SECURITISATION OF DEBT : SECURITISATION OF DEBT INTRODUCTION:- Financial system is in rapid transformation Due to this capital, money and the

debt market are getting widened and deepened Development of debt market increases the efficieny of a capital market Debt market should have both primary and secondary markets MEANING OF SECURITISATION : MEANING OF SECURITISATION Securitisation means technique by which a long term , non-negotiable and high valued financial asset like hire purchase is converted into securities of small values which can be tradable in the market just like shares Definition:-Securitisation s nothing but liquifying assets comprising loans and receivables of an institution through systematic issuance of financial instru ments. Securitisation helps them to recycle funds at a reasonable cost and with less credit risk As from the risk management point of view , the lending financial institutions have to absorb the entire credit risk by holding the credit outstanding in their own portfolio. Securitisation offers a good scope for risk diversification The entire transaction relating to securitisation is carried out on the asset side of balance sheet MODUS OPERANDI : MODUS OPERANDI The originator A special purpose vehicle (SPV) or a trust A merchant or investment banker A credit rating agency A servicing agent-receiving and paying agent (RPA) The original borrowers or obligors The prospective investors i.e.., the buyers of securities The various stages involved in the working of securitisation are:- Identification stage / process Transfer stage / process Issue stage / process Redemption stage / process Credit rating stage / process Identification Process : Identification Process Lending financial institution a bank or any institution for that matter which decides to go in for securitisation of its assets is called the originator Originator has got various assets: Commercial mortgages Lease receivables Hire purchase receivables Originator has to pick up from various assets which includes homogeneous nature , considering the maturities , interest rates involved and marketability. The process of a selecting a pool of loans and receivables from the asset portfolios for securitisation is called Identification Process. TRANSFER PROCESS : TRANSFER PROCESS The process of passing through the selected pool of assets by the originator to a SPV is called transfer process and once this transfer process is over , the assets are removed from the balance sheet of the originator ISSUE PROCESS After transfer process the SPV converts these assets in various types of maturity. SPV splits individual securities of smaller values and they are sold to investing public . SPV gets reimbursed by sales proceeds. the securities issued by SPV are known as Pay through certificates, Pass through Certificates , Interest only certificates , Principal only certificate.they are structured in such a way that the maturity of these securities may synchronise with the maturities of the securitised loans. REDEMPTION PROCESS : REDEMPTION PROCESS Redemption and payments of interest on these securities are facilitated by the collection received by the SPV from the securitised assets. Collection of dues is generally entrusted to originator or special servicing agent and paid with certain % of commission They are responsible for collection of interest and principal on assets pooled CREDIT RATING PROCESS Pass through certificate has to be publicly issued , they require credit rating by good credit rating agency so that they become more attractive and easily acceptable they should be rated by one credit rating agency on the eve of the securitisation issue can be guaranteed by external guarantor like merchant banker which would enhance credit worthiness of certificates These are tradable in secondary market this are negotiable securities ROLE OF MERCHANT BANKERS : ROLE OF MERCHANT BANKERS Merchant or Investment bankers play a big role in asset securitisation they act as special purpose vehicle (SPV) Many issues are involved like :- Timing of issue of pass through certificates Pricing of these certificate for marketing Underwriting of the issues In private placements , they act as agents for the issuer connecting the sellers and buyers They involve in structuring the issue to see:- legal regulatory Accounting tax and other requirement Merchant bank has a definate role to play Most of the issue is underwritten by popular merchant banker which adds credit to that issue and become more attractive from investors point ROLE OF OTHER PARTIES : ROLE OF OTHER PARTIES THEY ARE THE ORIGINAL BORROWERS AND THE PROSPECTIVE INVESTORS ORIGINAL BORROWERS ARE CALLED Obligors Infact the success of the securitision process depends upon these original borrowers and if this process fails to meet its commitment then its in danger the receipts of cash flows from original borrowers and passed to the investors the prospective buyers are nothing but public at large

STRUCTURE FOR SECURITISATION /TYPES OF SECURITIES : STRUCTURE FOR SECURITISATION /TYPES OF SECURITIES Securitisation is a structured transaction , whereby the originator transfers or sells some of its assets to a SPV which break this assets into tradeable securities of smaller values which could be sold to the investing public The general principle is that the securities must be structured in such a way that the maturity of these securities may coincide with the maturity of the securitised loans There are three types of important securities :- Pass through and pay through certificates Preferred stock certificates Assets based commercial papers Slide 10: Pass through and pay through certificates:- Payments to investors depends upon the cash flow from the assets backing certificates in other words , as and when cash (principal+interest) is received from the original borrower by SPV , it is passed on to holders of certificate at regular intervals In pay through certificates have a multiple maturity structure depending upon the maturity pattern of underlying assets The securities issued are of short , medium and long terms They are issued on investors demand for varying maturity patterns This type is more attractive from investors point of view This are offered at a discount Preferred stock certificates :- Subsidiary companies buy the trade debts and consumer receivables of parent companies , convert them into short term securities and help the parent companies to enjoy liquidity this securities are backed by guarantees by merchant banks this are normally short term in nature Asset-based commercial papers:-This type of structure is mostly prevalant in mortgage backed securities.The SPV purchases portfolio of mortgages from different sources and combined into a single group on the basis of interest rates , maturuty dates and underlying collaterals.Then it is tranferred to a trust which in trust issues certificate to the investors this are short term in nature certificate holder are entitled to participate in the cash flow from underlying mortgages to the extent of investmentsOther types :-1)Interest only certificates2)principal only certificates : Asset-based commercial papers:-This type of structure is mostly prevalant in mortgage backed securities.The SPV purchases portfolio of mortgages from different sources and combined into a single group on the basis of interest rates , maturuty dates and underlying collaterals.Then it is tranferred to a trust which in trust issues certificate to the investors this are short term in nature certificate holder are entitled to participate in the cash flow from underlying mortgages to the extent of investmentsOther types :-1)Interest only certificates2)principal only certificates SECURITISABLE ASSETS : SECURITISABLE ASSETS ALL ASSETS ARE NOT SUITABLE FOR SECURITISATION ONLY IN RARE CASES THEY ARE SECURTISED EG:- Preferred Stock Certificate The following assets are generally securitised by the financial institutions:- term loans to financially reputed companies Receivables from government departments and companies Credit card receivables hire purchase loans like vehicle loans Lease finance Mortgage loans etc BENEFITS OF SECURITISATION : BENEFITS OF SECURITISATION Additional source of funds Greater Profitability Enhancement of capital Adequacy Ratio Spreading of credit risk Lower cost of funding Provision of multiple instruments Higher rate of returns Prevention of idle capital Better than traditional instruments Other benefits SECURITISATION AND BANKS : SECURITISATION AND BANKS There is a vast scope for commercial banks to go in for securitisation due to following factors:- Innovative and Low cost source of funds Better Capital Adequacy Norms Creation of more credit Increased Profitability Tool for asset liability management and risk management

4 Reasons why Investors would go for debtsecuritization Debt securitization is a process of structured finance thatcan distribute the risk of gathering too many assets in asingle pool. This often involves selling off assets to a special purpose organization and then utilizing the proceeds in issuing new securities which are backed by the assets. These debt securities aresold to investors who share the risk and reward from these investors. All assets that can predict stable cash flows can be securitized. Debt securitization is a process of debt help thatwill help the lender securitize the debt and use the money in issuing different assets. As yousecuritize your debt, you can considerably

invest money and gain in long term period of time.Read on to the reasons why a loan originator would go for debt securitization.1.

It serves as an alternative to funding: On the part of the originator of such loans,debt securitization provides a good alternative to funding. An asset backed securitythat stands can stand on its own good rating and thus provides the originator with agenuine incremental funding that will appreciate with time. The existing creditors of the originators will invest in the asset backed securities and in exchange of this; hewill provide the originator with new lines of credit. By debt securitization, it is also possible to acquire a good credit rating for the asset backed security.2.

Management of balance sheet : As you free up the capital of the originator, there is afundamental benefit of a true sale. In response to this securitization, the balance sheet becomes compressed and robust. As you add on new assets to the balance sheet, youcan easily restore the reduction in leverage on the sale post securitization. A matchedfunding for balance sheet assets can also be achieved by debt securitization.3.

Risk allocation : The credit risk in the portfolio of the investors will be re- allocatedand transferred to the ABS investors and also helps to minimize the credit risk that theoriginator is exposed to. This is a very useful benefit of debt securitization as theoriginator will be able to be largely exposed to the individual borrowers and provide ahigh amount of comfort to the creditors.4.

Efficiency of operating process : The portfolio analysis and the risk reallocation thattakes place during the time of debt securitization leads to re-examination andrechecking of the operating process that is working within the originator organization.In many cases, specialists handle such components as funding, business management,administration and risk management. This promotes the efficiency of the operating process

The Originator also interchangeably referred to as the Seller is theentity whose receivable portfolio forms the basis for Security issuance, Obligor , is an entity, which has received a loan giving rise to the financialassets that is securitized by the Originator. Special Purpose Vehicle (SPV) , which as the issuer of the Securityensures adequate distancing of the instrument from the originator, The Servicer , who bears all administrative responsibilities relating to thesecuritization transaction, The Trustee or the Investor Representative , who act in a fiduciarycapacity safeguarding the interests of investors in the Security, The Credit Rating Agency , which provides an objective estimate of thecredit risk in the securitization transaction by assigning a well-defined creditrating, The Regulators , whose principal concerns relate to capital adequacy,liquidity, and credit quality of the Security, and balance sheet treatment of thetransaction, Service providers, such as Credit Enhancers and Liquidity Providers, and, Investors , more important than all the aforementioned are the investors inthe securitised paper. Investors are the ultimate judges of any securitizationeffort. Securitization Process Origination Process : The process of a selecting a pool of loans and receivables from the assetportfolios for securitisation is also called Identification Process. Pooling Process:

Similar loans or receivables are clubbed together to create an underlying poolof assets. Originator has to pick up from various assets which includeshomogeneous nature , considering the maturities , interest rates involved andmarketability. Issuing Process : The process of passing through the selected pool of assets by the originator to a SPV is called transfer process and once this transfer process is over , theassets are removed from the balance sheet of the originator. This process isalso known as Transfer process.

Structuring Process: SPV converts these assets in various types of maturity. SPV splits individualsecurities of smaller values and they are sold to investing public. They arestructured in such a way that the maturity of these securities may synchronisewith the maturities of the securitised loans. Various types such as: Pay through certificates, Pass through Certificates , Interest only certificates , Principal only certificate. Credit Enhancement Process: It is an arrangement which is designed to protect the holder of the securitiesissued by an SPE from losses and / or cash flow mismatches arising fromshortfall, or delay in collection from securitized assets. The arrangement ofteninvolve one or more of the following: Over collaterisation, assets in excess of the securitized assets. Recourse obligation accepted by the Originator. Third party guarantee, i.e., a guarantee normally extended by MerchantBankers.

 Structuring of the instruments into senior and subordinated securities. Independent credit rating of the securitised paper from a well knowncredit rating agency. Documentation process: In documentation lies the heart of all securitization. It is legal framework,which govern and provide fundamental to securities transactions. It clearlydefines legal obligations and recourse available to various aspect of securitisation such as: Legality of the transaction, Bankruptcy remoteness of the issuer from the originator, Payment schedules,

Redemption clauses, Duties and responsibilities of various parties, Claim of Investors Recourse Available Administration Process : Formal demarcation of duties and responsibilities and proper administration of different functions relating to securitised assets, such as: payment servicing

 managing relationship with the final obligors Collection of dues Redemption and payments of interest and principal Settlement of claims and grievances