SECURITISATION OF FINANCIAL ASSETS

1. SECURITISATION OF FINANCIAL ASSETS

2. SECURITISATION OF FINANCIAL ASSETS Why Securitisation: • A convenient mechanism to suit changing needs of borrowers and lenders • Matches supply of funds with demand demands for funds through floating negotiable securities • Shifts the source of repayment from earning to a pool of assets

3. SECURITISATION OF FINANCIAL ASSETS Genesis and Growth: • Severe financial crisis faced by certain states in US during 1969-70 • Federal government restriction on inter-state lending and borrowing • Raised funds from surplus states by issuing instruments backed by mortgaged properties

4. SECURITISATION OF FINANCIAL ASSETS Elements of Securitisation: • Conversion of existing illiquid assets like loans, advances and receivables into tradable security • Reconverting them into fresh assets through capital market operations

5. SECURITISATION OF FINANCIAL ASSETS Benefits of Securitisation: • Separates the credit risk of the assets from the credit risk of the Originator • Lower the cost of borrowing for Originator as the security is independent of the rating of the corporate securitising these assets • Illiquid assets converted into marketable securities and thus provide alternate funding source

6. SECURITISATION OF FINANCIAL ASSETS Benefits of Securitisation : (contd) • Remove assets from balance sheet and thus improve capital adequacy • Operations in a particular portfolio of assets can be increased without increasing total exposure • Creates a highly diversified portfolio in terms of assets and geography (seanoning) • Dependability of cash flows from the assets as signified by the ageing of the portfolio

7. SECURITISATION OF FINANCIAL ASSETS The Players and their Role: • Originator: An entity making loans to borrowers or having receivables from customers • Special Purpose Vehicle: The entity which buys assets from Originator and packages them into security for further sale • Bankruptcy remote • Separates the risk of assets from the credit risk of the seller • Credit Enhancer: To reduce the overall credit risk of a security issue by providing senior subordinate structure, over-collateralization or a cash collateral

8. SECURITISATION OF FINANCIAL ASSETS The Players and their Role: (contd) • Credit Rating Agency: To provide value addition to security • Insurance Company / Underwriters: To provide cover against redemption risk to investor and / or under-subscription • Obligors: Whose debts and collateral constitute the underlying assets of securitisation • Investor: The party to whom securities are sold

9. SECURITISATION OF FINANCIAL ASSETS Requirements for Eligible Collaterals: • Assets to be securitised to be homogeneous in terms of: • Underlying assets • Maturity period • Cash flow profile

10. SECURITISATION OF FINANCIAL ASSETS Eligible Collaterals: • Housing finance • Term loan finance • Car loan • Credit card receivables • Export credit • Etc.

11. SECURITISATION OF FINANCIAL ASSETS Eligible Collaterals: • Housing finance • Term loan finance • Car loan • Credit card receivables • Export credit • Etc.

12. SECURITISATION OF FINANCIAL ASSETS Structure of Securitisation: • 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

13. SECURITISATION OF FINANCIAL ASSETS • 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

14. SECURITISATION OF FINANCIAL ASSETS Instruments: Depending on the structure of securitisation, the instrument would be pass-through certificate (PTC), a promissory note, a bond or debenture. • The PTC passes the cash flows from borrowers in the same form to investors. However, negotiability is restricted as the investor has to return the PTC to SPV • Promissory note / bonds / debentures make available different tenor maturities and yield to different investors

15. SECURITISATION OF FINANCIAL ASSETS Securitisation Process: • Selection of assets by the Originator • Packaging of designated pool of loans and advances (assets) • Underwriting by underwriters • Assigning or selling to of assets to SPV in return for cash • Conversion of the assets into divisible securities

16. SECURITISATION OF FINANCIAL ASSETS • SPV sells them to investors through private placement or stock market in return for cash • Investors receive income and return of capital from the assets over the life time of the securities • The risk on the securities owned by investors is minimized as the securities are collateralisied by assets • The difference between the rate of the borrowers and the return promised to investors is the servicing fee for originator and SPV

17. SECURITISATION OF FINANCIAL ASSETS Legislations / Enactments and their impact on securitisation transactions: The Companies Act 1956 affect the SPV in the following manner: • Framing of Memorandum and Article of Association of the SPV and formation of SPV as a Limited Company • Management of affairs viz. Board of Directors, Borrowing Powers / delegation of powers for recovery of receivables etc. • Share Capital Structure • Issuance of Bonds / Debentures etc. to investors (whether by public issue or private placement) and servicing the investors