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Securitisation: Product of the new millennium - Views on News from Equitymaster
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  • Mar 24, 2001

    Securitisation: Product of the new millennium

    The financial sector in India is witnessing a sea change. Technological advancements have changed the face of the world of finance. It is today more a world of transactions than a world of relations.

    Just as the e-commerce industry replaced Y2K, fibre optic cables replaced the copper cables; the financial services industry is being transformed now that securitised credit is beginning to replace traditional lending. Like other technological transformations, this one will also take years to happen.

    What is securitisation?
    "Securitisation" in its widest sense implies every such process, which converts a financial relation into a transaction. It covers the process by which the future receivables of an organisation are converted into tradable tangible securities to generate liquidity. What it indicates is that contractual debt is converted into tangible securities and then it is sold to end investors after packaging and underwriting the same.

    Anything starting from trade receivable to consumer receivables (such as credit cards, car, telephone rentals, bank loans) and machinery leases to aircraft leases can be securitised.

    Who are the parties to the deal?
    The mechanism of securitisation normally involves four parties Originator, Investor, Special Purpose Vehicle (SPV) and the Seller.

    Originator:  The entity or organisation, which securitises its assets, is called as an originator of the transaction.

    Investor:  The persons (individual or a company) who invests the money to purchase the securities are called the investors.

    Special purpose vehicle (SPV): It is an intermediary, which holds the receivables on behalf of the investors. Generally as the number of investors keeps growing and their base may keep changing from time to time, it is essential to have an intermediary to secure the interest of investors.

    Seller:  He is the person who sells the receivables to the purchaser without expense, cumbersome formalities or without the consent of the debtors.

    How does the securitisation deal works?
    In the securitisation transaction, the originators sells the receivables such as trade receivables and lease rentals to the Special Purpose Vehicle in return for a purchase price payable immediately on sale. The SPV pays the purchase price by obtaining loans from banks or through issue of bonds to investors. Thus it provides security to investors. The securities, which it issues, are known as ‘Pay or Pass Through Certificates’ (PTCs). These are structured in such a way that the redemption of the same synchronises with the aggregate inflow of the interest and principal of the basket of loans.

    The SPV is either formed as a trust or as a company whose shares are held by an entity other than the originator. As a result SPV will not be considered as a subsidiary of the originator and consequently its accounts will not be consolidated with Originator’s balance sheet. Also in order to achieve the comfort that the receivables would be sufficient to pay the investors on time, credit enhancement devices such as third party guarantee to SPV are resorted to.

    So what does an originator gain through this deal. The originator receives fees from SPV as a collecting agent. The SPV empowers the originator either as a service or a collecting agent to collect the receivables and uses them to pay principal and interest on the funding loan. In case of any default, the service agent (originator) takes action against the debtors as the agent of the SPV.

    In short, through the process of securitisation the originator raises money from investors on the strength of the receivables. He retains the profits and passes on the risk of non-payment of receivables to the investors. Further, he also removes the assets and the funding loans from its balance sheet.

    Securitisation process

    Benefits of securitisation

    1. The main advantage of securitisation is to the banks’ and financial institutions.

      • As an originator these financial intermediaries may have to raise extra capital in order to support the receivables. This is to comply the capital adequacy norms. If securitisation is affected this can be avoided as assets are sold to SPV.

      • Credit risk and interest-rate risk are the key uncertainties that concern domestic lenders. By passing on these risks to investors, or to third parties when credit enhancements are involved, financial firms are better able to manage their risk exposures. Thus securitisation world over has become an important tool in the asset liability management and risk management for both banks and FIs.

    2. The investor too has his own advantage. He enters into the transaction on the strength of receivables, which are usually of high quality and thus securing his investments. He gets attractive returns on investments above the rate of bank fixed deposits as the receivables are purchased at a discounted value and are comparatively less risky as the securities are backed by assets.

    Features of securitisation

    • The very purpose of securitisation is to ensure marketability to financial claims. Hence, the instrument is structured so as to be marketable.

    • Creating a market for the instrument is also important. Securitisation is a fallacy unless the securitised product is marketable. The very purpose of securitisation will be defeated if the instrument is loaded on to a few professional investors without any possibility of having a liquid market therein.

    India is a promising market for securitisation looking at a vast banking and financial sector and growing economy. Although, the transactions have taken a very long time to happen, the ice has been broken by the NHB-HDFC securitisation deal in August ’00. This is the first RMBS (restructured mortgage based security) transaction in India of US $ 13 m (Rs 597 m). From this it appears that there would be a spate of securitisation issues in time to come, as investors' appetite for debt offers distinctively improves.

    Some examples of securitisation deals in the past

    1. Varun Shipping (an originator) has structured the deal for an amount of US $ 6.3 m (Rs 280 m). The deal has been financed by Infrastructure Leasing and Financial Services Limited. (Structured finance means a financial instrument structured or tailored to the risk-return and maturity needs of the investor.)

    2. Jet Airways, a private aviation company has raised US $ 355 m (Rs 16 bn) using securitisation process from domestic investors. Jet Airways will be using an SPV to give these aircraft on hire purchase (a type of financial lease) to Jet Airways, and the hire purchase rentals will be securitised by the SPV, thus raising the funds needed to buy the aircraft. With the proceeds of the rentals, the SPV will provide to Jet Airways on hire purchase 10 new Boeing 737 aircraft.

    3. Citbank has tied up with the software education major NIIT to fund IT education in India. It is a potent case of securitisation being used to fund one of the most important capital asset of our times - knowledge. It is also the first major organised attempt to fund IT education in a country that commands global edge in the field. Under the proposed deal, Citibank will provide funds of US $ 90 m (Rs 400 m) to students of NIIT under its flagship three-year IT training program iGNIIT. The program uses a structured risk-sharing pattern with the first loss risk of 11% being absorbed by NIIT as the originator. IFC (International Finance Corporation) will absorb risk to the extent of next 10%.

    Indian securitisation market is like a giant waiting to wake up. The above deals clearly point out that the giant is waking up indeed. In order to augment the growth of securitisation in India the FM has also proposed a comprehensive legislation for the purpose in the current budget.

    Although, the potential for securitisation market in India is unlimited, there are many hurdles both as regards to the formalities as well as expenses in the form of stamp and registration charges. This has impeded the growth of securitisation.

    Nevertheless, from the benefits stated above it seems that the securitisation is as important to the world of finance as motive power is to industry. Though its emergence in India is relatively late, once the regulatory framework is put in place and all the grey areas are sorted, securitisation is expected to emerge as a product of the new millennium.



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