Securitization - Past Present and Future in India

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MBA (F&B)-Internship Report

Securitization The Indian Perspective

Submitted by:-Amit Kumar -334Gowrishankar-NUMBAJagdish Agarwal-371Pritish Chaudhary-406Priyaranjan Singh-408Puneet Singh Bhatia-409Sujeet Kumar-461Tirthankar Ghosh 467

Securitization : The Past, Present & Future in India

Abstract

In this paper we analyze and explain The Past, Present and the possible future status of securitization in India. India being a developing country is counted among worlds fastest growing emerging economies. Be it Bond market or the securitization, India is still at a nascent stage and still need to mature in order to be counted among the big players.

2007-08 recession in US was a great learning for the world. Past learning & government initiatives have helped India in this regard. We will study, analyze and explain all the aspects of securitization.

TABLE OF CONTENTS

I. Introduction - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -4II. History- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 5III. Evolution of different securities in India - - - - - - - - - - - - - - - - - - - - - - - - - 7IV. Examples of Securitization - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - 10V. Regulatory Framework - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -11VI. Parties Involved in Securitization Process - - - - - - - - - - - - - - - - - - - - - - - -12VII. Securitization Cases1) Citibank Case - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -132) REB Case - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -133) L&T Case - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -144) RICO Case - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -14VIII. Recent Trends - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - -15IX. Future of Securitization in India- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -16X. Issues faced by Indian Securitization Market- - - - - - - - - - - - - - - - - - - - - - 18XI. Areas of Improvement- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -19XII. Conclusion- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 23

Introduction

Securitization is the process of pooling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors.

Through securitization illiquid assets are converted into tradable security in the secondary market. It is measure of replenishing the funds by recourse to the secondary market. Thus, the securitization is a process by which the originators of assets like loans, which are illiquid are able to transfer such assets to a special purpose vehicle ('SPV') which, in turn, issues tradable liquid securities to investors. In a typical securitization transaction, the company seeking to raise funds transfers certain assets to an SPV that is organized in such a way that minimizes the likelihood of bankruptcy.

History

The financial sector in India has witnessed a series of reforms and changes since 1991, that is, the period in which the government ensued upon a policy for larger economic reforms allowing foreign direct and indirect investment in India. The need for the legal framework on securitization can be traced way back from 1991 onwards where various committees recommended to have a law on securitization and enforcement, this was followed by the enactment of the Securitization and Reconstruction of Financial Assets & enforcement of Securities Interest Act, 2002. The Act encompasses the areas of: securitization of financial assets, reconstruction of financial assets, recognition to any security interest created for due repayment of a loan as security interest under the Securitization Act, irrespective of its form: banks and financial institutions have the power to enforce the security without intervention of the courts, setting up the Central Registry for registration of the transaction of securitization, reconstruction and creation of security interests.

Securitization of financial assets is a financial tool for the lenders to securitize their future cash flows from the secured assets and thus to release their funds blocked in them. The secured assets become a market commodity having financial returns on their realization. This aspect brings in the much-needed expertise in adept handling in realization of the secured assets. The Act has made an attempt to streamline the legal impediments of normal civil law procedures to foreclose the mortgaged assets by empowering the enforcement of the secured assets by flexible mechanism provided in the Act. It would be pertinent to inter alia highlight the key features of the Act. The Act makes provision for:

Incorporation of Special Purpose Vehicles Securitization of Financial Assets Funding of securitization Asset Reconstruction Enforcing security interest i.e. taking over the assets given as security for the loan. Establishment of Central Registry for regulating and registering securitization transactions. Offences & Penalties.

The growth in the Indian securitization market has been largely fuelled by the repackaging of retail assets and residential mortgages of banks and Financial Institutions. This market has been in existence since the early 1990s, though it has matured significantly only post 2000 with an established narrow band of investor community and regular issuers. According to Industry estimates, the structured issuance volumes have grown considerably in the last few years; though still small compared to international volumes.

Asset backed securitization (ABS) is the largest product class driven by the growing retail loan portfolio of banks and other FIs, investors familiarity with the underlying assets and the short maturity period of these loans. The mortgage backed securities (MBS) market has been rather slow in taking off despite a growing housing finance market due to the long maturity periods, lack of secondary market liquidity and the risk arising from prepayment/repricing of the underlying loan.

In the early 1990s, securitization was essentially a device of bilateral acquisitions of portfolios of finance companies. There were quasi-securitizations for sometime, where creation of any form of security was rare and the portfolios simply got transferred from the balance sheet of the originator to that of another entity. These transactions often included provisions, which offered recourse to the originator as well. In recent years, loan sales have become common through the direct assignment route, which is structured using the true sale concept. Though securitization of auto loans remained the mainstay throughout the 1990s, over time, the market has spread into several asset classes housing loans, corporate loans, commercial mortgage receivables, future flows, project receivables, toll revenues, etc that have been securitized.

Within the auto loan segment, the car loan segment has been more successful than the commercial vehicle loan segment, mainly because of factors such as perceived credit risk, higher volumes and homogenous nature of receivables. Other types of receivables for which securitization has been attempted in the past include property rental receivables, power receivables, telecom receivables, lease receivables and medical equipment loan receivables.

Revolving assets such as working capital loans, credit card receivables are not permitted to be securitized.

The Time line:

Evolution of different securities in India:

1. Mortgage Backed Securities (MBS)In 2004-05, the Mortgaged Backed Securities market grew moderately at 13% with the issuance valued at `33.4 billion. There was also an increase in the par transactions with all 15 transactions being made in 2005 having a par structure. Since the underlying home loans in MBS pool have a floating-rate, the scheduled cash flow on such pools is uncertain and liable to change, depending on actual interest rate. Moreover, options to convert from fixed to floating rate and vice-versa, coupled with negotiated re-pricing of loans, added to the uncertainty of the cash flow in the MBS pool.

With the underlying loans earning floating rates, Pass through Certificates (PTCs) inMBS issues are also being predominantly priced on a floating rate basis. In 2005, 52% of issuance was based on a floating rate. But given the significant expansion in the housing finance business, there is room for even more significant expansion in the MBS market.However, the long-term tenure of MBS and the lack of liquidity in the secondary market discourage investors from getting actively involved in the market. Also home loans in India get pre-paid or re-priced, thus exposing the structures to significant interest rate risk and leading to higher credit enhancement requirements.

2. Asset Backed Securities (ABS)In 2005, the market for Structured Finance (SF) grew by 121% in terms of value and 41% in the number of transactions, while the ABS market doubled from `80.9 billion in 2004 to Rs. 222.9 billion in 2004. ABS was the largest product class, accounting for 72% of the SF market in 2005. This was three times higher than the volume of `81 billion in 2003. The growth in ABS issuance was the result of the following factors:

Continued increase in disbursements by key retail asset financers Investors familiarity with the underlying asset class Relatively shorter tenure of issuances Stability in the performance of a growing number of past poo