Response to securitisation New environment subdues action

Updated: Apr 29 2007, 07:44am hrs
Executive Summary
This article takes stock of the trends in India's securitisation market a year after the Reserve Bank of India (RBI) introduced regulations for securitisation of standard assets initially in a draft form in April 2005 and subsequently the final regulations, which came into force in February 2006.

Issuance volumes dropped significantly in FY2006 as the market tried to adjust to the new regulatory framework as well as to rising interest rates and falling liquidity. The dilution of key incentives of capital relief and profit booking continue to impact issuance volumes in the current year FY2007; however, a pick-up has been observed in the recent quarters.

The increased regulatory recognition, clarity provided on hitherto ambiguous issues, and encouragement of active third party participation in securitisation transactions has steadily widened the investor base, which is a positive for the market. This has encouraged new, sophisticated investors in second loss pieces for asset-based securitisation (ABS) transactions. However, structural inflexibility, especially in long-tenure mortgage-based securitisation (MBS), continues to pose a challenge.

Market Update
ABS volumes pick up, MBS at a standstill Issuances had touched unprecedented levels in FY 2005. However, volumes fell sharply, by 35%, in FY2006 due to new regulations, rising interest rates and a liquidity crunch. Volumes continued to be depressed in FY2007; however, they have picked up in recent quarters. The long-tenure MBS market continues to be down, with few takers after originators were prohibited from providing put options.

A shift to direct assignments
An increasing number of issuances are being done through the direct assignment route rather than through the PTC route. Direct assignment transactions are similar to conventional securitisation, but continue to be outside the ambit of RBI guidelines. In FY2007, 45% of the issuances were direct assignments.

Rise in market concentration
Some of the large issuers were not active in the market in 2007. These include IndusInd Bank, Mahindra & Mahindra Finance, Centurion Bank of Punjab and Citicorp Finance. The top three originators accounted for 90% of the issuances in FY2007, as against 75% in FY2006. On a positive note, FY2007 witnessed maiden ABS deals by Magma Leasing, Shriram Transport Finance and Kotak Mahindra Prime Ltd. Going forward; these companies are expected to be active as originators.

Emergence of public sector banks as key investors
The increase in investments by public sector banks - a positive for the market - can be attributed to increased credibility and recognition for the securitisation market. Investors, continue to restrict themselves to the short and medium-term segments (up to five years) and to the highest-rated instruments (AAA/P1+). The absence of long-tenure investors continues to impede the development of a vibrant MBS market.

Third party credit enhancers to the fore
The RBI regulations, through various provisions, including preferential capital treatment, have created an opportunity for a third-party liquidity facility and for second-loss pieces. Incentives notwithstanding, establishing efficient benchmarks for pricing lower-rated paper and understanding the risks involved in such investments is a pre-requisite for developing the lower-rated subordinate tranche market. The last few months have seen a couple of ABS deals where foreign banks/non-banking finance companies (NBFCs) have invested in second-loss pieces. This could pave the way for a proper market for mezzanine tranches in India.

Standardisation of structures
In a shift from the past, when there was a steady stream of new structures coming into the market, the RBI guidelines have standardised the transactions as several innovative structuring methods used previously have been prohibited. Single tranche par or premium structures have now become the norm.

Medium-term outlook

In the medium term, volumes are expected to grow at a steady pace, driven by pressure for resources

More clarity is expected to emerge from the regulatory perspective

Beginning of tranche structures and the development of a market for mezzanine pieces.

New issuers, especially NBFCs, are expected to start securitisation programmes to tap capital markets.

New asset classes, such as credit card receivables, small and medium enterprise (SME) loans, and loan against shares, would come into the market.

Key triggers for boosting the securitisation market
The securitisation market faces many challenges, including lack of investors in long-tenure and low-rated instruments, and absence of a vibrant secondary market. Support from regulatory agencies could overcome some of these problems. In CRISIL's opinion, three key changes that can be catalysts for further development of the securitisation market are:

Enhanced regulatory recognition to bring in new investors: Pass-through certificates (PTCs) are not recognised as securities under the Securities and Contracts (Regulation) Act (SCRA). This means a large section of the market, such as provident funds and foreign institutional investors, cannot invest in PTCs. Further, PTCs are not allowed to be listed. The lack of a secondary market affects the yield on PTCs as well as the appetite for longer-tenure instruments. In the absence of a ready secondary market, investors like mutual funds cannot participate in the long-tenure PTCs. A bill to amend SCRA has already been introduced in Parliament.

A move to include PTCs as approved investments for insurance companies and pension funds is another eagerly awaited amendment, as this would bring in long-term investors to the market.

Increased institutional support to stimulate MBS: In India, MBS accounts for less than 3% of the new mortgage originations, in sharp contrast to international experience, where a significant proportion of mortgage originations are funded through MBS. National Housing Bank, a pioneer in the MBS market, could play a key role by providing guarantees or other forms of credit supports and laying down standard eligibility criteria for loans that can be securitised. In the US, a similar role is played by Government National Mortgage Association (GNMA), a government-owned corporation, which guarantees timely payment of principal and interest on MBS backed by federally insured or guaranteed loans. Specialised mortgage insurance companies could also be MBS facilitators.

Greater structuring flexibility to ease capital pressures and improve deal viability for originators

Reset of credit enhancements
If an originator retains loans on the balance sheet, the capital held against the loans decreases as the loan gets repaid. Similar treatment is not accorded in case of securitisation where credit enhancements stipulated initially have to be maintained throughout the tenure of the transaction. If these funds are not allowed to flow back periodically, they remain locked and increase the capital requirements in percentage terms over a period of time. This is a prohibitive cost for most issuers. Hence, reset of credit enhancements - either through cash collateral resets or regular payments to subordinate tranches - should be allowed. The amount of reset should be based on pool credit performance to ensure that senior investors are adequately protected in case of deterioration in the pool collections.

Flow back of subordinated excess interest spread
Current regulations do not allow flow back of excess interest spread (EIS) to originators till the PTCs have been fully redeemed. Thus, the unutilised EIS, which is a sizeable component, remains with the special purpose vehicle (SPV) as a credit enhancement for the entire tenure of the instruments. This has a negative impact on the originator's capital and finances. EIS flow-back would enable the originators to recover their funds over a period of time.

Put options by originators for MBS
Allowing put options, with a minimum tenure of four to five years, is one way to build the MBS market; this is becoming increasingly important, given the growth in the housing loan sector and the asset-liability mismatches faced by banks/housing finance companies. This will allow the originators to target medium-term investors, and widen the investor base for MBS issuances. At the same time, the restriction to at least four to five years before which the options cannot be exercised will ensure that there is a genuine market for long-term issuances.