Sunakshi Bahgla

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1
 INTRODUCTION
• Some companies or firms who are involved in
sending the money or making credit sale must
have a huge balance of receivables in their
Balance Sheet. Though they have a huge
receivable but still they may face liquidity crunch
to run their business. One way may to adopt
borrowing route, but this results in change debt
equity ratio of the company which may not be
acceptable to some stakeholders but also put
companies to financial risk which affects the
future borrowings by the company. To overcome
this problem the term ‘securitization’ was coined.
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 What is Securitization?
• Securitization is the process in which certain
types of assets are pooled so that they can be
repackaged into interest-bearing securities. The
interest and principal payments from the assets
are passed through to the purchasers of the
securities.

• In concept, all assets can be securitized so long as

they are associated with a stable and steady
amount of cash flow.
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 What is Securitization?
Some of the assets/ financial instruments that can
be securitized are:
• Auto Loans
• Mortgages
• Student Loans
• Accounts Receivable
• Credit Card Receivables
• Corporate or Sovereign Debt
• Services
• Productive Projects
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 Features of Securitization
The securitization has the following features:
• Bundling and Unbundling – When all the
assets are combined in one pool it is bundling
and when these are broken into instruments of
fixed denomination it is unbundling.
• Tool of Risk Management – In case of assets
are securitized on non-recourse basis, then
securitization process acts as risk management
as the risk of default is shifted.
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 Features of Securitization
• Structured Finance – In the process of securitization,
financial instruments are tailor structured to meet the
risk return trade of profile of investor, and hence, these
securitized instruments are considered as best examples
of structured finance.
• Tranching – Portfolio of different receivable or loan or
asset are split into several parts based on risk and return
they carry called ‘Tranche’. Each Tranch carries a
different level of risk and return.
• Homogeneity – Under each tranche the securities are
issued of homogenous nature and even meant for small
investors the who can afford to invest in small amounts.
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 SECURITIZATION IN INDIA
• It is the Citi Bank who pioneered the concept of securitization in India by
bundling of auto loans in securitized instruments.
• Thereafter many organizations securitized their receivables. Although
started with securitization of auto loans it moved to other types of
receivables such as sales tax deferrals, aircraft receivable etc.
• With growing sophistication of financial products in Indian Capital Market,
securitization has occupied an important place.
• As mentioned above, though, initially started with auto loan receivables,
it has become an important source of funding for micro finance
companies and NBFCs and even now a days commercial mortgage backed
securities are also emerging.
• The important highlight of the scenario of securitization in Indian Market
is that it is dominated by a few players e.g. ICICI Bank, HDFC Bank, NHB
etc.
• As per a report of CRISIL, securitization transactions in India scored to the
highest level of approximately ` 70000 crores, in Financial Year 2016.
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(Business Line, 15th June, 2016)
 Securitisation Process
• The securitisation process is listed below:
1. Asset are originated through receivables, leases, housing loans or any
other form of debt by a company and funded on its balance sheet. The
company is normally referred to as the “originator”.
2. Once a suitably large portfolio of assets has been originated, the assets
are analysed as a portfolio and then sold or assigned to a third party, which
is normally a special purpose vehicle company (“SPV”) formed for the
specific purpose of funding the assets. It issues debt and purchases
receivables from the originator. The SPV is owned by a trust/the originator.
3. The administration of the asset is then subcontracted back to the
originator by the SPV. It is responsible for collecting interest and principal
payments on the loans in the underlying pool of assets and transfer to the
SPV.
4. The SPV issues tradable securities to fund the purchase of assets. The
performance of these securities is directly linked to the performance of the
assets and there is no recourse (other than in the event of breach of
contract) back to the originator.
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 Securitisation Process
5. The investors purchase the securities because they are
satisfied that the securities would be paid in full and on
time from the cash flows available in the asset pool. The
proceeds from the sale of securities are used to pay the
originator.
6. The SPV agrees to “pay any surpluses which, may arise
during its funding of the assets, back to the originator.
Thus, the originator, for all practical purposes, retains its
existing relationship with the borrowers and all of the
economies of funding the assets.
7. As cash flow arise on the assets, these are used by the
SPV to repay funds to the investors in the securities.

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Securitisation Process

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 PARTICIPANTS IN SECURITIZATION
• Broadly, the participants in the process of
securitization can be divided into two categories

PARTICIPANTS

Primary Secondary
Participant Participant

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 Primary Participant
• Primary Participants are main parties to this process. The primary
participants in the process of securitization are as follows:
(a) Originator: It is the initiator of deal or can be termed as securitizer. It
is an entity which sells the assets lying in its books and receives the
funds generated through the sale of such assets. The originator
transfers both legal as well as beneficial interest to the Special
Purpose Vehicle
(b) Special Purpose Vehicle: Also, called SPV is created for the purpose of
executing the deal. Since issuer originator transfers all rights in assets
to SPV, it holds the legal title of these assets. It is created especially
for the purpose of securitization only and normally could be in form
of a company, a firm, a society or a trust.
The main objective of creating SPV to remove the asset from the
Balance Sheet of Originator. Since, SPV makes an upfront payment to
the originator, it holds the key position in the overall process of
securitization. 12
 Primary Participant
Further, it also issues the securities (called Asset Based
Securities or Mortgage Based Securities) to the
investors.
• (c) The Investors: Investors are the buyers of
securitized papers which may be an individual, an
institutional investor such as mutual funds, provident
funds, insurance companies, mutual funds, Financial
Institutions etc. Since, they acquire a participating in
the total pool of assets/receivable, they receive their
money back in the form of interest and principal as per
the terms agree.

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 Secondary Participants
• Besides the primary participants other parties involved
into the securitization process are as follows:
(a) Obligors: Actually they are the main source of the
whole securitization process. They are the parties who
owe money to the firm and are assets in the Balance
Sheet of Originator. The amount due from the obligor is
transferred to SPV and hence they form the basis of
securitization process and their credit standing is of
paramount importance in the whole process.
(b) Rating Agency: Since the securitization is based on
the pools of assets rather than the originators, the
assets have to be assessed in terms of its credit quality
and credit support available. Rating agency assesses the
following:
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 Secondary Participants
• Strength of the Cash Flow.
• Mechanism to ensure timely payment of interest and
principle repayment.
• Credit quality of securities.
• Liquidity support.
• Strength of legal framework.
Although rating agency is secondary to the process of
securitization but it plays a vital role.
(c) Receiving and Paying agent (RPA): Also, called Servicer or
Administrator, it collects the payment due from obligor(s)
and passes it to SPV. It also follow up with defaulting
borrower and if required initiate appropriate legal action
against them. Generally, an originator or its affiliates acts as
servicer.
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 Secondary Participants
(d) Agent or Trustee: Trustees are appointed to
oversee that all parties to the deal perform in the
true spirit of terms of agreement. Normally, it takes
care of interest of investors who acquires the
securities.

(e) Structurer: It brings together the originator,

investors, credit enhancers and other parties to the
deal of securitization. Normally, these are
investment bankers also called arranger of the deal.
It ensures that deal meets all legal, regulatory,
accounting and tax laws requirements.
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 Advantages of Securitization
• A form of off-balance sheet financing which involves
the pooling of financial assets.
• Allows highly rated securities to be created from less
credit worthy assets.
• Can be in local or foreign currency, depending on client
needs.
• A rapidly growing asset class with proven benefit for
emerging market borrowers.
• Securitized deals can get a better rating from rating
agencies as compared to the rating of the originator's
firm due to factors like credit enhancements, financial
guarantees etc.

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 Advantages from the viewpoint of the
originator:
• Alternative source of Funding: Securitization is a tool to
convert illiquid assets into marketable assets, thereby
acting as a source of funds.
• Balance sheet management: Securitization helps to free
up the capital of the originator, thus compressing the
balance sheet and making it more robust.
• Securitization can also remove asset liability
mismatches in the investor’s balance sheet.
• Securitization helps to transfers the originator's market
risks, i.e., liquidity, interest rate and prepayment risks,
to investors and reduces risk capital requirement.

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 Advantages from the viewpoint of the
investors:
• To meet priority sector lending targets: Securitization presents a
simple and effective way of investing in priority sector lending to
help the banks in meeting their targets.
• Higher yield to investors: Securitization offers higher yield to
investors over corresponding similar rated instruments.
• Asset Liability management: Investors can deploy their funds to
match their cash flow and maturity requirements. Instruments can
be structured according to the requirements of the investors.
• Transfer risk: Securitization helps to transfer risks from an entity that
does not want to bear it, to one that does.
• Structured issuances: Through appropriate structuring, an ABS can
be tailored to meet investor requirements on credit quality, yield and
maturity. Working with a pool of receivables gives the originator the
needed flexibility to be able to offer investors a menu of options
around which issuances could be made. 19
 Risks of Securitization
• Securitization is a time consuming and complex process.
• It requires intensive documentation and financial and legal expertise.
• Filing fees have to be paid to the SPV, rating agency and the investment bankers.
• The process of seuritization is expensive due to the various fees invovled such
as underwriting fees, legal fees, credit rating fees, system costs and sometimes
unforeseen costs due to changing scenario.
• It is complicated to structure a securitization deal because the number of
parties involved is many.
• The negatives associated with securitization revealed after the sub prime crisis
are-
First, there is a lack of transparency in the process. The more complex the
structure of the asset, the greater is the lack of transparency and consequently
harder it is to analyze and forecast default risk and security performance.
Second, the process of securitization abandoned common sense and over-relied on
complex mathematical models to predict future cash flows.

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 Applications of Securitization
• Improves Capital Adequacy Ratio in The Originator's Balance
sheet–
When mortgage loans are securitized from the bank’s balance
sheet, it improves the capital adequacy ratio of the bank. The
following example illustrates clearly how by packing off Mortgage
Loans from banks balance sheet in form of a securitization deal
can improve the company's Capital Adequacy ratio. This results in
improved capital planning and helps to reduce capital
requirements of the originators.
CAR= capital/ Risk weighted assets.

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Applications of Securitization

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 Applications of Securitization
• Risk Weighted Assets (RWA)
=0% x (50,100) + 20% x (200) + 50% x (300) + 100% x (300, 50) =540
• Tier I Capital = 50/5540=9.26%
• Tier II Capital = 20 / 540=3.7%
• :. CAR=9.26% + 3.7%=12.96%
CAR when Mortgage loan on the Balance Sheet are securitized-
RWA=0% x (50,100) + 20% x (200) + 100% x (300, 50) =390
• TIER I Capital = 50/390 = 12.82 %
• TIER II Capital = 20/390 = 5.12 %
• CAR = 17.94%

Thus, the CAR of the bank improves from 12.96% to 17.94% as certain
Assets (of 50% risk weightage in this case) is securitized.

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 Applications of Securitization
• 2. Improves Balance Sheet Ratios
Securitisation of assets can help improve some key ratios of a firm as
reflected in the balance sheet. This may help to improve the financial health
of the firm as calculated through these ratios:
(a) Return on Assets (ROA): The return on assets for a company will improve
significantly if the company goes in for securitization of its assets namely
credit card receivables, auto loan receivables, (carrying 100% risk
weightage), mortgage loans (carrying 50% risk weightage). In the whole
process of securitization assets are created and are put off the balance sheet
by parking them with an SPV. This act by the firm would helps to improve the
asset related ratios because though the asset is made to disappear from the
firms balance sheet but still the income generated from the asset get
accelerated.
(b) Return on Equity (ROE): Securitization makes sound business sense for
banks and is a cost effective funding tool. The process of securitization leads
to a capital relief for the Originators which in turn improve both leverage
and the return on equity of an organization.

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 Applications of Securitization
ROE is a function of the following three ratios:
• (i) Profitability (PAT /Sales)
• (ii) Asset Management (Sales/Assets)
• (iii) Financial Leverage (Asset/Equity)
ROE = Profit Margin x Fixed Assets Turnover x Leverage
Return on equity improves when the above three ratios are taken care
of by the management. If the firm can reduce its equity capital then
definitely the ROE would improve. The removal or reduction of risk
weighted assets from the originator's balance sheet would lead to a
reduction in the capital to risk weighted assets ratio. This helps to
reduce the total cost of financing for the originator. Ultimately this
would lead to a tremendous improvement in the return on equity
of the originator firm.

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 Applications of Securitization
c) Debt Equity Ratio- The debt equity ratio of an organization can improve with
the help of securitization.

The following example illustrates the process. You are given the balance sheet of
ABC Company.

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 Applications of Securitization
Now suppose ABC Ltd. borrows a loan by securing their credit card
receivables, the balance sheet size would increase and the Debt Equity Ratio
worsens i.e. it becomes 2:1

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 Applications of Securitization
Now assume that the credit card receivables are securitized and the cash
so generated is utilized to pay the old debt. This will not only will improve
the debt equity ratio but also help in reducing the size of the balance
sheet.

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 Applications of Securitization
3. Securitization unlocks capital
The following example illustrates the capital relief provided by
securitization.
According to RBI directives, banks need to keep 9% of the value of their
risk weighted assets as capital. For example, if a bank has a risk weighted
asset base of Rs. 100, it needs to maintain Rs. 9 as capital to meet the
regulatory requirements. Now assume that the bank securitizes risk
weighted assets worth Rs. 15, without any credit enhancement and
replaces these assets by cash on its balance sheet. Post securitization,
the risk weighted assets of the bank would decline to only Rs. 7.65
according to the regulatory requirements. (9% of Rs 85)
This would mean that the bank capital is in excess by 15% vis-a vis
regulatory requirements. It can further do business to the extent of Rs.
1.35( 15x 9%) in terms of originating risk weighted assets without adding
capital to its balance sheet. Hence, the bank has increased the efficiency
of its capital usage with the help of securitization.

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Applications of Securitization

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 SECURITIZATION INSTRUMENTS
• On the basis of different maturity characteristics, the securitized
instruments can be divided into following three categories:

SECURITIZATION
INSTRUMENTS

Pass Through
Pay Through Stripped
Certificates
Security (PTS) Securities
(PTCs)

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 Pass Through Certificates (PTCs)
• As the title suggests originator (seller of the assets) transfers the
entire receipt of cash in form of interest or principal repayment
from the assets sold. Thus, these securities represent direct claim of
the investors on all the assets that has been securitized through
SPV.
• Since all cash flows are transferred the investors carry proportional
beneficial interest in the asset held in the trust by SPV.
• It should be noted that since it is a direct route any prepayment of
principal is also proportionately distributed among the securities
holders. Further, due to these characteristics on completion of
securitization by the final payment of assets, all the securities are
terminated simultaneously.

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 Pay Through Security (PTS)
• In contrast to PTC in PTS, SPV debt securities backed by the
assets and hence it can restructure different tranches from
varying maturities of receivables.
• In other words, this structure permits de-synchronization of
servicing of securities issued from cash flow generating from
the asset. Further, this structure also permits the SPV to
reinvest surplus funds for short term as per their requirement.

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 What is difference between Pass Through
Certificate and Pay Through Certificate?

• In Pass Through Certificate, the principal

amount or interest to be received on loan
from the company is given directly to the
investor, whereas in Pay Through Certificate,
the principal amount or interest is not given to
the investor. Rather they are issued new
securities by SPV in return to this.

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