investor, except related parties of the borrower or persons disqualified in terms of Section 29A of the IBC. AIFs, FPIs, ARCs, all NBFCs (28th Feb 2025 notification), Banks (QBs)HNIs and well-informed, sophisticated  investors
Diversification of poolSecuritisation requires pool diversification – Herfindahl Index to be within 0.3. Single loan or chunky loans cannot be securitisedSingle loan or chunky loans may be securitisedWill mostly be applicable in case of corporate loans undergoing JLF/IBC mechanism
Types of assets that can  be acquiredNPAs- must be min. 90% Up to 10% can be stressed loans with 1 to 89 DPDFraud/red-flagged/wilful default accounts cannot be securitized.All stressed loans which are in default for 1 DPD or more, NPAs,SRs of other ARCs, Fraud/wilful default accounts allowed (with conditions)Stressed loans under clause 58 of TLE Directions, SRs of ARCs,Securities of distressed companies
MHP required on stressed assets NoneNone in case of transfer to ARCNone in case of transfer to SSF;Further 6 month MHP is applicable on SSF
Enforcement of  security interest under  the SARFAESI ActPossible to retain originator’s privity with the borrower; hence, originator’s original powers (if any) may continue. Enforcement under SARFAESI – sec 13 Special powers under sec. 9In case original loan did not have the power, the power of the assignee is questioned in court rulingsRecommendation has been made by  SEBI to RBI to include SSFs under the  definition of ‘Secured Creditor’ under  SARFAESI
Stamp Duty implicationsStamp duty as per Indian Stamp Act, 1899No stamp duty (8F of the Indian Stamp  Act, 1899)Stamp duty as per Indian Stamp Act,  1899, till any specific exemption is  granted similar to ARCs
Tax TreatmentIncome-tax Act section 115TCA currently does not cover this mode, as it refers to standard assets only.Listed PTCs may be the option.Pass through treatment u/s 115TCA of the Income Tax Act 1961SSF exempted under Section 10(23FBA) Income is taxable directly in the hands of the investors under Section 115UB
Due DiligenceRBI-regulated lenders making investment shall do DD.ARC do DD of the stressed assets.Initial and continuous DD of it’s Investors- as applicable on ARCs

Eligible Lenders

Eligible Lenders who were eligible to securitise under the Securitisation of Standards Asset Master Directions (SSA Directions) are also the permissible/eligible lenders who can securitise their stressed asset under these Draft Directions. Hence accordingly the lenders who can securitise their stressed loans shall mean:

  1. Scheduled Commercial Banks (except RRBs)
  2. All India Financial Institutions
  3. Small Finance Banks
  4. All NBFCs (Including HFCs)

Eligible Assets

Stressed Loans under the Draft Directions will include loans having a DPD status of more than 0 days. It should be mentioned here that under the current SSA Directions, loans having a DPD status of upto 89 days can be securitised. Thus, the current draft directions will cover both, i.e.,

  • Loans having a DPD status of 1-89 days as well as
  • Loans classified as Non performing assets

However, certain conditions are required to be met for the securitisation of a pool of assets under the Draft Directions:

a. The sum of the outstanding exposures in the underlying pool classified as NPA is equal to or higher than 90% of the total outstanding amount

Here, it may be mentioned that our recommendation made to RBI in February 2023, we discussed including standard assets as a part of the stressed loan pool. Our submission was that considering that regulatory frameworks world over do not restrict the inclusion of standard assets and therefore the composition of the pool should be left for the market forces to determine.

b. Sum of squares of relative shares of underlying stressed loans is 0.30 or less calculated as follows:

  1. Calculate the outstanding balance of each loan
  2. Divided this figure by total outstanding balance of the portfolio on the origination cut-off date
  3. Square the figures obtained
  4. Calculate the total sum of these squares
  5. The resulting number should be equal to or less than 0.30.

Let us illustrate the same with an example:

 Outstanding Balance of each loan (L) L/B(L/B)^2 = S
     
L1100L1/B0.10638297870.01131733816
L2120L2/B0.12765957450.01629696695
L3130L3/B0.13829787230.01912630149
L4150L4/B0.15957446810.02546401086
L5110L5/B0.11702127660.01369397918
L690L6/B0.095744680850.009167043911
L780L7/B0.085106382980.007243096424
L8160L8/B0.1702127660.02897238569
 
Total outstanding balance of the portfolio (B)940 Sum of S0.1312811227

This approach has been mandated to prevent a single loan from comprising a significant portion of the pool. Given that these are stressed loans, ensuring diversification and avoiding concentration of any one loan is particularly important.

Assets that cannot be securitised

Similar to the present SSA Directions, the Draft Directions for securitisation of stressed loans also contain a list of assets that cannot be securitised. These include,

  1. Re-securitisation exposures
  2. Exposures to other lending institutions
  3. Refinance exposures of AIFIs
  4. Farm Credit
  5. Education Loan
  6. Accounts identified as Fraud/Red Flagged Account, and
  7. Accounts identified as or being examined for ‘Wilful Default

It may also be noted that under the Draft Directions, where standard assets form part of the pool (up to a maximum of 90% of the total outstanding amount), it must be ensured that such standard loan assets do not fall under the negative list prescribed under the SSA Directions.

Homogeneity of the Pool

The Draft Directions prescribe that the underlying loans must be homogenous. In this regard, the Draft Directions provide that loan exposures from the following two categories of loans should not be mixed as a part of the same pool:

  1. Personal loans and business loans to individuals; and Loans to Micro Enterprises, not exceeding ₹50 Crore and,
  2. All other Loans

Minimum Holding Period (MHP)

The Draft Directions do not prescribe any MHP requirements, aligning with their objective of facilitating the securitisation of NPAs. Since assets must be held for a certain period to be classified as NPAs, the intent behind MHP is inherently met.

While the framework allows up to 10% of the pool to consist of stressed assets not yet classified as NPAs, we believe MHP should not apply to these either.

Minimum and Maximum Risk Retention

  1. Minimum Retention Requirements

Under the Draft Directions, unlike the SSA Directions, maintaining a MRR is not a mandatory requirement. In our representation submitted to RBI, we discussed how imposing a MRR requirement might be unnecessary. We submitted that, under the SSA Directions, MRR is intended to ensure that the originator maintains a continuing stake in the securitised pool, thereby discouraging an originate-to-sell model that could lead to weak origination or underwriting standards.

However, in the context of NPAs, the originator has already demonstrated a continuing stake in the assets, and the objective of securitisation is now to offload these stressed exposures from its books. This changes the risk dynamics, making a mandatory MRR less relevant in such cases.

It may however be noted that paragraph 8 of the Draft Directions provides that the originator, the relationship manager (ReM), or both may retain a portion of the risk, in accordance with the terms of the contractual arrangement between them. Notably, where the originator is also appointed by the Special Purpose Vehicle (SPV) to act as the ReM for the purposes of resolution and recovery, a retention requirement is triggered.

  1. Maximum Retained Exposure

Like the SSA Directions the Draft Directions provide a maximum retention of 20% by the originator, however interestingly one stipulation that has been introduced under the Draft Directions requires that any exposure above 10% upto 20% should be recognized as a first loss piece for all prudential purposes.

Structure

The Draft Directions has referred to the present SSA Directions for provisions around providing of credit enhancement facilities, liquidity facilities, underwriting facilities and servicing facilities to securitisation of stressed assets.

Resolution Manager

The Draft Directions also discuss that a ReM may be appointed who shall be responsible for administering the resolution/recovery of the underlying stressed exposures. Such ReM is required to have requisite expertise in the resolution of NPAs, including drawing of effective business plans, recovery strategies, and loan management.

It may be mentioned here that, the representation made to RBI in 2023 discussed how globally, a resolution manager is not a common feature in most NPA securitisation Structures and therefore, in this regard, the suggestion will be to provide for enabling provisions which will allow the market participants to appoint a resolution manager should there be a need to appoint one, depending on the characteristics of the underlying pool. Thus, our suggestion was to allow discretion with the market participants to appoint a RM.

Requirements relating to Resolution Manager

  1. Should not be a person disqualified under Section 29 A of IBC;
  2. Should not be a related party of the originator;
  3. Should not support losses of SPV except to the extent contractually agreed upon;
  4. Should remit all cashflows as per agreed terms;
  5. During interim period from cash collection to remitting to SPE, collections to be made in escrow account;
  6. ReM can raise additional finance for the purpose of resolution related activities of the pool to the extent of 75% of total requirement. However finance cannot be taken from originator
  7. ReM to adhere to guidelines of FPC issued by RBI

Comparison of SSA, TLE and Proposed SOSTRA Framework

 SSA frameworkTLE frameworkProposed SOSTRA framework
Loans not in defaultPermittedPermittedNot permitted
DPD 1-89 days (Classified as Standard)PermittedPermittedPermitted upto 10% of the pool size
DPD 1-89 days (Classified as NPA)Not permittedPermittedPermitted
DPD > 90 daysNot permittedPermittedPermitted
Intent of the originatorLiquidity, capital relief etcLiquidity, capital relief, off-balance sheet, concentration reliefNPA clean up
Intent of the investorYieldInorganic book buildingYield
MRRRequiredNot requiredNot required
MHPRequiredRequiredNot required
Credit EnhancementCan be providedCannot be providedCan be provided
Liquidity FacilityCan be providedCannot be providedCan be provided

[1] Availabe at: https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1402