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List of compliances for listing of securitisation notes

– Aanchal Kaur Nagpal, Assistant Manager | Sharon Pinto, Manager | finserv@vinodkothari.com

Our write-ups on related topics:

  1. FAQs on Securitisation of Standard Assets – https://vinodkothari.com/2021/10/faqs-on-securitisation-of-standard-assets/
  2. After 15 years: New Securitisation regulatory framework takes effect – https://vinodkothari.com/2021/09/rbi-master-directions-on-securitisation-of-standard-assets-and-transfer-of-loan-exposures/

9th Securitisation Summit – Report and Presentations

Next year will mark our 10th anniversary of the Securitisation Summit. It is scheduled to be held in mid May 2022.

Presentations made at the 9th Securitisation Summit, 2021 can be accessed from the links given below:

  1. Mr. Loic Chiquier – click here
  2. Dr. Vincenzo Bavoso – click here
  3. Mr. Mark Adelson – click here
  4. Mr. Abhishek Dafria – click here
  5. Mr. Ajay tendulkar – click here

Post-summit report:

Profile of Speakers – 9th Securitisation Summit | November 18, 2021 | Hotel Four Seasons, Mumbai

Agenda for the 9th Securitisation Summit can be viewed herehttps://vinodkothari.com/2021/11/agenda-9th-securitisation-summit-november-18-2021-hotel-four-seasons-mumbai/

Summit home page can be viewed here: https://vinodkothari.com/secsummit/

Agenda – 9th Securitisation Summit | November 18, 2021 | Hotel Four Seasons, Mumbai

Profile of speakers can be viewed herehttps://vinodkothari.com/2021/11/profile-of-speakers-9th-securitisation-summit-november-18-2021-hotel-four-seasons-mumbai/

Summit home page can be viewed here: https://vinodkothari.com/secsummit/

Indian Securitisation Awards, 2021

As the securitization market in India is on an upswing, it is time to recognize performance, innovation and service. Awards are not merely a sense of accomplishment – awards are to encourage players to move to better services and consistent performance. The awards will be given by the Indian Securitisation Foundation at the 9 th Securitisation Summit 2021 on November 18, 2021 at Four Seasons Hotel, Mumbai and may be handed over to the awardees during the Securitisation Summit.

Details for 9th Indian Securitisation Summit may be accessed at this Link.

One stop RBI norms on transfer of loan exposures

– Financial Services Division (finserv@vinodkothari.com)

[This version dated 24th September, 2021. We are continuing to develop the write-up further – please do come back]

We invite you all to join us at the Indian Securitisation Summit, 2021. The details can be accessed here

The RBI has consolidated the guidelines with respect to transfer of standard assets as well as stressed assets by regulated financial entities under a common regulation named Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (“Directions”).

The Directions divided into five operative chapters- the first one specifying the scope and definitions, the second one laying down general conditions applicable on all loan transfers, the third one specifying the requirements in case of transfer of loans which are not in default, that is standard assets, the fourth one provides the additional requirement for transfer of stressed assets and the fifth chapter is on disclosure and reporting requirements.

Under the said Directions, the following entities are permitted as transferor and transferee to transfer loans-

Permitted Transferors Permitted Transferees
Scheduled Commercial Banks; Scheduled Commercial Banks;
All India Financial Institutions Th(NABARD, NHB, EXIM Bank, and SIDBI); All India Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI);
Small Finance Banks; Small Finance Banks;
All Non Banking Finance Companies (NBFCs) including Housing Finance Companies (HFCs); All Non Banking Finance Companies (NBFCs) including Housing Finance Companies (HFCs)
Regional Rural Banks; 

(only for stressed loans under Chapter IV)

Asset Reconstruction Companies registered with the Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; 

(only for stressed loans under para 58)

Primary (Urban) Co-operative Banks/State Co-operative Banks/District Central Co-operative Banks; 

(only for stressed loans under Chapter IV)

A company, as defined in sub-section (20) of Section 2 of the Companies Act, 2013 other than a financial service provider as defined in sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016. Acquisition of loan exposures by such companies shall be subject to the relevant provisions of the Companies Act, 2013 

(only for stressed loans under para 58)

An entity incorporated in India or registered with a financial sector regulator in India and complying with the other conditions under clause 58 

(only for stressed loans under para 58)

Coverage

The Directions state that no lender shall undertake any loan transfers or acquisitions other than those permitted and prescribed under the Directions and the provisions of Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021. Therefore,  loans originated by the Transferor (mentioned above) cannot be transferred outside the purview of the aforesaid guidelines. Accordingly, the loans cannot be transferred to anyone, other than the transferee mentioned above, hence, this would now prohibit any loan transfers that happened outside the purview of the Directions. This in turn would also restrict covered bonds transactions wherein the loan pool was assigned to an SPV- unless the same is specifically permitted by the RBI. However, if the transfer does not result in transfer of economic interest, the same shall not be considered as a ‘transfer’ per se. Hence, covered bonds transactions that are structured in a way that the legal title is transferred, however, the economic interest is retained by the originator, the same shall be considered as ‘loan transfer’. 

At the time of occurence of default, the actual loan transfer happens and the same shall be

Further, the Directions shall be applicable even in case of sale of loans through novation or assignment, and loan participation.

In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the transferee(s) to the extent of economic interest transferred.

Meaning of the word ‘Transfer’

The term transfer has been defined to mean a transfer of economic interest in loan exposures by the transferor to the transferee(s), with or without the transfer of the underlying loan contract, in the manner permitted in the Directions.

It is to be noted that loan participation transaction have also been recognised under the Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee(s) without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

General Conditions on all loan transfers

The Directions lays down some generic requirements on all loan transfers. Some of the crucial ones are as follows:

  1. Having a board approved policy
  2. Must result in transfer of economic interests without resulting in a change in underlying terms and conditions of the loan contract.Must result in transfer of economic interests without resulting in a change in underlying terms and conditions of the loan contract.
  3. Clearly delineated roles and responsibilities of the transferor and the transferee
  4. No credit enhancement or liquidity facilities in any form
  5. Transferor cannot reacquire, except as a part of Resolution Plan
  6. Immediate separation of the transferor from the risks and rewards associated with loans
    1. For retained exposure- the loan transfer agreement should clearly specify the distribution of the principal and interest income from the transferred loan between the transferor and the transferee(s)
  7. Transferee to get right to transfer or dispose off the loans transferred
  8. Rights of obligors not to be affected Immediate separation of the transferor from the risks and rewards associated with loans
    1. For retained exposure- the loan transfer agreement should clearly specify the distribution of the principal and interest income from the transferred loan between the transferor and the transferee(s)
  9. Transferee to get right to transfer or dispose off the loans transferred
  10. Rights of obligors not to be affected
  11. Monitor on an ongoing basis and in a timely manner performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any.

The aforesaid clauses are applicable on all loan transfers under the Directions- this should not include the ones exempted from the purview of the Directions. The transactions that are specified under the exclusion list should be exempted from the applicability of the entire guidelines. However, the language is suggesting that the aforesaid general conditions including the requirement of not having any form of credit enhancement is applicable, even if the transaction is exempt from purview of Chapter III regulations on Transfer of Standard Assets.

Transferor as a service provider

As allowed under the existing guidelines as well, the transferor may act as servicing facility provider for the loans transferred. While appointing a servicing facility provider, following conditions must be fulfilled:

  • Execution of written agreement outlining:
    • nature and purpose and extent of services, 
    • standards of performance
    • duration (limited to amortisation of loans, payment of all claims of transferee or termination by parties) 
    • Right of transferee to appoint other facility provider
    • No obligation on facility provider, being transferor, to transfer funds until they are received;
    • Facility provider, being transferor, must hold cashflows in trust for transferee and avoid commingling
  • Facility to be on arm’s length basis;
  • Fee must not be subject to deferral, waiver or non-payment clauses; Also, no recourse to servicing facility provider beyond contractual obligations;

Transfer of Standard Loans

Transfer of all standard loans, except the following, shall be covered under the Directions:

Exclusion List:

●      transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;

●      inter-bank participations covered by the circular DBOD.No.BP.BC.57/62-88 dated December 31, 1988 as amended from time to time;

●      sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;

●      sale of stressed loans; and

●      any other arrangement/transactions, specifically exempted by the RBI

Minimum Risk Retention

The Directions specifically require that the due diligence in respect of the loans cannot be outsourced by the transferee(s) and should be carried out by its own staff, at the level of each loan, with the same rigour and as per the same policies as would have been done for originating any loan.

However, in case of loans acquired as a portfolio, in case a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the transferor has to retain at least 10% of economic interest in the transferred loans. In such a case as well, the transferee shall perform due diligence at the individual loan level for not less than one-third of the portfolio by value and number of loans in the portfolio and at the portfolio level for the remaining.

In case of multiple transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferees is unable to perform the DD at individual level.

The following graphic summarises the position of MRR in case of transfer of loan exposures:

Minimum Holding Period

Under the erstwhile framework, there were three blocks of minimum holding periods, however under the new Directions there are two major brackets – one for loans with original maturity less than 2 years and one with more than 2 years. The table below summarises the MHP requirements for different classes of loans:

  Secured Loans

 

Unsecured Loans Project loans Acquired Loans
Loan Tenor MHP MHP MHP MHP
Upto 2 years 3 months  from the date of registration of the underlying security interest 3 months  from the date of first repayment of the loan 3 months  from the date of commencement of commercial operations of the project being financed Six months from the date on which the loan was taken into the books of the transferor
More than 2 years 6 months from the date of registration of the underlying security interest 6 months from the date of first repayment of the loan 6 months from the date of commencement of commercial operations of the project being financed
MHP requirement is not applicable to loans transferred by the arranging bank to other lenders under a syndication arrangement

 The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator for a certain specified time period. However, in case of secured loans, the MHP is being counted from the date of creation of security interest- this does not seem to be in sync with the intent of having a MHP.

Accounting of transfer of loans

If the transfer of loans result in loss or profit, which is realised, should be accounted for accordingly and reflected in the Profit & Loss account of the transferor for the accounting period during which the transfer is completed. However, unrealised profits, if any, arising out of such transfers, shall be deducted from CET 1 capital or net owned funds for meeting regulatory capital adequacy requirements till the maturity of such loans.

Borrower-wise accounts will have to be maintained for the loans transferred and retained by the transferee and the transferor, respectively.

The income recognition, asset classification, and provisioning norms will be followed by the transferor and the transferee with respect to their share of holding in the underlying account(s).

Transfer of Stressed Loans

The transfer of stressed loans can be done through assignment or novation only; loan participation is not permitted in the case of stressed loans. .In general, lenders shall transfer stressed loans, including through bilateral sales, only to permitted transferees and ARCs

Contents of the Board approved policies on Transfer and / or acquisition of Stressed Loans:

●      Norms and procedure for transfer or acquisition of such loans;

●      Manner of transfer- including e-auctions;

●      Valuation methodology to be followed to ensure that the realisable value of stressed loans, including the realisability of the underlying security interest, if available, is reasonably estimated;

●      Delegation of powers to various functionaries for taking decision on the transfer or acquisition of the loans;

●      Stated objectives for acquiring stressed assets;

●      Risk premium to be applied considering the asset classification, for discounting the cashflows to arrive at the difference between the NPV of the cashflows estimated while acquiring the loan and the consideration paid for acquiring the loan;

●      Process of identification of stressed loans beyond a specified value;

●      Price discovery and value maximization approach;

The Directions also restrict the transferor to not assume any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee(s) with reference to the loan transferred. Any fresh exposure on the borrower can be taken only after a cooling period laid down in the respective Board approved policy, which in any case, shall not be less than 12 months from the date of such transfer.

Transfer of stressed loans undertaken by way of a resolution plan

In case of transfer of stressed loans undertaken as a resolution plan under the RBI (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 resulting in an exit of all lenders from the stressed loan exposure, such transfer is permitted to the prescribed class of entities, including a corporate entity, that are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator, a

However, in case such transferee(s) are neither ARCs nor permitted transferees, the transfer shall be additionally subject to the following conditions:

  • The transferee entity should be incorporated in India or registered with a financial sector regulator in India (Securities and Exchange Board of India, Insurance Regulatory and Development Authority of India, Pension Fund Regulatory and Development Authority, and International Financial Services Centres Authority).
  • The transferee should not be classified as a non-performing account (NPA) by any lending institution at the time of such transfer;
  • The transferee(s) should not fund the loan acquisition through loans from Permitted Transferors.
  • Permitted transferors should not grant any credit facilities apart from working capital facilities (which are not in the nature of term loans) to the borrower whose loan account is transferred, for at least three years from the date of such transfer.
  • Further, for at least three years from the date of such transfer, the Permitted Transferors should not grant any credit facilities to the transferee(s) for deployment, either directly or indirectly, into the operations of the borrower.

Accounting treatment in the books of the transferee

Treatment of stressed loan in the books of the transferee for the purpose of prudential requirements such as asset classification, capital computation, income recognition shall be as follows-

Pool of stressed loans acquired on a portfolio basis shall be treated as a single asset provided that the pool consists of homogeneous personal loans.

 

Homogeneity should be assessed on the basis of common risk drivers, including similar risk factors and risk profiles.

In all other cases, the stressed loans acquired shall be treated as separate assets

Additional requirement for Transfer of NPAs

For Transferor For Transferee
Continue to pursue the staff accountability aspects as per the existing instructions in respect of the NPAs transferred Cash flows in excess of the acquisition cost, if any, can be recognised as profit only after amortising the funded outstanding in the books, in respect of the loans
If classified as standard upon acquisition, assign 100% risk weight to the NPA

 

If classified as NPA, risk weights as applicable to NPA shall be applicable

Additional requirement for Transfer to ARCs

The following stressed loans may be transferred to ARCs:

  • loans in default for more than 60 days
  • classified as NPA
  • Including loans classified as fraud as on the date of transfer- along with proceedings related to such complaints shall also be transferred to the ARC

The Directions provide for sharing of surplus between the ARC and the transferor, in case of specific stressed loans. The Directions, however, do not specify what kinds of stressed loans these will be.

Further, the Directions also allow repurchase of the accounts from ARCs where the resolution plan has been successfully implemented.

The Directions also allow ARCs to take over loans only for the purpose of recovery (as recovery agents), without the same being removed from the Originator’s books. In such cases, the loans shall be treated as existing in the books of the Originator only.

Swiss Challenge Method[1]

Swiss Challenge method would be mandatory in the following cases:

  1. In case of a bilateral transfer of stressed loans on a bilateral basis, if the aggregate exposure (including investment exposure) of lenders to the borrower/s whose loan is being transferred is Rs.100 crore or more
  2. In case of transfer of stressed loans undertaken as a resolution plan under the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 with the approval of signatories to the intercreditor agreement (ICA) representing 75% by value of total outstanding credit facilities (fund based as well non-fund based) and 60% of signatories by number, for the exit of all signatories to the ICA from the stressed loan exposure, irrespective of any exposure threshold.

Disclosure and Reporting Requirement

Appropriate disclosures shall be made in the financial statements, under ‘Notes to Accounts’, relating to the following

  1. total amount of loans not in default / stressed loans transferred and acquired to / from other entities as prescribed under the Directions, on a quarterly basis starting from the quarter ending on December 31, 2021
  2. quantum of excess provisions reversed to the profit and loss account on account of sale of stressed loans
  3. distribution of the SRs held across the various categories of Recovery Ratings assigned to such SRs by the credit rating agencies

Additionally, transferors must maintain a database of loan transfer transactions with adequate MIS concerning each transaction till a trade reporting platform is notified by the RBI.

 

[1] Refer our write-up on Swiss Challenge Method- https://vinodkothari.com/wp-content/uploads/2017/03/sale_stressed_assets-1.pdf

 

Refer our write-up on revised securitisation guidelines here- https://vinodkothari.com/2021/09/rbi-master-directions-on-securitisation-of-standard-assets-and-transfer-of-loan-exposures/ 

After 15 years: New Securitisation regulatory framework takes effect

-Financial Services Division (finserv@vinodkothari.com)

[This version dated 24th September, 2021. We are continuing to develop the write-up further – please do come back]

We invite you all to join us at the Indian Securitisation Summit, 2021. The details can be accessed here

On September 24, 2021, the RBI released Master Direction – Reserve Bank of India Securitisation of Standard Assets) Directions, 2021 (‘Directions’)[1]. The same has been released after almost 15 months of the comment period on the draft framework issued on June 08, 2020[2]. This culminates the process that started with Dr. Harsh Vardhan committee report in 2019[3].

It is said that capital markets are fast changing, and regulations aim to capture a dynamic market which quite often leads the regulation than follow it. However, the just-repealed Guidelines continued to shape and support the securitisation market in the country for a good 15 years, with the 2012 supplements mainly incorporating the response to the Global Financial Crisis (GFC).

Considering the fact that securitisation, along with its regulatory alternative (direct assignment) has become a very important channel of inter-connectivity and bridging between the non-banking finance companies and the banking sector, and since the ILFS crisis, has been almost existential for NBFCs, it is very important to examine how the new regulatory framework will support securitisation market in India.

By way of highlights:

  • The bar on securitisation of purchased loans has been removed; there is a holding period requirement for acquired loans, after which the same may be securitised.
  • The risk retention requirement for residential mortgage backed transactions has been reduced to 5%.
  • Minimum holding period reduced to 6 months maximum, whereas it will be 3 months in case of loans with a tenure of upto 2 years.
  • In line with EU and other markets, there is a new framework for simple, transparent and comparable (STC) securitisations, which will qualify for lower capital requirements for investors.
  • Ratings-based risk weights introduced for securitisation transactions, adopting the ERB approach of global regulators.
  • Direct assignments continue to be subjected to the familiar criteria – no credit enhancement or liquidity facility, adherence to MHP, etc. However, risk retention criteria in case of direct assignments, called Transfer of Loan Exposures, have been removed, except where the buyer does not do a due diligence for all the loans he buys.
  • By defining who all could be permitted transferees of loans, the fledgling market for sale of loans through electronic platforms, to permit retail investors to participate in the loan market, completely nipped in its bud.

Scope of Applicability

Effective date:

The Directions are applicable with immediate effect. This should mean, any transaction done or after the date of the notification of the Directions must be in compliance therewith. Para 4 of the Directions clearly provides that any transaction of securitisation “undertaken” subsequent to the notification of the Directions will have to comply with the same. This implies that 24th September is the last date for any securitisation transaction under the erstwhile Guidelines.

The immediate implementation of the new Directions may create difficulties for transactions which are mid-way. Para 4 refers to transactions undertaken after the notification date. What is the date of “undertaking” a transaction for determining the cut-off date? Quite often, securitization transactions involve a process which may be spread over a period of time. The signing of the deed of assignment is mostly the culmination of the process. In our view, if the transaction is already mid-way, and effective term sheets have been signed with investors within the 24th September, it will be improper to disrupt that which has already been structured.

Lending entities covered:

As proposed in the Draft Directions, the Directions are applicable to banks and small finance banks (excluding RRBs), all India Term financing institutions (NABARD, NHB, EXIM Bank, and SIDBI), NBFCs and HFCs. These institutions are referred to as Lenders (or Originators) herein.

Eligible Assets

What is not eligible:

The Directions provide a negative list i.e. list of the assets that cannot be securitised. These are:

  1. Re-securitisation exposures;
  2. Structures in which short term instruments such as commercial paper, which are periodically rolled over, are issued against long term assets held by a SPE. Thus, what is globally prevalent as “asset backed commercial paper” (ABCP) has been ruled out. ABCP transactions were seen as responsible for a substantial liquidity crisis during the GFC regime, and Indian regulators seem to have shunned the same.
  3. Synthetic securitisation; and
  4. Securitisation with the following assets as underlying:
    1. revolving credit facilities
    2. Restructured loans and advances which are in the specified period; [Notably, the Directions do not seem to define what is the “specified period” during which restructured facilities will have to stay off from the transaction. It appears that the bar will stay till the facility comes out of the “substandard” tag. This becomes clear from para 8 of the Directions.
    3. Exposures to other lending institutions;
    4. Refinance exposures of AIFIs; and
    5. Loans with bullet payments of both principal and interest as underlying;

The draft guidelines did not exclude 2, 3, 4(b), (c) and (d) above. It is noteworthy that the exposure to other lending institutions has also been put in the negative list. Further, synthetic securitisation, on which several transactions are based, also seems to be disallowed.

Apart from the above, all other on-balance sheet exposures in the nature of loans and advances and classified as ‘standard’ will be eligible to be securitised under the new guidelines.

With respect to agricultural loans, there are additional requirements, as prescribed in the draft directions. Further, MHP restrictions shall not be applicable on such loans.

What is not not eligible, that is, what is eligible:

It is also important to note that the bar on securitisation of loans that have been purchased by the originator goes away. On the contrary, Explanation below para 5 (l) [definition of Originator] clearly states that that the originator need not be the original lender; loans which were acquired from other lenders may also be the part of a securitisation transaction. Further, Para 9 provides that the respective originators of the said assets transferred to the instant originator should have complied with the MHP requirements, as per the TLE Directions.

At the same time, a re-securitisation is still negative listed. That is, a pool may consist of loans which have been acquired from others (obviously, in compliance with TLE Directions), but may not consist of a securitisation exposure.

Another notable structure which is possible is securitisation of a single loan. This comes from proviso to para 5 (s). This proposal was there in the draft Directions too. While, going by the very economics of structured finance, a single loan securitisation does not make sense, and reminds one of the “loan sell off” transactions prior to the 2006 Guidelines, yet, it is interesting to find this clear provision in the Directions.

Rights of underlying obligors

Obligors are borrowers that owe payments to the originator/ lender. Securitisation transactions must ensure that rights of these obligors are not affected. Contracts must have suitable clauses safeguarding the same and all necessary consent from such obligors must be obtained.

MRR Requirements

Underlying Loans MRR Manner of maintaining MRR
Original maturity of 24 months or less 5% Upto 5%-

●      First loss facility, if available;

●      If first loss facility not available/ retention of the entire first loss facility is less than 5%- balance through equity tranche;

●      Retention of entire first loss facility + equity tranche  < 5%- balance pari passu in remaining tranches sold to investors

 

Above 5%

●      First loss facility, or

●      equity tranche or

●      any other tranche sold to investors

●      combination thereof

In essence, the MRR may be a horizontal tranche, vertical tranche and a combination of the two (L tranche]. If the first loss tranche is within 5%, the first loss tranche has to be originator-retained, and cannot be sold to external investors. However, if the first loss tranche is more than 5%, it is only 5% that needs to be regulatorily retained by the originator.

 

 

Original maturity of more than 24 months

 

10%
Loans with bullet repayments
RMBS (irrespective of maturity) 5%

Para 14, laying down the MRR requirements, uses two terms – equity tranche and “first loss facility”. While the word “first loss facility” is defined, equity tranche is not. Para 5(h) defines “first loss facility” to include first level of financial support provided by the originator or a third party to improve the creditworthiness of the securitisation notes issued by the SPE such that the provider of the facility bears the part or all of the risks associated with the assets held by the SPE .

However, Explanation below para 14 may be the source of a substantial confusion as it says OC shall not be counted as a part of the first loss facility for this purpose.

What might be the possible interpretation of this (euphemistically termed as) Explanation? OC is  certainly a form of originator support to the transaction, and economically, is a part of the first loss support. However, first loss support may come in different ways, such as originator guarantee, guarantee from a third party, cash collateral, etc. Equity tranche, deriving from the meaning of the word “tranche” which includes both the notes as also other forms of enhancement. Therefore, what the Explanation is possibly trying to convey is that in capturing the equity or first loss tranche, which, upto 5%, has to be  originator-retained, the OC shall not be included.

This, however, does not mean that the OC will not qualify for MRR purposes. OC is very much a part of the originator’s risk retention; however, in constructuring the horizontal, vertical and L tranche of transactions, the OC shall not be considered.

To give examples:

  • A transaction has 15% OC, and then a AAA rated tranche: In this case, the original has the 15% OC which meets the MRR requirement. He does not need to have any share of the senior tranches. This point, looking at the language of the Explanation, may be unclear and may, therefore, reduce the popularity of OC as a form of credit enhancement.
  • A transaction as 5% OC, 5% junior tranche, and remaining 95% as senior tranche. The originator needs to hold the entire 5% junior tranche (assuming original maturity > 24 months).
  • A transaction has 5% OC, 2% junior tranche, and 98% senior tranche. The originator needs to hold the entire 2% junior tranche, and 3% of the 98% senior tranche.

Para 16 first clarifies what is though clear from the 2006 Guidelines as well – that the requirement of retention of MRR through the life of the transaction does not bar amoritisation of the MRR. However, if MRR comes in forms such as cash collateral, it cannot be reduced over the tenure, except by way of absorption of losses or by way of reset of credit enhancements as per the Directions.

Listing Requirements

The Directions specify a minimum ticket size of Rs. 1 crore for issuance of securitisation notes. This would mean an investor has to put in a minimum of Rs 1 crore in the transaction. Further, the Directions also state that in case securitisation notes are offered to 50 or more persons, the issuance shall mandatorily be listed on stock exchange.

Interestingly, the limit of 50 persons seems to be coming from the pre-2013 rules on private placements; the number, now, is 200. It is typically unlikely that securitisation transactions have 50 or more investors to begin with. However, recently, there are several portals which try to rope in non-traditional investors for investing in securitisation transactions. These portals may still do a resale to more than 50; it is just that the number of investors at the inception of the transaction cannot be more than 49. Also, if there are multiple issuances, the number applies to each issuance. The number, of course, has to be added for multiple tranches.

The Draft Directions stated a issuance size based listing requirement in case of RMBS, as against the investor group size based requirement prescribed in the Directions.

SPE requirements

SPE requirements are largely routine. There is one point in para 30 (d) which may cause some confusion – about the minimum number of directors on the board of the SPE. This is applicable only where the originator has the right of nominating a board member. If the originator has no such right, there is no minimum requirement as to the board of directors of the SPE. In any case, it is hard to think of SPEs incorporated in corporate form in India.

Accounting provisions

The Directions give primacy to accounting standards, as far as NBFCs adopting IndAs are concerned. In such cases, upfront recognition of profit, as per “gain on sale” method, is explicitly permitted now. As for other lenders too, if the gain on sale is realised, it may be booked upfront.

Unrealised gains, if any, should be accounted for in the following manner:

  1. The unrealised gains should not be recognised in Profit and Loss account; instead the lenders shall hold the unrealised profit under an accounting head styled as “Unrealised Gain on Loan Transfer Transactions”.
  2. The profit may be recognised in Profit and Loss Account only when such unrealised gains associated with expected future margin income is redeemed in cash. However, if the unrealised gains associated with expected future margin income is credit enhancing (for example, in the form of credit enhancing interest-only strip), the balance in this account may be treated as a provision against potential losses incurred.
  3. In the case of amortising credit-enhancing interest-only strip, a lender would periodically receive in cash, only the amount which is left after absorbing losses, if any, supported by the credit-enhancing interest-only strip. On receipt, this amount may be credited to Profit and Loss account and the amount equivalent to the amortisation due may be written-off against the “Unrealised Gain on Loan Transfer Transactions” account bringing down the book value of the credit-enhancing interest-only strip in the lender’s books.
  4. In the case of a non-amortising credit-enhancing interest-only strip, as and when the lender receives intimation of charging-off of losses by the SPE against the credit-enhancing interest-only strip, it may write-off equivalent amount against “Unrealised Gain on Loan Transfer Transactions” account and bring down the book value of the credit-enhancing interest-only strip in the lender’s books. The amount received in the final redemption value of the credit-enhancing interest-only strip received in cash may be taken to the Profit and Loss account.

STC securitisations

Having a simple, transparent and comparable (STC) label for a securitisation transaction is a very important factor, particularly for investors’ acceptability of the transaction. Securitisation transactions are structured finance transactions –the structure may be fairly complicated. The transaction may be bespoke – created with a particular investor in mind; hence, the transaction may not be standard. Also, the transaction terms may not have requisite transparency.[4]

Simple transparent and comparable securitisations qualify for relaxed capital requirements. STC structures are currently prevalent and recognised for lower capital requirements in several European countries. The transactions are required to comply with specific guidelines in order to obtain a STC label. The Basel III guidelines set the STC criteria for the purpose of alternative capital treatment.

The STC criteria inter-alia provides for conditions based on asset homogeneity, past performance of the asset, consistency of underwriting etc.The Para 37 of the Directions provides that securitisations that additionally satisfy all the criteria laid out in Annex 1 of the Directions can be subject to the alternative capital treatment. The criteria mentioned in the Directions are at par with requirements of Basel III regulations.

Investors to the STC compliant securitisation are allowed relaxed risk-weights on the investment made by them.

The Directions further require, originator to disclose to investors all necessary information at the transaction level to allow investors to determine whether the securitisation is STC compliant.

STC criteria need to be met at all times. Checking the compliance with some of the criteria might only be necessary at origination. .In cases where the criteria refer to underlying, and the pool is dynamic, the compliance with the criteria will be subject to dynamic checks every time that assets are added to the pool.

Facilities supporting securitisation structures

A securitisation transaction may have multiple elements – like credit enhancement, liquidity support, underwriting support, servicing support. These are either provided by the originator itself or by third parties. The Directions aim to regulate all such support providers (“Facility Providers”).  The Directions require the Facility Providers to be regulated by at least one financial sector regulator. For this purpose, in our view, RBI, IRDAI, NHB, SEBI etc. may be considered as financial sector regulators.

Common conditions for all Facilities

For provision of any of the aforesaid facilities, the facility provider must fulfill the following conditions:

  • Proper documentation of the nature, purpose, extent of the facility, duration, amount and standards of performance
  • Facilities to be clearly demarcated from each other
  • On arm’s length basis
  • The fee of the Facility Provider should not be subject to subordination/waiver
  • No recourse to Facility Provider beyond the obligations fixed in the contract
  • Facility Provider to obtain legal opinion that the contract does not expose it to any liability to the investors

Credit Enhancement Facilities

In addition to the above mentioned conditions, following conditions must be fulfilled by the Facility Provider:

  • To be provided only at initiation of transaction
  • Must be available to SPV at all times
  • Draw downs to eb immediately written-off

Liquidity facilities

The provisions about liquidity facilities are substantially similar to what they have been in the 2006 Guidelines. However, the provisions of 2006 Guidelines and the Draft Directions requiring co-provision of liquidity facility to the extent of 25% by an independent party have been omitted. This would mean, the originator itself may now be able to provide for the liquidity facility if an independent party could not be identified or in any other case.

Underwriting facilities

Underwriting is hardly common in case of securitisations, as most issuances are done on bespoke, OTC basis. Again, most of the provisions in the Directions relating to underwriting are similar to the 2006 Guidelines with one difference. The 2006 Guidelines required Originators (providing underwriting facilities) to reduce Tier 1 and Tier 2 capital by the amount of holdings (if it is in excess of 10% of the issue size) in 50-50 proportion.

The Directions are silent on the same.

Servicing facilities

Third party service providers have started emerging in India, particularly by way of  necessity (forced by events of default  of certain originators) rather than commercial expediency.

The provisions of the Directions in para 59-60 are applicable even to proprietary servicing, that is, the originator acting as a servicer, as well as a third party servicer.

It is important to note that arms’ length precondition [Para 45 (b) ] is applicable to originator servicing too. Hence, if the servicing fees are on non-arms’ length terms, this may certainly amount to a breach of the Directions. The other requirement of para 45 (e) seems also critical – the payment of servicing fee should not be subordinated. There should not be any bar on structuring a servicing fee in two components – a fixed and senior component, and an additional subordinated component. This is common in case of third party servicers as well.

Lenders who are investors

The meaning of “lenders” who are investors, in Chapter V, should relate to the entities covered by the Directions, that is, banks, NBFCs, HFCs and term lending institutions, who are investing money into securitisation notes. Obviously, the RBI is not meant to regulate other investors who are outside RBI’s regulatory ambit. The part relating to stress testing was there in the earlier Guidelines too – this finds place in the Directions.

It is also made clear that the investors’ exposure is not on the SPE, but on the underlying pools. Hence, the see-through treatment as given in Large Exposures Framework applies in this case.

Capital requirements

Capital has to be maintained in all securitisation exposures, irrespective of the nature of the exposure an entity is exposed to. If the securitisation transaction leads to any realised or unrealised gain, the same must be excluded from the Common Equity Tier 1 or Net owned Funds, and the same must be deferred till the maturity of the assets.

Further, if an entity has overlapping exposures, and if one exposure precludes the other one by fulfilment of obligations of the former, then the entity need not maintain capital on the latter. For example, if an entity holds a junior tranche which provides full credit support to a senior tranche, and also holds a part of the senior tranche, then its exposure in the junior tranche precludes any loss from the senior tranche. In such a situation, the entity does not have to assign risk-weights to the senior tranche.

Liquidity facilities

For the liquidity facilities extended in accordance with Chapter IV of the Directions, capital can be maintained as per the External Rating Based Approach (which has been discussed later on). For liquidity facilities not extended in accordance with Chapter IV of the Directions, capital charge on the actual amount after applying a 100% CCF will have to be considered.

Derecognition of transferred assets for the purpose of Capital Adequacy

 The Directions has laid down clear guidelines on derecognition of transferred assets for capital adequacy, and has no correlation with accounting derecognition under Ind AS 109. Therefore, irrespective of whether a transaction achieves accounting derecognition or not, the originator will still be able to enjoy regulatory capital relief so long as the Directions are complied with.

There is a long list of conditions which have to be satisfied in order achieve derecognition, which includes:

  1. There should complete surrender of control over the transferred exposures. The originator shall be deemed to have retained effective control over the exposures if:
    • It is able to repurchase the exposures from the SPE in order to realise the benefits, or
    • It is obligated to retain the risk of the transferred exposures.
  2. The originator should not be able to repurchase the exposure, except for clean-up calls.
  3. The transferred exposures are legally taken isolated such that they are put beyond the reach of the creditors in case of bankruptcy or otherwise.
  4. The securitisation notes issued by SPE are not obligations of the originator.
  5. The holders of the securitisation notes issued by the SPE against the transferred exposures have the right to pledge or trade them without any restriction, unless the restriction is imposed by a statutory or regulatory risk retention requirement
  6. Clean-up call
    • The threshold at which clean-up calls become exercisable shall not be more than 10% of the original value of the underlying exposures or securitisation notes.
    • Exercise of clean-up calls should not be mandatory.
    • The clean-up call options, if any, should not be structured to avoid allocating losses to credit enhancements or positions held by investors or otherwise structured to provide credit enhancements
  7. The originators must not be obligated to replace loans in the pool in case of deterioration of the underlying exposures to improve the credit quality
  8. The originator should not be allowed to increase the credit enhancement provided at the inception of the transaction, after its commencement.
  9. The securitisation does not contain clauses that increase the yield payable to parties other than the originator such as investors and third-party providers of credit enhancements, in response to a deterioration in the credit quality of the underlying pool
  10. There must be no termination options or triggers to the securitisation exposures except eligible clean-up call options or termination provisions for specific changes in tax and regulation

Further, a legal opinion has to be obtained confirming the fulfilment of the aforesaid conditions.

The draft directions issued some quantitative conditions as well, which have been dropped from the final Directions.

Securitisation External Ratings Based Approach

 The Directions require the lenders to maintain capital as per the ERBA methodology. Where the exposures are unrated, capital charge has to be maintained in the actual exposure.

Para 85 signifies that the maximum capital computed as per the ERBA methodology will still be subject to a cap of the capital against the loan pool, had the pool not been securitised.

The maximum risk weight prescribed in the ERBA approach is 1250%, which holds good for banks, as they are required to maintain a capital of 8%. For NBFCs, the capital required is 15%, so the maximum risk weight should not have been more that 667%. However, para 85 should take care of this anomaly which limits the capital charge to the capital against the loan pool, had the pool not been securitised.

Investor disclosures

Disclosures, both at the time of the issuance, and subsequent thereto, form an important part of the Directions. A complete Chapter (Chapter VII) is dedicated to the same. The disclosures as laid in Annexure 2 are to be made at least on half yearly basis throughout the tenure of the transaction.

This includes substantial pool- level data- such as a matrix of % of the pool composition and corresponding maturities, weighted average, minimum and maximum MHP, MRR and its composition broken down into types of retention, credit quality of the pool (covering overdue, security related details, rating, distribution matrix of LTVs, Debt-to-Income ratios, prepayments etc.), distribution of underlying loan assets based on industry, geography etc.

 

[1] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/85MDSTANDARDASSETSBE149B86CD3A4B368A5D24471DAD2300.PDF

[2] https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/STANDARDASSETS1600647F054448CB8CCEC47F8888FC78.PDF

[3] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48106

[4] Our write-up on STC criteria can be viewed here; https://vinodkothari.com/2020/01/basel-iii-requirements-for-simple-transparent-and-comparable-stc-securitisation/

 

Refer our write-up on guidelines for transfer of loan exposures here- https://vinodkothari.com/2021/09/rbi-norms-on-transfer-of-loan-exposures/

Global Securitisation Markets in 2020: A Year of Highs in the midst of Turmoil

-Vinod Kothari (vinod@vinodkothari.com)

[Revised March 2021]

Even as the pandemic disrupted life and economies across the globe, securitisation activity in different countries scaled new highs, at least in certain asset classes.

Securitisation in USA

Agency and non-agency RMBS

Agency RMBS was the star performer, at least in terms of new issuance volumes. Data available till Nov 2020 suggests that the new issuance volumes for 2020 will be about double of what it was in 2019, and the highest ever achieved in history. There are two reasons primarily responsible, of which the first one is quite obvious – historically low mortgage rates, particularly for refinancing activity. Second reason is that during the pandemic, there was extensive use of technology in mortgage origination and documentation, which led to far faster and simpler turnarounds for the borrowers.

Non-agency RMBS, however, is expected to end about 40% lower than 2019 volumes. Origination levels were halted because of shut-downs and the prevailing economic situation. Lenders put caution on the forefront as 30-day delinquencies continued to soar up.

Figure 1: US RMBS Issuance [By author, based on SIFMA data]

As may be clear, the issuance of agency MBS in 2020 was almost double of last year, whereas as non-agency securities were 45% lower or almost half of the number in 2019.

Asset-backed securities

The issuance volumes across all other classes of asset backed securities were down – from about 6% in case of auto-ABS to about 90% in case of credit cards ABS.

Figure 2: ABS issuance in USA

The CLO market was among the asset classes very badly affected, with the 2020 issuance less than 40% of the number in 2019. The decline in origination volumes of asset classes like credit cards is attributed to tighter lending standards by banks, and of course, lesser spending by individuals on travel or amusement, due to lock down.

Securitisation in Europe

Euro area will end with a GDP contraction estimated at 7.7% in 2020[1].

As per data prepared by AFME, new issuance in 2020 in Europe was down by about 11.9% compared to 2019[2].

EU regulators proposed some amendments to securitisation regulations, by amending Capital Requirements Regulations. “Securitisation can play an important role in enhancing the capacity of institutions to support the economic recovery, providing for an effective tool for funding and risk diversification for institutions. It is therefore essential in the context of the economic recovery post COVID-19 pandemic to reinforce that role and help institutions to be able to channel sufficient capital to the real economy.”[3] Accordingly, three amendments are proposed to securitisation regulatory framework: more risk-sensitive treatment for STS on-balance-sheet securitisation; removal of regulatory constraints to the securitisation of non-performing exposures; and recognition of credit risk mitigation for securitisation positions.

Figure 3: European securitisation issuance

Securitisation in China

Securitisation in China is expected to be about 10-15% lower than the volumes in 2019. A report from S&P recorded first half of 2020 to be almost the same as first half of 2019, but given the concerns and tightened lending by banks, it is expected that lower RMBS issuance will keep overall issuance levels low in 2020[4].

Figure 4: Securitisation Issuance in China – from S&P report

Securitisation in India

Indian securitisation statistics are typically collated on April-March basis. For Q2, Q3 and Q4 of calendar year 2020, securitisation activity [in Indian parlance, securitisation also includes bilateral portfolio transfers, called direct assignment] was highly subdued, as shadow-banking entities which are the major originators of transactions had stopped lending due to the prevailing lock-down. In addition, there were moratoriums imposed by the RBI whereby payments under existing loans were permitted to be withheld for a period of 5 months.

However, once the lockdowns have gradually been lifted, there is a very strong resurgence of economic activity. The Govt. had provided a sovereign guarantee for an additional 20% lending on existing lending facilities, subject to limits. While the non-banking financial entities are not needing significant funding by way of securitisation, there is a strong investor appetite.

This period has also been associated with defaults or credit events by some of the originators, and sale of the ABS investments held by some mutual funds. Hence, the market has seen servicer transitions, as also tested the (il)liquidity of investments in securitisation transactions.

Rating activity

As may be expected, there have been major rating actions during the year as performance of most asset classes was disrupted due to the pandemic. Rating agency S&P reported 2551 structured finance rating actions, which included 1950 downgrades owing to the impact of the pandemic[5]. Moody’s, in a report, states that once Covid-led payment holidays abate, there will be increasing pressures on retail-focused ABS transactions. RMBS transactions, consumer ABS etc are likely to see rising delinquencies.

Moody’s also forecasts the default rates in non-investment grade corporates to increase to 9.7% (trailing average of 12 months) by March, 2021. This will be the highest default rate after 2009. This will result into substantial pressure on CLOs.[6]

 

[1] Moody’s estimate

[2] https://www.afme.eu/Publications/Data-Research/Details/AFME-Securitisation-Data-Report-Q4-2020

[3] https://oeil.secure.europarl.europa.eu/oeil/popups/printficheglobal.pdf?id=716379&l=en

[4] https://www.spglobal.com/ratings/en/research/articles/200811-china-securitization-performance-watch-2q-2020-the-worst-may-have-passed-11604587

[5] https://www.spglobal.com/ratings/en/research/articles/201218-covid-19-activity-in-global-structured-finance-as-of-dec-11-2020-11782903

[6] https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1249099

Link to related articles:

 

Evolution of securitisation – Genesis of MBS

finserv@vinodkothari.com

Securitisation as a concept, has a history of over 50 years. In this write up, the author traces the events leading up to the evolution of securitisation in 1970 with the issuance of the first MBS program by Ginnie Mae.

Fifty years of global securitisation – list of chapters

List of chapters for the anthology on fifty years of global securitisation –

Go back to fifty years of securitisation page.

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