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Asset Securitization

Himanshu Arora
Securitization
Securitization is the issuance of marketable
securities backed by the expected cash flows
from specific assets (receivables)
Parties to an issue
The initial owner of the loans.
Originator Sells them to the SPV

SPV Set up specifically for transaction.


Purchases assets from Originator.
Special purpose
Company/Trust/ Mutual Fund
Vehicle

The loan customers.


Obligors Pay cashflows that are securitised

Subscribe to securities
Investors issued by SPV
Parties to an issue (contd.)
Collects money from Obligors,
Collection monitors and maintains assets.
Agent Usually the originator

Provides a rating for the deal


Credit Rating based on structure, rating of parties
Agency & portfolio, legal and tax opinion etc

Credit Provides credit enhancement


by way of swaps, hedges,
Enhancement
guarantees, insurance etc.
Provider
As structurer for designing &
Merchant executing the transaction and
Banker as arranger for the securities
Generic deal diagram
Credit
Obligors Enhancement
Providers
2 Collections 3 Credit enhancement
Original 9 Issue of securities
1 Cash flows
Loan
10 11 Servicing
Collection SPV of securities Investors
Sale of
Agent asset 6
4 Rating 8 Subscription to securities
Originator 7
Purchase
consideration Rating Agency Arranger

5 Contracts
Ongoing cash flows
Initial cash flows
Structurer
Why securitize assets?

More efficient financing


Improved balance sheet structure
Better risk management
SECURITISATION OF FINANCIAL
ASSETS
Structure of Securitisation:
1. Pass Through Certificates:
Sale of asset to SPV
Investors purchase interest in the assets of
SPV
Cash flow (interest and principal) passed
through as and when occurred without any
reconfiguration
Payments made are most often on monthly
basis
Reinvestment risk carried by investor
SECURITISATION OF FINANCIAL
ASSETS
2. Pay Through Certificates:
Sale of assets to SPV
SPV issues a debt security collateralized by asset cash
flows
Cash flows (interest and principal) reconfigured to suit
the requirements of the investors i.e. based on the
maturity period of the security
Reinvestment risk carried by SPV
Each trench is redeemed one at a time
Payments would be at different time intervals than the
flows from the underlying assets
What type of assets can be securitized?

Any type of asset with a reasonably


predictable stream of future cash flows can be
securitized.
Assets that are easiest to securitize are those:
that occur in large pools; for which past
experience can be used to predict default
rates; for which documentation is
standardized; and for which ownership is
transferable.
Types of Securitization
MBS (Mortgage based securitization )

ABS (Asset based securitization)

MBS are securities created from the pooling of mortgages,


and then sold to interested investors, whereas ABS have
evolved out of MBS and are created from the pooling of non-
mortgage assets. These are usually backed by credit card
receivables, home equity loans, student loans and auto loans.
What is required for a successful asset
securitization?
Robust financial infrastructure
The Legal Environment
The Accounting Environment
The Regulatory Environment
The Taxation Environment
Back-office Systems
SECURITISATION -INDIAN CONTEXT
First deal in India between Citibank and GIC Mutual Fund, in 1990 for
Rs. 160 million.
Securitisation of cash flow of high value customers of Rajasthan State
Industrial and Development Corporation in 1994-95, structured by SBI
cap.
Securitisation of overdue payments of UP government to HUDCO by
issue of tax-free bonds worth Rs. 500 million
Securitisation of Sales Tax deferrals by Government Of Maharashtra in
August 2001 for Rs. 1500 million with a green shoe option of Rs. 75
million.
First deal in power sector by Karnataka Electricity Board for receivables
worth Rs. 1940 million and placed them with HUDCO.
Data indicate that ICICI had securitised assets to the tune of Rs. 27500
million in its books at end March 1999.
Some of the companies that have been Involved
in this are

Ashok Leyland finance


Cholamandalam investment & finance
Esanda finance
Sakthi finance
Tata finance
SRF finance
MBS - A Win-Win for All
Originators
Churn higher returns on lower capital base
Investors
Can invest in low-risk rated home loans paper without
hassles of origination/ servicing
Financial system as a whole
Expertise of Specialists helps maintain quality of
underlying assets and reduces ALM mismatches
Home Loan Customers
Access to cheaper funds
MORTGAGE BACKED SECURITIES IN INDIA
The beginning of Mortgage Backed Securities
(MBS) in India was made in August 2000,
when National Housing Board (NHB) issued
the first MBS with issue size of INR 59.7
crores, originated by HDFC Ltd.
The US secondary mortgages market
The US secondary mortgages market is
considered to be the worlds most developed
mortgage securitisation market.
The mortgage originators are commercial banks,
thrifts, mortgage banks, and mortgage brokers.
The main secondary market conduits are Fannie
Mae, Ginnie Mae and Freddie Mae.
Some private investment banks also act as
conduits in the secondary mortgages market, but
to a limited extent.
The investors in the secondary mortgages market
are the pension funds, the life insurance
companies, the commercial banks, the thrifts,
and Fannie Mae.
INSTITUTION FRAMEWORK FOR THE SECONDARY
MORTGAGES MARKET IN THE US

The housing and mortgages industry in US is


overseen by U.S. Department of Housing and
Urban Development (HUD).
It also sets goals for government owned
Ginnie Mae, and Government Sponsored
Enterprises (GSE) like Fannie Mae and Freddie
Mac.
The Secretary of HUD is the mission regulator
for Fannie Mae and Freddie Mac with
oversight authority to ensure that both GSEs
comply with the public purposes set forth in
their charters.
The secretary is charged with the general
regulatory authority over GSEs in all areas
other than the GSEs financial safety and
soundness.
The financial safety and soundness of GSEs is
regulated by an independent office of HUD,
the Office of Federal Housing Enterprise
Oversight (OFHEO).
It regulates both the GSEs for safety and
soundness, by ensuring that they are
adequately capitalized and operating their
businesses in a financially sound manner.
Institutional Framework in India
Under the present institutional framework
National housing Board (NHB) is the apex level
financial institution for the housing sector in the
country
and performs the role of promotion and
development, regulation and supervision,
financing, development of secondary mortgages
market through securitization of housing loans,
and promotion of rural housing.
Most securitisations in India adopt a trust
structure with the underlying assets being
transferred by way of a sale to a trustee, who
holds it in trust for the investors.
The trustee typically issues PTCs. A PTC is a
certificate of proportional beneficial interest.
Beneficial property and legal property is distinct
in law the issuance of the PTCs does not imply
transfer of property by the SPV but certification
of beneficial interest.
Stamp duty
Stamp duty arises from the fact that a transfer of
actionable claims (which term includes most receivables)
will require a written instrument, and such instrument is
treated as a conveyance in law, meaning a document
whereby legal interest is conveyed in property.
A conveyance is a stampable document, and most states
impose stamp duties ranging between 3% to 15-16% on the
value of the property being transferred in a conveyance.
Since this would completely rule out any securitisation
transaction, several states have relaxed their duties
applicable on securitisation transactions mostly to
provide for 0.1% duty on the value of receivables being
transferred.
Taxation
The tax laws have no specific provision dealing
with securitisation.
Hence, the market practice is entirely based
on generic tax principles, and since these were
never crafted for securitisations, experts
opinions differ.
The generic tax rule is that a trustee is liable to
tax in a representative capacity on behalf of
the beneficiaries
therefore, there is a prima facie taxation of
the SPV as a representative of all end
investors.
However, the representative tax is not
applicable in case of non-discretionary trusts
where the share of the beneficiaries is
ascertainable.
The share of the beneficiaries is ascertainable
in all securitisations through the amount of
PTCs held by the investors.
The market believes, though with no reliable
precedent, that there will be no tax at the SPV
level and the investors will be taxed on their
share of income.
The scenario is, however, far from clear and
the current thinking may be short lived.
Thank You

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