SECURITIZATION

INTRODUCTION OF SECURITIZATION

A lot has been written and spoken about securitization in recent times. Indeed, one has
been hearing about it in India since the early 1990s, but with increasing regularity in
recent times. This concept note is intended to place the concept of securitization in the
right perspective, and importantly, set aside some myths and misconceptions associated
with it.

The deals that have been talked about are Citibanks sale of its car loan portfolio,
among others. With only this much information provided on this deal, it may be
concluded that such transactions are only in the nature of refinancing arrangements,
since no new marketable securitization, in our meaning, is explained in the following
paragraph.

Consider the case of a limited company and its financing advantages over a partnership
firm. A partnership firm is based on relationships, which cumbersome to handle, and
whose changes in composition could affect the firms liquidity. In the case of limited
company, share is issued to each partner and the companys capital structure does not
change with a change in the composition of its partner. Shareholder come and goes as
they please. This is because the shareholders stake is concurrent with their holdings of
share certificates, which are transferable pieces of paper, called securities. Securitization
therefore is the process of converting relationship into transactions. The trend of
debentures and bonds replacing illiquid loans by a bank is also a step in the direction of
converting relationship into transactions.

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Securitization is an innovation of the home loan financing segment of banking, called

residential mortgage financiers. These organizations typically lend over a 20-year
period, and need to raise finance of sufficiently long tenors. A major asset they hold are
the receivables in respect of loans already granted. Thus, these receivables are sold in
order to garner receivable

for a whole new round of fresh loans. Therefore, the advantages of securitization are in
the forms of.
1) making illiquid receivable liquid
2) getting loans of long tenors, thereby withstanding the shocks that could come
from short term funding (asset-liability management or ALM) and
3) Lock on to a long-term, low-cost source of finance, enhancing their credit
planning efforts.

Apart from the stated advantages, securitization also in enhancing the Capital Reserve
Adequacy Ratio (CRAR) and reduces the overall cost of capital due to transfer of risk
off its balance sheet, as explained later. Thus, securitization involves financial
engineering with several associated credit derivatives.

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HISTORY OF SECURITIZATION

Securitization may be said to have originated in Denmark. Loans were granted when
bonds of an equal amount and tenor were sold. This is form of asset-liability matching,
resource management, and even the interest margins are protected. Therefore seems to
be sound policy. In Prussia, bonds backed by mortgage loan were issued by some banks,
the instrument, and a bond symbolizing the underlying cash flows called pfandbrief.
Interestingly, over its 200 years history, no pfandbriefs has ever been defaulted upon.
However, standardization and liquidity seem to pose a problem, otherwise tradability of
such instrument will be only in restricted markets.

Securitization in its modern form really took off in Chicago. Chicago is also a home to
many seminal developments in finance. Mortgage bankers would deploy their initial
capital in creating mortgages. Fresh borrowers would have to turn away. Chicago
mortgages banker struck upon the idea of selling the loan portfolios to larger mortgages
banker. The largest mortgage bankers carved of the stream of underlying receivables
into tradable denominations as in equity and bonds in order to attract investors and
facilitate trading in these bonds. Other innovation followed. First, the interest and
principle portions were separately traded. These are called STRIPS, the acronym for
Separately Traded Interest Only (IO) and principal only (PO) Segments. Other
innovation included the splitting up of the bonds to sort investors having an appetite for
varied lengths of time. The details are explained elsewhere in this paper. To sum up, the
underlying receivables were carved in a process known as slicing and dicing, analogous
to the beef cuts that were sold as a marketable commodity, as opposed to trading in the

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whole animal itself. Securitization instruments shorn of such innovations are known as
plain vanilla securitization instruments.
The concept of securitization is rapidly spreading in several countries in various stages
of development. From the Danish origins and the pfandbriefs, securitization has spread
and evolved in the US. Policy makers in several developing countries are keen that
securitization takes off, since these are capital deficit countries. Securitization in these
markets will strengthen lending agencies and improve their linkages with the capita
markets.

SECURITIZATION TRANSACTION PROCESS

The successful execution of a securitization depends on the investors uncontested right

to securitized cash flows. Hence, securitized loan need to be separated from the
originator of the loan. In order to achieve this separation, a securitization is structured as
a three-step frame work:

1. A pool of loan is sold to an intermediary by the originator of the loans. This

intermediary (called a special purpose vehicle or SPV) is usually incorporated
as trust. The SPV is an entity formed for the specific purpose of transferring the
securitized loans out of the originators balance sheet, and does not carry out
any other business.
2. The SPV issues securities, backed by the loan, and by the payment streams
associated with these loans. These securities are purchase by investors. The
proceeds from the sale of the securitized are paid to the originator as a purchase
consideration for the loan receivables.

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3. The cash flows generated by the loans over a period of time are used to repay
investors. There could also be some credit support built into the transaction to
protest investors against possible losses in the pool. However, the investors will
typically have no recourse to the originator.

Diagrammatic representation of a securitization transaction

Issues
Transfer/sells PTC
loans SPV Investors
Originator (Trust managed by
(Owner of the assets) Consideration the trust)
Consideration
Payment
from Payment
borrower Collection account made to
deposit (Operated by the trusty) investors
from
originator

Loans Installment
(Assets) Payment
Borrowers Credit Support
(Given by the originator or
third party)

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PARTIES INVOLVED IN SECURITIZATION TRANSACTION

Originator: The originator is the original lender and the seller of the
receivables. Typically, the originator is a Bank, a Non Banking Finance
Company (NBFC), or a Housing Finance Company (HFC). Some of the
larger originator in India includes ICICI Bank, HDFC Bank and
Citigroup.
Seller: The seller pools the assets in order to securitize them. Usually, the
originator and the seller are the same but in some cases originator sell
their loans to the other companies that securities them.
Obligors/borrowers: The borrower is the counter party to whom the
originator makes the loan. The payments made by borrowers are the
sources of cash flows used for making investor payments.
Issuer: The issuer in a securitization deal is the special purpose vehicle
(SPV) which is typical set up as a trust. The trust issues securities which
investors subscribe to.
Investors: Investors are the purchase of the securities. Banks, Financial
Institution, NBFC and Mutual Fund are the main investors in securitized
paper.
Service: The service collects the periodic installments due from
individual borrowers in the pool, make s payouts to investors, and
follows up on delinquent accounts. The service also furnishes periodic
information to the rating agency and the trustee on pool performance.
There is a service fee payable to the service. In most cases, the originator
acts as the service.

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Trustee: Trustees are normally reputed Banks, Financial Institutions or

independent trust companies set up for the purpose of settling trusts.
Trustees oversee the performance of the transaction till maturity and are
vested with necessary powers to protest investors interests.
Arrangers: These are Investment banks responsible for structuring the
securities to be issued, and liasoning with other parties such as investors,
credit enhancers and rating agencies to successfully execute the
securitization transaction.
Rating agencies: Independent rating agencies analyze the risks
associated with a securitization transaction and assign a credit rating to
the instrument issued.

VARIOUS STAGES INVOLVED IN WORKING OF SECURITIZATION

Identification Process: The lending financial institution either a bank or any

other institution for that matter which decides to go in for securitization of its
assets is called the originator. The originator might have got assets comprising
of a variety of receivables like commercial mortgages, lease receivables, hire
purchase receivables etc. The originator has to pick up a pool of assets of
homogeneous nature, considering the maturities, interest rates involved frequency
of repayments and marketability. This process of selecting a pool of loans and
receivable from the asset portfolios for securitization is called identification
processes.
Transfer Process: After the identification process is over the selected pool of
assets are then passed through to another institution which is ready to help the

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originator to convert those pools of assets onto securities. This institution is called
special purpose vehicle (SPV) or the trust. The pass through transaction between
the originator and the SPV is either by way of outright sale basis. This 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 this process is over the SPV takes up the onerous task of
converting these assets to various type of different maturities. On this basis SPV
will issue securities to investors. The SPV actually splits the packages into
individual securities of smaller values and they are sold to the investing public.
The SPV gets itself reimbursed out of the sale proceeds. The securities issued by
the SPV are called by different names like Pay through Certificates, Pass
through Certificates. Interest only Certificate, Principal only Certificate. The
securities are structured in such a way that the maturity of these securities may
synchronies with the maturity of the securitized loans or receivables.
Redemption Process: The redemption and payments of interest on these
securities are facilitated by the collections by the SPV from the securitized assets.
The task of collection of dues is generally entrusted to the originator or a special
service agent can be appointed for this purpose. This agency paid certain
commission for the collection service rendered. The servicing agent is responsible
for collecting the principal and interest payments on assets pooled when due and
he must pay a special attention to delinquent accounts. Usually the originator is
appointed as the service. Thus under securitization the role of the originator gets
reduced to that of the collection agent on behalf of SPV in case he is appointed as
a collection agent. A pass through certificate may be either with recourse to the

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originator or without recourse. The usual practice is to make it without

recourse. Hence the holder of a pass through certificate has to look the SPV for
payment of the principal and interest on the certificate held by him. Thus the main
task of the SPV is to structure the deal raise proceeds by issuing pass through
certificates and arrange for payment of interest and principal to the investors.
Credit Rating Process: The passed through certificate have to be publicly issued,
they required credit rating by a good credit rating agency so that they become
more attractive and easily acceptable. Hence these certificates are rated at least by
one credit rating agency eve of the securitization. The issues could also be
guaranteed by external guarantor institutions like merchant bankers which would
enhance the credit worthiness of the certificates and would be readily acceptable
to investors. Of course this rating guarantee provides to the investor with regard
to the timely payment of principal and interest by the SPV.

VARIOUS CATEGORIES OF SECURITIZATION INSTRUMENT:

Asset Backed Securities (ABS) are instruments backed by receivable from financial
assets like vehicle loans, credit cards, personal loans and other consumer loan but
excluding receivables from housing loans. Mortgage Backed Securities (MBS) are the
instruments backed by receivables from housing loans. Collateralised Debt obligation
(CDO) is instruments backed by various types of debt including corporate loans or
bonds.

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Different types of securities:

1. Pass through and pay through certificates: In case of pass through

certificates payments to investors depend upon the cash flow from the assets
backing such certificates. In other words as and when cash (principal and interest)
is received from the original borrower by the SPV it is passed on to the holders of
certificates at regular intervals and the entire principal is returned with the
retirement of the assets packed in the pool. Thus, pass through have a single
maturity structure and the tenure of these certificates is matched with the life of
the securitized assets.
On the other hand pay through certificates has a
multiple maturity structure depending upon the maturity pattern of underlying
assets. Thus, two or three different types of securities with different maturity
patterns like short term, medium term and long term can be issued. The greatest
advantage is that they can be issued depending upon the investors demand for
varying maturity pattern. This type of is more attractive from the investors point
of view because the yield is often inbuilt in the price of the securities themselves
i.e. they are offer at a discount to face value as in the casa of deep-discount bonds

2. .Preferred stock certificate: Preferred stocks are instruments issued by a

subsidiary company against the trade debts and consumer receivables of its
parent company. In other words subsidiary companies buy the trade debts and
receivables of parent companies to enjoy liquidity. Thus trade debts can also
be securitized through the issue of preferred stocks. Generally these stocks are

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backed by guarantees given by highly rated merchant banks and hence they
are also attractive from the investors point of view. These instruments are
mostly short term in nature.

3. Asset-based commercial papers: This type of structure is mostly prevalent

in mortgage backed securities. Under this the SPV purchases portfolio of
mortgages from different sources (various lending institution) and they are
combined into a single group on the basis of interest rate, maturity dates and
underlying collaterals. They are then transferred to a Trust which in turn issued
mortgage backed certificate to the investors. These certificates are issued
against the combined principal value of the mortgages and they are also short
term instrument. Each certificate is entitled to participate in the cash flow from
underlying mortgages to his investments in the certificates.

Other type

Apart from the above there is also other type of certificate namely
i. Interest only certificates
ii. Principal only certificate.

In the case of interest holding certificate payments are made to investors only
from the interest incomes earned from the assets securitized. As the very name
suggest payment are made to the investors only from the repayment of
principal by the original borrower. In the case of principal only certificates
these certificate enables speculative dealings since the speculators know well

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that the interest rate movements would affect the bond value immediately. For
instance the principal only certificate would increase the value when interest
rate go down and because of these it becomes advantageous to repay the
existing debts and resort to fresh borrowing at lower cost. This early
redemption of securities would benefit the investors to a greater extent.
Similarly when the interest rate goes up, interest holding certificate holders
stand to gain since more interest is available from the underlying assets. One
cannot exactly predict the future movements of interest and hence these
certificates give much scope for speculators to play the game.

Need of Special Purpose Vehicle (SPV) in securitization:

The investors return in securitization transaction should depend purely on the

securitized cash flows and should be insulated from the financial risks
associated with the originator. Hence, it is necessary to have legal separation of
these assets from the estate of the originator. This is achieved by means of sale
of the assets to SPV. The SPV is set up solely for the purpose of the
securitization transaction and does not engage in any other business activity.
The SPV does not borrow or lend any money and hence cannot go bankrupt.
Most SPV follow a set of pre-determined activities clearly identified by the
securitization documents. Without the flexibility of taking any management
decision. This mode of structuring the transaction ensures that securitized assets
become bankruptcy remote from the originator.

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Securitized instruments v/s Debentures v/s factoring

An investor in a debenture issued by a bank or a loan originator will be on official

liquidators list in the event of its winding up. However, a PTC holder has access to the
obligors asset, and is hence saved from winding up. Liquidation or bankruptcy
proceedings. PTC therefore, is understood to be bankruptcy-remote.
Secondly, credit perception of PTC is based on the strength of the obligor and not the
balance sheet of the originator. This is the feature that enhances the credit rating of the
PTC, which is not the case in Debentures, which is based on the originators own
balance sheet.
For the above reasons, coupon rates on securitized instruments are lower than coupon
rates on plain vanilla bonds.
Thirdly, securitization can result in the return of a fraction of principal loan along with
interest, as part of each installment. In the case of debentures and other bonds, the initial
stream of payments is in respect of interest only, with entire repayment in bullet form on
a specified maturity date. At period intervals, say monthly installments, every rupee of
the installment amount is adjusted against a fraction of principal and balance against
interest.

There have also been interesting comparisons between securitization and factoring
services. The similarities are in the refinancing aspect, as both the processes result in
exchange of receivables for cash inflows. There are however, significant differences.
Factoring is predominantly a service, collection mechanism. With financing (in the case

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of advance factoring). Securitization is essentially a financing mechanism, with several

other powerful financial engineering implications. Additionally, in factoring, no
marketable financial instrument comes into existence. To sum up, it may be stated that
an organization engaged in advance factoring may resort to securitization as a source of
finance!

Securitization different from traditional debt instruments:

Securitized instrument have some distinct features which distinguish them from
traditional debt:
Isolation of pool of assets: In the securitization the securitized assets are
separated from the original lender through a sale to a separated legal entity
called as a Special Purpose Vehicle (SPV) which acts as an intermediary.
Claims against a pool of assets: Traditional debt instrument represent claim
against the company that issue the debt. Investors rely entirely on the borrower
companys credit quality for repayment of their debt. In securitization
transaction, investor payout is made from collection of securitized assets and
the instruments are thus claims on the assets securitized. Investor does not
typically recourse to the originator.
Credit enhancement: Credit enhancement is an additional source of funds
that can be used if collections on the assets are insufficient to pay investors
their dues in full. Credit enhancement thus support the credit quality of the

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securitized instrument and enable it to achieve a higher credit rating than the
pool of assets on its own, in many cases the rating would also be higher than
that of the originator. This is not possible in conventional debt.
Payment Mechanisms: securitized instrument typically incorporate structural
features to ensure that scheduled payment reach investor in a timely manner.
Operational and administrative requirements: as the SPV is the only shell
entity the administration of the pools of securitized loans involves multiple
parties performing various functions. These functions include collection,
accounting, and loan servicing, legal compliances etc which need to be
performed through out the life of transaction.

Economic benefit of securitization:

Securitization creates tangible economic benefits. These benefits are more visible
in US and other developed countries where securitization markets have matured
over the past two decades.

Market Efficiency: Through securitization process the companies holding

financial assets like loans have ready access to low cost sources of fund and can
reduce their dependence on financial intermediaries for their capital requirement.
This translates into lower interest cost the benefits of which are also passed to the
end consumers.

Specialisation: The classic bank/financial institution model of Origination-

Funding-Credit administration of loans has led to an unbundling of roles and

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greater specialization as various player can now concentrate on their core

function, be it origination, funding or credit administration.

Streamlined system and process: Securitization demand high levels of data

transparency and requires robust system. This enhances the overall monitoring
and control of asset portfolios.

Why securitize? An originators perspective.

Efficient Financing: In securitization it is possible to achieve much higher

target rating for instrument than the originators credit raring by providing
credit rating enhancements for the transaction. Thus the borrower can
obtain fund at lower interest rates applicable to highly rated instrument and
gain a pricing advantage.
Off balance sheet funding: For accounting purposes securitization is
treated as a sale of assets and not as financing. Therefore the originator
does not record the transaction as a liability on its balance sheet. Such off
balance sheet raise funds without increasing the originators or debt equity
ratio.

Lower capital requirement: Securitization enables banks and financial

institutions to meet regulatory capital adequacy norms by transferring
assets and their associated risks off the balance sheet. The capital support

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the assets is released and the proceeds from securitization can be used for
further growth and investment.
Liquidity management: Tenor mismatch due to long term assets funded
by short term liabilities can be rectified by securitization as long term
assets are converted into cash. Thus securitization is a tool of asset liability
management.
Improvement in financial ratios: Since securitization help in undertaking
larger transaction volumes with the same capital profitability and return on
investment ratios increase post securitization.
Profit on sale: Securitization helps in up-fronting profits. This would
otherwise accrue over the tenor of the loans. Profits arise from the spread is
booked as profit leading to increased earnings in the year of securitization.

Why invest? An investors perspective.

Securitization instrument offer investors an attractive investment proposition
since they combine above average yields with a strong credit performance.
Potential investors in this instrument in India should consider the following
factors:
Size of investment opportunity: The securitization market in India is
growing leap and bound. In the financial year 2004-05, securitization
volumes are expected to reach Rs 250billion with 15% of retail loans
(excluding MBS) currently funded through securitization.
Safety Features: Securitization offers investors a diversification of
risks, since the exposure is to a pool of assets. Most issuances are

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highly rated by independent credit rating agency and have credit

support built into the transactions. Investors get the benefit of the
payment structure closely monitored by an independent trustee which
may not always be in the case of traditional debt instruments.
Performance track record: Securitization instruments have
demonstrated consistently good performance with no downgrades or
defaults on any instrument in India.
Yields: Yields of ABS/MBS/CDO are higher than those of other debt
instrument with comparable rating. Spreads of securitized instrument
are typically in the range of 50-100 basis points over comparable AAA
corporate bonds.
Flexibility: An important advantage of securitization is the flexibility
to tailor the instrument to meet the investors risk and tenor appetite.
o Durations can range from few months to many years.
o Repayment are usually made on monthly basis but can be
structured on a quarterly or semi annually basis.
o Interest rate can be fixed or floating depending upon investor
preferences.

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UNDERSTANDING RISKS IN SECURITIZATION

Risk investors face in securitization:

Investors in securitized instruments can take advantage of the benefits that these
instrument offer, however they also need to be aware of the inherent risks in these
transaction. These risks classified into:
Asset pool risks which arise due to the unpredictable behavior of the
underlying borrowers. The payment behavior of underlying borrowers can
be estimated with a reasonable degree of accuracy based on historical
data.
Legal risks due to lack of judicial precedence on securitization legislation
and regulation.
Counter party risk arise as a securitization transaction involved multiple
parties throughout the tenure of the instrument. The investors returns can
be impacted by non-performance or bankruptcy of any of these
counterparties.
Investment risks like all other investment securitized instruments are
subject to market related risks.

Investors are protected against these risks by means of structural features and
credit enhancement which enable the instrument to achieve high credit ratings.

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Assets pool risk in a securitization and mitigation:

Assets pool risks are classified into credit risks and prepayment risks.

Credit risks: Investors have a direct exposure to the repayment ability of the
underlying borrowers whose loans have been securitized. If borrower default on
payment of installments or make delay payment collection will be inadequate to
scheduled investors payouts. Thus timely investor payments will depend on the
credit quality of the pool borrower.
Mitigation: Credit enhancement provide for PTC is sizes to cover the expected
levels of payment default and delays. In case there is short falls in the collection
the credit enhancement is used to make timely payment to the investors.
However, in the event of short falls over and above credit enhancement levels
investors will incur losses on their investment.
Risk of prepayment: Investors face the risks that underlying borrowers may
prepay all or part of the principal outstanding of their loans. When prepayment
occurs they are passed on to the investor (unless the instrument structure
provides for a separate class of PTC to absorb prepayments). This can affect
investor in two ways:
o Reinvestment risk: If there are heavy prepayment in the pool the average
tenure of the instrument reduces resulting in reinvestment risk for the
investor.
o Prepayment loss: If the investor has paid an additional consideration to
receive excess interest spreads generated by the pool the investor principal
outstanding is greater than the pool principal outstanding. Hence when the
contract is prepaid this excess interest spread payable to the investor from

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that contract is lost. Hence prepayments can result in the shortfalls in

payments.
Mitigation: Reinvestment risks can be mitigated by carving out a separate class
of PTC from pool cash flows to absorb prepayments occurring in the pool. This
class of PTC is called a prepayment strip and commonly found in securitized
instruments. Prepayment loss is mitigated as the credit enhancement is sized to
cover such losses. However in case of excessive prepayment losses greater than
the credit enhancement amount will be borne by the investor.
Property/asset price risk: Assets backing securitized instruments may be
prepossessed and sold post securitization. The proceeds and loss on sale depends
upon market values of the assets, which fluctuate.

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LEGAL ISSUES WITH SECURITIZATION

Documents that are used in securitization transaction:

Following document is part of the securitization transaction and represents current

practice in the securitization market. Some or all of these would be used in any
securitization transaction.
Trust deed: This document settles a trust for the purpose of purchasing the
receivables. The right and duties of the trustee are spelt in this document.
Deed of assignment of receivables: This document evidences the transfer of
receivables to the trust for the consideration. It is made by the originator in the
favors of SPV.
Declaration of trust: The unilateral document prepaid by the originator,
where the originator acts as the SPV/trustee, declaring that it holds the
receivables in trust for the investors.
Information memorandum: The offer document that provides details of the
proposed securitization of receivables to the potential investors.
Service agreement: Outlines the terms and conditions of the securitization
transaction and the right and the duties involved. It also lays down the right
and duties of servicing agents.
Cash collateral agreement: Spells out the termed and conditions under which
the cash collateral and yield reserve can be utilized/released. This agreement is
executed between the seller/service and a designated bank where the cash
collateral will be maintained.

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Power of attorney: This authorizes the trustee to execute acts and deeds with
regards to the securitization contracts, including the enforcement of security.
Collection and payout account agreement: This document spells out the
operational details of the collection account.

Stamp duty impact securitization transaction:

Stamp duty can be described as a tax levied on all documents of a commercial

nature. Stamp duty is an important issue for securitization transaction executed in
India due to:
Serious consequences of stamp duty evasion: Inadequately stamp
documents attract an enormous penalty, sometimes as much as ten times
the deficiency in stamp duty paid. Documents that are inadequately
stamped are also not recognized in court as evidence and are therefore
unenforceable.
Bearing the cost of stamp duty: The general is that the person claiming
the benefit of a document should bear the stamp duty or any penalties/fines
levied on that document.
Differential role of stamp duty: All states in India are empowered to
determine their own stamp duties and these vary from state to state.
In most of the states sale of asset attracts high stamp duty, sometimes up to
12% of the value of the assets transferred. This result in prohibitive transaction
costs. Only the states of Maharashtra, Gujarat, Tamil Nadu, West Bengal,
Andhra Pradesh and Karnataka have enacted stamp duty law favorable to the
transfer of assets. Legal expert believe that a consequence of the differential

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stamp duty is that if document executed in one state is taken into another state,
the document is liable to be stamped in the second state if the stamp duty in
the latter is higher.

True sale of assets relevant in securitization:

True sale ensures that the sale of assets in a securitization is absolute and binding and
effectively removes the financial assets from the balance sheet of the originator. It is
relevant since the investors return in asset securitization depends purely on cash flows
from the securitized assets. A true sale will ensure that the investors rights and
entitlements in respect of these cash flows are not affected in case of bankruptcy or
liquidity of the originator.
There is no statutory definition or judicial interpretation of true sale as yet in India.
However, the following issues are pertinent in evaluating a transaction for true sale:
Extent of recourse to and risk retained by the originator in the securitized
assets: Generally company is of the opinion that in cases where the originator
retains a high level of risk in the assets, the courts are likely to recognize the
transaction as a secured borrowing.
Options and obligations to repurchase assets: The presence of an option to
repurchase does not by itself negate true sale. However, company treats an
originators obligation to repurchase assets on account of deteriorating asset
quality as inconsistent with true sale.

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Extent of control retained by the originator over the assets: Company will
acknowledge a transfer as a true sale only if the transferee gains unrestricted
rights to the assets.

Company like CRISIL, CARE also bases its analysis of a securitization transaction
on professional opinion from an independent legal counsel, confirming that the
transfer of assets is consistent with a true sale.

NHB role in Mortgage Backed Securitization (MBS):

The National Housing Bank (NHB) is a regulatory body to promote and support
Indian housing finance companies (HFC and the housing portfolios of banks). NHB
has played a lead role in starting up MBS and developing a secondary mortgage in
India by:
Setting up Special Purpose Vehicle (SPV) for MBS and acting as a trustee to
the issuance on behalf of investors.
Acting as a guarantor and facilitating MBS transactions.
Acting as a refinancing arm for HFC by making loans and advances as well
as rendering financial assistance to scheduled banks and HFC.
Making continual efforts to generate awareness about residential MBS
among market participants.

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Risk applicable on MBS investments for Banks:

To improve the flow of credit housing sector, RBI has liberalized the
prudential requirement on risk weight for housing finance by Banks.
Accordingly, Banks extending housing loan to individual against the mortgage
of residential housing properties will be permitted to assign risk weight of
75% instead of the earlier requirement of 100% provided certain condition are
met. However,
Loans against the security of commercial real estate will continue to attract
100% risk weight. Moreover, bank investments in MBS of residential assets of
HFC will also be eligible for risk of 75% for the purpose of capital adequacy,
subject to certain terms and condition.
The loans should be securitized under the true sale of assets to the
SPV.
The loans to be securitized should be loans advanced to individuals for
acquiring/constructing residential houses, which should have been
mortgaged to HFC by way of exclusive first charge.
The loans to be securitized should be accorded an investment grade
credit rating by a credit rating agency at the time of the assignment of
SPV.
The securitized loans should be originated from housing finance
company/banks.

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 SECURITIZATION

Can banks investment in PTC:

Banks can invest in PTC. The Reserve Bank of India (RBI) issued guidelines
in November 2003 prescribing prudential limits for banks on all non-SLR
investment, specifically for investments in unlisted securities. In December
2003, RBI clarified that investment in either security receipts issued by
securitization companies/reconstruction Company registered with RBI, or
Assets Backed Securities (ABS) and Mortgage Backed Security (MBS) which
are rated at or above the minimum investment grade will not be reckoned as
unlisted non-SLR securities for computing compliance with the prudential
limits prescribed in the above guidelines. Therefore there is no impact on the
ability of the banks to invest in PTC as issued currently in transaction. It is
expected that the PTC would soon be specifically notified as securities under
SCRA and hence get listed.

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 SECURITIZATION

RATING PROCESS IN SECURITIZATION

Rating scale employed by credit rating agency in securitization transaction:

Credit rating agency has developed a framework for rating the debt obligation of Indian
corporate supported credit enhancements. For example CRISIL ratings of structured
obligation (SO) factor the credit enhancement extended by an entity, which could be in
the form of guarantees, over collateral, cash etc. (SO) rating are based on the same scale
as CRISIL other rating (AAA through D for long term debt, and P1 through P5 for short
term debt). The rating indicates the degree of certainty regarding timely payment of
financial obligation on the instrument.

Provisional rating:

When any credit rating agency rates a securitized pool of assets, it initially assigns a
provisional rating. The provisional rating assigned is valid for a period of 90 days,
before which the originator must comply with the following:
Submit copies of all executed transaction documents to credit rating agency.
Submit a letter from the trustee confirming that the transaction documents have
been executed to the trustees satisfaction.
Furnish representation and warranties as stipulated by credit rating agency.
Submit an auditors certificate where required.
Submit the required legal opinion from an independent counsel.

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 SECURITIZATION

Upon receipt of the above documents, credit rating agency examines if the
documents are in line with the transaction structure as envisaged at the time of
assigning provisional rating. If the documentation and the other compliances are to
credit rating agency satisfactions than agency issues a letter of compliance for the
transaction formalizing rating.

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 SECURITIZATION

Rating process for securitization:

Initial Mandate letter received from the client

Transaction details and structure communicated to rating company.

Company send its information requirement to the client specifying

Rating details of the information needed for the analysis. Based on information
made available, the rating team has detail managed meetings to
understand the originator business, process, assets quality parameters,
pool characteristics etc.

Team put together a rating report based on its interactions and presents
its report and recommendations to the rating committee.

A provisional rating is assigned to the transaction. If the client accepts

this, Company issues a rating letter with the rationale for the rating
Process
assigned

Post A compliance letter for the rating is issued once the final transaction
issue documents, legal opinion and other compliance documents have been
received by Company legal analyst and compliance team.

Monit
oring
Company does not end with the issue of the initial rating. Company has
a dedicated surveillance team, which monitors the performance of the
securitized pool every month to ensure that it is line with the
outstanding rating

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 SECURITIZATION

Typical due diligence done at the time of rating:

Credit rating agency carries out a through due diligence for all rating, before and
after the provisional rating.

Originator due diligence: The due diligence of originator MIS and the risks
control mechanism give a fairly good idea of the originator assets portfolio
vis--vis industry benchmarks, and forms critical inputs in the stipulation of
the credit enhancement levels for transaction.
Pool due diligence: Agency check if all pool contracts adhere to stipulated
selection criteria. Auditors statement are obtained to ensures that all
information furnished to rating agency relating to the pool has been verified
and found to be correct and true.
Transaction structure: Rating agency analyses the structure for each
transaction to adequately assess any risks which investors might face. This is
extremely important as the structure is becoming more complex.
Legal due diligence: The legal team also checks the draft transaction
documents, to identify any legal issues pr legally untenable clauses. The basic
documentation examined is the trust deed, assignment agreement/deed of
assignment, service agreement and cash collateral agreement. The corporate
undertaking or guarantee is also examined where relevant.

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 SECURITIZATION

Origination system

Management Credit appraisal and underwriting Risk

Information Control
System Mechanis
(MIS) m

Disbursement and post disbursal

documentation

Collection and recovery mechanism

Due diligence structure

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 SECURITIZATION

Surveillance process adopted by rating agency:

Rating agency believes it is of vital importance to monitor pool performance so

that it is in line with the outstanding rating. Surveillance is necessary because the
receivables from the pool of assets are used to service investors payouts. The
investors recourse is thus limited to these receivable, and to credit
enhancements, if any provided by the originator.

Additionally, complex structures have been introduced recent times in the

securitization market, with issuances incorporating staggered payouts
mechanisms, floating rate instruments and trigger based structures. These
complexities require close monitoring by the trustee and the rating agency to
ensures that the instruments adhere to the originally stipulated and appropriate
action is initiated at the right time in case of any deviation.

Rating agency has set up a dedicated surveillance team to monitor the

performance of rated pools. Transaction is monitored on a monthly basis and the
key parameter is tracked. This is done on the basis of monthly servicer reports
provided by servicer/trustees. The reports are checked for accuracy and
performance analysed. Thereafter, the team interacts with the concerned parties
to understand the reasons behind the trends, and the likely steps have been or
need to be undertaken to arrest adverse fluctuations in the pools performance.

A comprehensive review is under taken at least once a year, unless warranted

more frequently by deviations in the monitorables from rating agency estimates.

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 SECURITIZATION

Key monitorables of rating agency surveillance process:

Collective performance: The collection performance is analysed in terms

of monthly collection ratio (MCR) and cumulative collection ratio
(CCR).The MCR gives the flow element of the pool collection
performance and acts as an early warning indicator. The CCR reflects the
stock element of the pool collection performance.
Delinquency level: Credit rating agency analysis the overdue levels in
terms of various delinquency buckets. This analysis provides an estimate
of the credit losses in the pool to date and gives an indicator of future
losses.
Counter party credit quality: Rating agency also monitors the credit
quality of the counter parties involved in the transaction. These include the
servicer, the trust, the retention account bank, the cash collateral bank or
guarantor and the swap counter party.
Credit support: The credit enhancement available indicates the level of
cushion in the transaction. This cushion is required to withstand relevant
stress levels for the corresponding rating category. This parameter rounds
off the overall analysis and ensures that the outstanding rating is current.

In addition the credit rating agency monitors other parameters such as

prepayment, collection efficiencies and collateral utilization.

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 SECURITIZATION

Indian experience with securitization:

Securitization commenced in India with a car loan transaction originated by

Citibank in 1992. Since then, the market has grown rapidly, with India become
the third largest securitization market in Asia, after Japan and Korea. Proceeds
from Asset Backed Securitization (ABS) transaction account for close to 15% of
incremental disbursements in the Indian consumer finance market, underlining
the importance of securitization as a financing tool. Market sophistication has
also increased rapidly in 2004-05 with the advent of new asset classes and
structures.

Breaking new ground:

1992: First auto loan securitization was done by Citibank.

2000: First MBS was done by National Housing Bank.
2001: First offshore transaction backed by aircraft purchase receivable.
2004: First successful multi asset was done by ICICI Bank.

Size of the market: Rating agency estimates that over 330 transactions,
involving a cumulative volume of Rs 530 billion, have been placed in the market.
Issuance has grown exponentially with ABS volumes growing at a CAGR of
51% and MBS volumes growing at a CAGR of 65% since 2000.

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 SECURITIZATION

Originator and investor in securitization market:

Securitization has gained popularity over the years as reflected in the increasing
number of originator entering in the market. Some key originator in the market
includes ICICI Bank, HDFC Bank, Citigroup, and Tata group.
The predominant investors in securitized instrument are mutual funds,
public sector bank, foreign bank, private sector banks and insurance company.

Asset classes securitized in India:

Assets Backed Securities Collateralized Loan Obligation

Cars Corporate bonds
Commercial vehicles Municipal bonds
Two wheelers W.C. & term loan facilities
Construction equipment Sales tax loan receivable
Aircraft purchase receivable Corporate loans
Personal loans Oil receivable
Utility vehicles Lease receivable
Used cars
Three vehicles Mortgage Backed Securities
Office equipment receivable Residential loans

Forms of Special Purpose Vehicle used in India market:

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 SECURITIZATION

In India, an SPV is typically in the nature of trust. The trust is usually settled by
the third party who is appointed as the trustee, to manage the trust properties (the
securitized assets) and distribute the income from the same. The trustee is the
legal owner of the assets, whereas investor is entitled to all the benefit arising
from the trust properties. An SPV can also be formed by declaring trust over the
assets. In such cases, the originator holds the assets are transferred to the
investors, while the legal ownership of the assets continues to vest with the
originator in its capacity as the trustee.

Common structure used in the Indian market to securitise assets:

Structures have evolved in India based on investor risk, tenor preferences, and
issuer requirement.
Fully amortising structure: In India, we see fully amortising
instrument (i.e. principal is repaid to the investors along with the interest
over the tenor of the PTC). This is different from bullet structure, where
the entire principal is repaid at maturity. Fully amortising structure is
designed to closely reflect the full repayment of the underlying loans
through the interest and principal payment.
Par and premium structure: In par structure, the investor pays a
consideration equal to the principal outstanding (par value) of future
cash flows. In return the investor is entitled to receive scheduled
principal repayment from the pool of receivable along with a pre decide
rate of interest. Par structure also has an element of Excess Interest

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 SECURITIZATION

Spread (EIS) generated if the yield on the pool is higher than the yield
on the PTC. The originator has the right to receive the EIS amount.

A premium structure is one where the investor pays a consideration greater than the
principal outstanding of future cash flows, for the additional right to receive EIS
arising from the securitized assets. Predominantly, par structure is used in MBS and
premium structure is used in ABS.
Senior subordinate structure: Cash flows from the securitized assets can be
carved into multiple classes of securities having different tenors and risk profiles.
The senior class is accorded the first claim on the cash flows from the pool,
whereas the subordinate class has a lower claim. Thus, the subordinate class is
first loss price and the support payment to the senior classes. Typically in India,
senior classes are highly rated instruments while subordinate classes are unrated
and retained by the originator.
Fixed and floating rate structures: PTC is issued at both fixed and floating
rates of interest. The motivation for fixed or floating rates depends on interest
rate trends in the economy. Investor preferences and other such parameters.
Recently there have been many issuances at floating rates, where the rates are
benchmarked to a designated index like the NSE, MIBOR. If underlying assets
are fixed rate loans, floating coupon rates introduce the element of interest rate
risk in the transaction. This risk can be mitigated by using an interest rate swap
with a swap provider who exchange rate payouts made by the trust for floating
rate payout to the investors.

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 SECURITIZATION

Credit enhancement found in India:

The most common forms of credit enhancement found in the Indian market are listed
below. They are not mutually exclusive a combination of two or more forms of credit
support is often used.
Cash collateral: This is an external form of credit support. The originator or the
third party provides a predetermined amount of cash, which is put into the reserve
account. Withdrawals can be made from this account to off set losses on the
securitized assets. The cash collateral is held by the trustee in the favor of
investors.
Excess interest spread: This is an internal form of credit enhancement available
in transactions where the interest rate received on underlying loans is higher than
the interest rate paid on the PTC backed by those loans. This give rise to excess
margin or spread that can be applied to offset in the pool collection.
Subordinate tranches: One of the common methods of credit enhancement is
senior subordinate tranches structure, where the subordinate tranches acts as a
credit enhance for the senior tranches.

Over collateralization: This is the form of credit enhancement where the

principal outstanding of securitized assets is greater then the principal
outstanding of the PTC. For example, if Rs 150 million of assets backs Rs
100 million of PTC, then Rs 50 million is the over collateral in the

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 SECURITIZATION

transaction. After the PTC redeemed, the over collateral assets belong to
the residual beneficiary in the transaction.
Guarantees: A legally valid and enforceable guarantee from the higher rated
entity for funding shortfalls in collections is external form of credit
enhancement. Such guarantee if present are usually limited to
predetermined amount.

Waterfall mechanism structured:

The term waterfall is used to describe the order of priority in which proceeds
realized from securitized assets will be utilized. Payments to stake holders in the
securitization will be made as per the term and conditions laid out in the waterfall.
Statutory or regulatory dues pertaining to the securitized receivable.
Expenses incurred by service provider like the trustee agent, rating agency,
auditor and legal advisors.
Senior PTC holders payment.
Top up cash collateral.
The residential amount. If any is paid to subordinate PTC holders, if there are no
subordinate PTC, the residual amount flows back to the residual beneficiary in the
transaction, usually the originator.

Innovation in Securitization

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 SECURITIZATION

Strips

STRIPS are the acronym for Separately Traded Interest and Principal Segments. The
interest and principal steam of cash flow are deterministic and are known in advance.
These are sold at their present values as deep discount bonds. The principal only (PO)
and interest only (IO) segments represent two synthetic instruments that are excellent
hedging instruments. By investing in various combinations, investors can create their
own risk-return profile, something not enabled by holding plain-vanilla puts. The strip
reacts differently to changes in interest rate behavior. To understand this better, think of
strips to be the present values of a stream of cash flows, denoted by

Where C represents the cash flow from the underlying receivables

T Represents the timing of the cash flow,

R Represents the current rate discounting, the market yield

The price movements of strips are impacted the repayment effect, discounting effect and
their combined effect.

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 SECURITIZATION

In the case of PO, a fall in market interest rates would induce mortgage borrowers to
prepay existing loans and borrow a fresh at lower rates. This will accelerate the cash
flows appearing in the numerator, and reduce the discounting factor in the denominator;
both effect together leading to a value appreciation and hence price of a PO. Reserve is
the case for a rise in the interest rates where borrowers would stay put and tend to
prepay, and the denominator rising, leading to a fall in the price of a PO.

In the case of the IO, a fall in the markets interest rates would reduce the denominator to
lift the price. However, due to repayment, large section of outstanding would be bereft
of future interest inflows. This represent losses in the interest income to service the IO.
The magnitude of interest rates shift and prepayments would determine the combined
effect and final value of the IO. A rise in the interest rates would protect the numerator,
but there will also be a rise in the denominator. Here again, the combined effect and the
impact on the final valuation depends on the magnitudes of the rate shift.

Hedging instruments, bank investing in the long end of the market would like interest
rates to be high. They therefore would buy Pos to protect their losses. Bank wanting
interest rates to fall to increase their lending volumes would be interested in getting
hedge protection by investing in Ions. Thus, it is to be understood that PO and IO strip
moves in opposite directions in relation to interest rates shift in order to devise hedging
strategies.

Tranched transactions

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 SECURITIZATION

Tranched transactions are Collateralized Mortgage Obligation (Comes). The normal

pass through mechanism is altered here to mean pay through. In other words, under the
pay through structure, the SPV merely acts as a payment gateway. Under the pay
through structure, the SPV plays an active role in determining which class of securitized
instruments gets a priority in the principal repayment, meaning that the other classes of
instrument get only the interest for the time being. The sequence goes on until, in a
phased manner, all classes of instruments are fully redeemed with interest. This pattern
facilitates the attraction of investors with varying appetites of loan tenors and interest
rates.
As an illustration, consider the following tranches:

Type Amount raised Coupon % Repayment

(Rs. Lakhs) p.a. Years
A 50.00 8.00 1 to 5
B 50.00 8.25 6 to 10
CAT 50.00 8.50 11 to 15

The A, B and C classes of securities represent different classes of investors. The

tranches are shown as fixed interest bearing securities. The interest rates are
hypothetical and illustrative in nature.

There could be a variation, where tranches C assume the name Z, where the entire
interest is re-appropriated to the repayments of A, and the amounted temporarily

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 SECURITIZATION

foregone is added back to the outstanding principal Z. these Z tranches are wildcards
and are hedging instruments as well as catering to the appetite of risk friendly investors.
Note that the presence of B, C and Z tranches serves as cushions to safeguard A. the
presence of such cushions raises the credit rating of A class securities and hence lower
there coupons obligation in the risk return matrix.

It is possible to switch from an existing fixed-interest security like A, B or C into a

floating rate mechanism, using financial techniques. The instruments so designed would
be called Floaters and Inverse Floaters. A brief description is provided below.

Floaters

A coupon-bearing bond where the coupon rates is linked to a reference rate. The
investors gains when the reference rates rises. The floating rates are equal to or above
the reference rates, the difference between the two rates being the quality spread (i.e. the
risk element embedded in the interest rate). Floaters are issued on a stand-alone basis or
complementary to Inverse Floaters.

Inverse floaters

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 SECURITIZATION

These are issued complementary to floaters. The coupons rates are pegged at a fixed
ceiling rate minus floating rate. For example, if the floating rate is say 7%, and the
ceiling rate is at roughly double, say, 155 the coupon on the inverse will yield (15-7)% =
8%. When floating rates rise to say 9%, the inverse will yield less, i.e. (15-9) % = 6%
and vise versa. A set of floaters and inverse floaters can be used to replace fixed coupon
bearing bonds. In such situations, class securities would be split in the ratio 1:1, via Rs.
25 lakhs floaters and other Rs. 25 lakhs inverse floaters. In many cases the investment
bankers assist in designing such instruments.

Variations of this theme are supper-floaters and super inverse floaters. For example,
Rs. 50 lakhs interest at 8.50 could be split in the ratio 2:1, into Rs. 34.5 lakhs floating at
say 8% at a point in time, or say, reference rate of 7% + 1%, at a point in time. This
comes with a co-existing inverse-floating rates of (ceiling of 24% - 2 times the floating
rate of say 8%) = 44% at a given point in time. The inverse-floaters are issued for an
amount of Rs. 17.5 lakhs, half the amount of the floating securities. Considering the
magnitude of the amount and the ceiling interest rate, the inverse floaters assume the
name super-inverse floaters.

A close perusal the two schemes outlined will reveals the interest rate hedging
mechanism of the floating rate securitized instruments.

CAT Bonds

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 SECURITIZATION

Until now, the applicability of the securitization was assumed to be in the banking
sector. However, Catastrophe Bonds as they are called is also an effective risk transfer
and risk financing device in the insurance sector. The mechanism of CAT bonds is
explained in the paragraph below.

Let us assume that there is an insurance company, and it has done well in extending its
business in say, Gujarat. The premium incomes are with the company. It could so
happen that a catastrophe in Gujarat could lead to claim amounts that could wipe out
this insurance company. The conventional method of dealing with such risk would be
elements of re-insurance, where part of the premium would be ceded by the insurer to
the reinsurers, taking a proportionate amount of risk also off its balance sheet. However,
it must be appreciated that there could be some catastrophic events which make even so-
called normally anticipated losses are exceeded. To avail of contingent financing for
contingent events, the device of CAT Bonds has been innovated. Here, CAT Bonds are
issued at a high coupon rate for the contingent amount, to cover the perceived under-
financed claim-losses. Catastrophic losses beyond the threshold level trigger the
appropriation of CAT Bonds principal proceeds to settle claims, the principal now not
being repayable to the CAT Bonds investor. If no claim arises on CAT Bonds, the entire
proceeds are refund on expiry of the term of the risk insured against, in which case the
interest is a clean profit for the investors. The redemption amount is secured against
stream of premium payments, as insurance companies gain credibility (hence business
and premium inflows) when they successfully settle claims over a period of time. Thus,
CAT Bonds represents the conversion of risk, packaging them into a tradable
commodity and garnering capital markets solutions to safeguard against losses from
natural calamities.

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Notably, all that is an SPV acceptable to the potential investors, the SPV essentially is a
trust that can be wound up once the objectives of the trust are achieved. Its role is only
in appropriating payments in a diligent manner to safeguard the investors interest, it is
the collective representation of the investors. Thus reinsurance-type protection as
reinsurance can be offered through the mode of securitization, obviating the need for
incorporation as a reinsurance company and the requisite minimum capital requirement
of Rs.200 cores.

CASE STUDIES ON SECURITIZATION

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 SECURITIZATION

CASE STUDY 1:
CITIGROUP DIRECT ASSIGNMENT OF RECEIVABLES

DEAL SUMMARY

Originator, Seller & Servicer: Citicorp Finance (India) Ltd.

Trustee: IDBI Trusteeship Services

Instrument: Direct assignment of Receivables from the Originator to

Banks

Issue Size : Gross value of receivables Rest 79.5 cores; Purchase

Consideration (discount value) of Rest 72.4 Cores

Rating : AAA(so) from ICRA

Nature of Receivables : Arising from loan contracts for commercial

vehicles entered into between Originator and borrowers who are Small
Road Transport Operators (Strops)

Credit Enhancement:
Corporate Undertaking of 9.36% of assigned receivables

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 SECURITIZATION

CFIL shall assign right that it has under the Franchisee Agreement
specific to the Loss sharing undertaking (varies between 0% to 30% of
the amount financed) Provided by Franchisee and on the Earnest
Money Deposit (EMD) Provided by each Franchisee against loan
Agreements originated by the Franchisee acting as an Agents for
CFIL.

Maturity : Door to Door of 47 Months; Average of 18 months

SELECTION CRITERIA

The Pool has selected by CFIL from the loan contracts currently on its books
using the following criteria as on December 31 st 2004, which is referred to as
the cut-off-Date:

No Over dues of greater than 60 days as on the cut- off date.

CFIL should not have initiated legal / repossession action against any
borrowers
Minimum Seasoning on cut-off date of 2months
Contracts for financing intermediaries who then onward finance the
vehicle to the final customer should not be included

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 SECURITIZATION

When both body and chassis is funded then both or none should be
included in the pool. If only body is funded then such cases should not be
included
The Receivables were generated in the ordinary course of its business by
CFLD either directly or through its franchisees.

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 SECURITIZATION

POOL CHARACTERISTICS

Weight Average Seasoning of 4.5

months

Delayed payments are common in

the CV financing market hence some
over dues

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 SECURITIZATION

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 SECURITIZATION
Weight Average LTV of
68% (after imputing body
cost of 25%)

Geographically well
diversified across 19 states.

Weight Average Amount

financed is Rs. 5.5%

CASESTUDY2

MMFSL Securitization under floating rate Structure with swap

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 SECURITIZATION

Deal Summary

Originator, seller & servicer: Marinara & Marinara Financial Service Ltd.
SPV: VE Trust; Trustee: UTI Bank Ltd.
Instrument: Pass Through Certificates

Maturity Coupon Issue Size Payment

Frequency
Strips A1 to Door to door NSE MIBOR Rest 45 cores Quarterly
A3 of 12 + spread
months;
average of 6-
7 months
Strip A4 to Door to door NSE MIBOR Rest 45 cores Quarterly
A6 of 28 + spread
months;
average of
16-17
months
Strip A7- Door to door Fixed Rate Rest 21 cores Monthly
prepayment of 35
strip months;
average of 22
months

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 SECURITIZATION
Rating: P1+/AAA(so) from CRISIL
Nature of Receivable: Arising from loan contracts for utility vehicles
and cars entered into between originator and borrowers
Credit Enhancement:
Subordinate PTC of 9.8%
Cash Collateral of 5.75%
Opening over dues subordination

Selection Criteria:

The pool has been selected by MMFSL from the loan contracts currently on its
books using the following criteria as on October 2003, which is referred to as the
Cut-off-Date:
The pool comprises of only utility vehicles and cars.
The pool contracts have a minimum seasoning of three months.
The over dues on the contracts do not exceed a period of one month.
Only contracts directly originated by the seller and whose collection is
directly undertaken by the seller have been included.
The maximum balance tenor as on February 1, 2004 is 35 months.
The original LTV of the contracts is restricted to a maximum of 90%.

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 SECURITIZATION

Asset class Utility Vehicles and

Passenger Cars
Number of contracts 6,130
Total Receivables from Feb, 1 2004 (Rest.) 1,245,092,239.00
Average contract balance (Rest.) 203,115
Minimum contract balance (Rest.) 6,385
Maximum contract balance (Rest.) 529,000
Weighted average seasoning (monthly) (as on 11.35
January 31, 2004)
Minimum seasoning (months) (as on January 31, 7.00
2004)
Weighted average balance maturity (months) 24.24
Maximum balance maturity 35.00
Weighted average LTV 73.31%
% of pool with nil over dues (as on cut-off date) 74.74%

Pool Characteristics:

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 SECURITIZATION

Weight Average Seasoning 11.35

months

75% of the pool had nil over dues and

balance had 1 EMI over dues

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 SECURITIZATION

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 SECURITIZATION

Weighted Average LTV

73%

Pool is geographically well

diversified across 19 states

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 SECURITIZATION

Structure Diagram

Originator/Seller
(MMFSL) Obligors
Issue of
subordinate PTC Sale of receivables
& purchase
consideration for
Liquidity Reserve receivable
Servicer
SPV
Interest rate Swaps Monthly
Collection Collection
Citibank Investors Account
Agent
Issue of
floating rate & Payout
fixed rate PTC on PTC
Trustee

Investors

Interest rate swaps have been entered into between the Investors agent and Citibank to convert
fixed pool to a floating rate coupon to investors.

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 SECURITIZATION
Performance of previous issuances
CFIL & CAN April 02 June 02 July 02 Oct 02
Issuance
Issue size (Rest. 66.92 74.57 115.38 109.5
Cores)
Total number of 69 77 117 111
PTC
Issue rating AAA (so) P1 (so) P1 (so) LAAA (so)&
+PSCE& AAA +PSCE& MAAA (so)
(so) AAA (so)
CE stipulated 8.00% 8.50% 8.50% 4.50%+PSCE
O/s level of CE as 39.68% 13.51% 60.94% 41.73%
% future investor
cash flows
Cum. Principal 8.50% 3.97% 10.32% 3.43%
prepaid as a % of
the original
principal
outstanding on the
issuance
Peak usage of CE 16.52% 12.26% 6.42% 16.70%
(as a % of O/S
CE)
First 3 months 86.70% 76.80% 77.53% 93.42%
First 6 months 92.27% 87.21% 86.68% 95.95%
As on date 98.95% 119.29% 97.23% 97.93%

ANALYSIS OF THE SURVEY

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 SECURITIZATION
Analysis for the better understanding about Securitization. Questionnaire method was
used to carry out the survey. A set of 5 question was used in the questionnaire, which
varied from objective type of question. Questionnaire was framed and designed in such a
manner that it could be filled up with in 5minutes by the person thus saving time of
interviewee. The sample size of the survey was taken to be 50, of this 50 people 18
questioned were to business person, 20 people were servicemen and professional, 12
were student. Question Ranged from getting information about securities, securitization,
credit rating etc.

1. Do you invest in securities?

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2. Are you aware of securitization?

3. Before you invest in company do you check credit rating?

4. Do you think securitization is important?

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5. For securitization which one is better?

Summary

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Securitization is the process of converting relationships into transactions. These

transaction must lead to the creation of tradable instruments. Incomplete securitization is
the non-existence of tradable securities, where the essential feature of relationship
continues to prevail. Securitization enables financial institutions to raise from existing
receivable streams. These resources are essentially stable and long-term, with protection
to interest spreads. In the case of well-designed securitization structures, the cost of funds
for financial instruments can be substantially reduced in comparison to plain
conventional borrowing.
The advantage for the investor are liquid investment for a range of tenors and
risks profiles.
The various forms of securitization include Asset Backed Securities, which includes
receivables from loans for tangible assets, such as mortgages, automobiles and
equipment. Securitization of credit card receivables, student loans and infrastructure and
utilities receivables is also feasible, bit here the asset is stream of future cash flows and
physical assets. The securitization process involves several players such as originator, the
obligor, merchant banker, SPV, underwriters, investors, escrow bankers, rating agencies
and credit insurance agencies.
Innovation in securitized instruments are in the forms of STRIPS, where the
interest and the principal components of receivable, in the pass through mode, are sold
off separately. These can be used as hedging instruments. Another innovation is in term
of carving up receivables and designing debt instruments for potential investors such as
short-medium and long-term investors. Such structure are known as pat through
structures or Collateralized Mortgage Obligation (CMO). Further add-on innovations in
CMO are converting fixed rate coupon cash streams into variable rate cash streams using
floaters and inverse floaters. Thus, securitization process involve financial engineering.

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The success of securitization is very important in the development of the economy.

Possible area for the application of securitization is residential and commercial
mortgages, infrastructure receivables, custom bile and equipment loans, student loans and
credit card loans. The advent of Catastrophe Bonds (CAT) is the interface between the
capital markets and the insurance sector.

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Conclusion:

Securitization in is at the crossroads. A lot has been heard about it since

1990, very little done. We are familiar with the sad Indian story of minor
irritants playing a major role in stalling major development. But just as the
revolution in India was out come of import liberalization for computers, so
also, it is only a matter of time before high quality securitization forms the
backbone of housing, infrastructure and trade finance in India. Perhaps what
we also need is Ginnie Mae and Fannie Mae type origination in India.

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Bibliography:

www.goggle.com

www.wikipedia.com

www.vinodkothari.com

www.crisil.com

Vipul prakashan

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