By Dr Sanjay Chaturvedi, LLB, PhD.
Introduction
Stock markets are securitisation of Ownerships, Mutual Funds is the securitisation of Debt markets, Commodity markets are securitisation of trading process and Real Estate Investment Trust could be the securitised form of Real Estate trading. Many a times, irregulated Real Estate Market feels the dire need for securitisation of Real Estate. Housing finance companies are feeling better after Securitisation Act passed by Indian Government. But process of securitisation still finding difficult in real estate since it is attached with human value. More than 500 Acts and state level Act and regulation governs the real estate transaction.
The major players in the asset securitisation market in India are expected to be commercial FIs, PSUs, Corporate, Government bodies, Mutual Funds, Pension Funds, etc. Securitisation generally pre- supposes that the Originator has a bulk of its assets in the form of self-amortizing financial assets, either with or without underlying security. It is also imperative that these assets should have a clearly established repayment schedule. Moreover, since capital market instruments have a minimum marketable tenure, the receivables underlying the securities should themselves have a sufficiently long tenure, so as not to frustrate the securitisation exercise.
While securitisation started off in the housing loan sector, the development of the securitisation market as a standard funding option across most industries has been the result of a constantly expand- ing universe of securitisable non-mortgage asset types. This lays emphasis on three potential areas of securitisation in India – MBS,
ABS and Infrastructure Sector.
Mortgage Backed Securities (MBS)
The securitisation of assets historically began with, and in sheer volume remains dominated by residential mortgages. The receivables are generally secured by way of mortgage over the property being financed, thereby enhancing the comfort for investors. This is be- cause mortgaged property does not normally suffer erosion in its value like other physical assets through depreciation. Rather, it is more likely that real estate appreciates in value over time. Further,.
>· the receivables are medium to long-term, thus catering to the needs of different categories of investors;
- the receivables consist of a large number of individual homogenous loans that have been underwritten using standardized procedures. It is hence suitable for securitisation;
>· in the US where it originated, these mortgages were also secured by guarantees from the Government;
>· the receivables also satisfy investor preference for diversification of risk, as the geographical spread and diversity of receivable profile is very large.
In the Indian context, the funds requirement in the housing sector is immense, estimated at Rs. 150,000 crore during the current five- year plan. Of this, it is envisaged that about Rs 52,000 crore would be financed by the formal sector. It is unlikely that this gap can be filled out of budgetary allocation or regular bank credit. Securitisation allows this gap to be bridged by directly accessing the capital markets without intermediation. Securitisation tends to lower the cost at which the housing sector accesses funds. It also facilitates a sufficiently deep long term debt market. It is estimated that about Rs 2,500 crore would be mobilized through the securitisation route during the current five-year plan.
Asset Backed Securities (ABS) – Existing assets
- Auto loans:
Though securitisation was made popular by housing finance compa- nies, it has found wide application in other areas of retail financing, particularly financing of cars and commercial vehicles. In India, the auto sector has been thrown open to international participation, greatly expanding the scope of the market. Auto loans (including instalment and hire purchase finance) broadly fulfil the features necessary in securitisation. The security in this case is also considered good, because of title over a utility asset. The development of a second hand market for cars in India has also meant that foreclosure is an effective tool in the hands of auto loan financiers in delinquent cases.
Originators are NBFCs and auto finance divisions of commercial banks.
- Investments:
Investments in long dated securities as also the periodical interest instruments on these securities can also be pooled and securitised. This is considered relevant particularly for Indian situation wherein the FIs are carrying huge portfolios in Government securities and other debt instruments, which are creating huge asset-liability mis- matches for the institutions. Government securities issued domesti- cally in Indian Rupee can be bundled and used to back foreign cur- rency denominated bonds issues. It would more be of the nature of derivative. The subordinated Government securities are intended to absorb depreciation in the value of the rupee thereby protecting to certain extent the senior securities that the Government securities back. The senior securities are directed at the international capital markets and are structured using offshore SPVs by countries like Mexico. Similarly, under the STRIPs mechanism, the interest coupons on the Government dated securities are separated and traded in the secondary markets. Such interest instruments can also be bundled and securitised in the normal asset securitisation method.
- Others:
Financiers of consumer durable, Corporate whose deferred trade receivables are not funded by working capital finance, etc are Originators of other asset classes amenable to securitisation. Corporate loans, in a homogeneous pool of assets, are also subject to securitisation There is virtually no known instance so far in the United States or in other countries of an ABS transaction having failed. This is despite the fact that the markets for ABS are exceptionally large. Industry experts attribute this to three main factors. ABS transactions are always planned, prepared and carried out with great care. Second reason is the intrinsic value of the paper and in particular the high level of transparency on the quality of the underlying assets. Third, ABS transactions are sponsored generally by large and well known institutions which can’t afford to jeopardies their reputation with investors, the majority of which are institutional investors.
Securitisation of infrastructure receivables
Securitisation of wholesale assets refers mainly to the use of securitisation as a technique for infrastructure funding. The availability of an efficient infrastructure framework is vital to the economic growth and prosperity of any country. Traditionally, infrastructure facilities have been developed and provided by Governments and are looked upon as basic privileges of a citizen and have thus been accorded priority for Government investment. The Central Government has envisaged that more than 40% of the annual central plan outlay would be for the development of infrastructure. ii In the context of India’s size, population, and economic growth, the present infrastructure continues to be inadequate and will require massive incremental in- vestment to sustain economic growth. Hence, the participation of private capital in the development of infrastructure (over and above the Government’s direct involvement) is essential. The India Infra- structure Report submitted by the Rakesh Mohan Committee in 1995 estimated that a total outlay of Rs 400,000 – 450,000 crore would be required for infrastructure financing in the period of 1996-2001. Some of the broad observations outlined in the report in respect of various infrastructure segments are detailed in the table hereunder.
Along with the Government’s earnest attempt at attracting private investment into infrastructure funding, the role of innovative funding techniques such as securitisation is vital. The suitability of security sation for infrastructure funding stems from the fact that cash flows are stable and concession driven, and also because ultimate credit risk (which is central to the concept of securitisation) is partly guaranteed by Government. Securitisation is particularly appropriate at the post-commissioning stage when the project begins to generate cash, with overall project risk being largely replaced by credit risk.
Some of the typical characteristics of infrastructure projects that set them apart from other financing needs are:
Multiple level project risks: Infrastructure financing involves risk participation at multiple levels and is complex to understand for individual investors. The nature of project risk in various stages is vola- tile, it is highest in the pre-commissioning stage and is sought to be mitigated through contractual framework, which is concession driven or provides guaranteed returns. These guarantees and concessions are typically extended by Government and quasi Government organisations and thus minimize financial risk. Unconventional asset cover: Infrastructure projects are typified by the creation of unconventional assets. The assets of an infrastructure project could comprise roads or bridges, jetties and quays in a port infrastructure project, drills and rigs pertaining to an oil well, water treatment plants. These assets are not amenable to resale or reapplication and hence are unacceptable as security cover to conventional lenders. Furthermore, the step-in rights to lenders are non- existent since such projects are awarded on the basis of concession and are on a Build Operate and Transfer (BOT) basis with the “ownership” of such assets resting with the State or Central Government.
Tenure and size of funds required: Infrastructure projects are typically long gestation projects involving high capital outlay and back- ended project returns. The sources of funds would hence have to be long term and provide for a sufficient moratorium.
Securitisation will benefit infrastructure financing because it:
- permits funding agencies whose sector exposures are choked, to continue funding to those sectors.
- permits the participation of a much larger number of investors by issue of marketable
- lowers the cost of funding infrastructure projects; long term funding (a sine quo non for most infrastructure projects) is more feasible in securitised structures than conventional
- facilitates risk participation amongst intermediaries that specialize in handling each of the component risks associated with infrastructure funding (while these may initially be borne by regular financial intermediaries and insurance companies, it is expected that specialized institutions would develop over time).
- shifts the focus of funding agencies to evaluation of credit risk of the transaction structure rather than overall project This is because the other components of project risk (as mentioned above) would be borne by specialized intermediaries, at a fee.
Future
Securitisation will grow in future for two significant reasons:
- securitised paper is rated more creditworthy than the FI itself
- strict capital requirements are imposed on the FIIs
Future trends in securitisation of assets will not only be influenced by those FIs who are knowledgeable about this process, and there- fore, aware of its potential but will also be affected by the level of knowledge in the financial community as a whole as well as the perception of the regulators. While the benefits that securitisation brings in its wake are well documented, it may however, be worth- while to examine whether the domestic financial markets are suffi- ciently developed to accept the product and utilize it efficiently.
Risk Management by Commercial banks in India
The subprime mortgage crisis has brought to light the important of risk management, process and due diligence for real estate credit policies of financial institutions. Following are couple of examples of Indian banks.
Relaxation of NPA and other prudential norms for real-estate In the context of ongoing slowdown in the Indian economy, modifications in NPA norms were necessary as the spillover effects of the global downturn had started affecting the Indian economy particularly from September 2008 creating stress for the otherwise viable units.
The Reserve Bank of India on Friday has that said all accounts which were standard accounts on September 1, 2008 would be treated as standard accounts on restructuring provided the restructuring is taken up on or before January 31, 2009 and the restructuring package is put in place within a period of 120 days from the date of taking up the restructuring package.
The period for implementing the restructuring package has also been extended from 90 days to 120 days in respect of those accounts. The special regulatory treatment will also be available to ‘standard’ and ‘substandard accounts’. These provisions would be in addition to the usual provisions as per the current regulation.
Special Treatment for Commercial Real Estate
Banks can extend exceptional / concessional treatment to the commercial real estate exposures which have been restructured up to June 30, 2009. Presently, exposure to commercial real estate, capital market exposure and personal / consumer loans are not eligible for the exceptional regulatory treatment of retaining the asset classification (of the restructured standard accounts) in the standard category i.e. loans given to real estate, capital market or personal loan segment are declared as a bad loan by the lender at the time of restructuring of the loans. However credit extended to other sectors are not classified as non-performing assets (NPAs) on onetime re- structuring. With the above concessional treatment to commercial real estate restructuring of loans to commercial real estate will en- able a bank to avoid an account from falling into the NPA category. RBI announcement has come as a relief to several sectors of the economy, particularly the commercial real estate sector which the RBI has been viewing suspiciously for a long time.
Classification as Priority Sector Loans-Boost to low cost housing Loans granted by banks to Housing Finance Companies (HFCs) for on-lending to individuals for purchase/construction of dwelling units may be classified as a priority sector loan, provided the housing loans granted by HFCs do not exceed Rs 20 lakh per dwelling unit per family. However, such classification is subject to a cap of 5 per cent of the individual bank’s total priority sector lending. This special dispensation will be available for loans granted by banks to HFCs up to March 31, 2010. This is a win-win situation for banks and small- ticket borrowers. The RBI clearly wants to boost low-cost housing schemes as the loan amount is capped at 20 lacs.
Standardized norms for restructuring debt to real estate companies Commercial banks in the country have asked RBI to declare a standardized norm for restructuring debt to realty companies in order to escape the chances of loans extended to troubled real estate companies to turn into bad loans. Presently, loans given to real estate, capital market or personal loan segment are declared as a bad loan by the lender at the time of restructuring of the loans. However credit extended to other sectors are not classified as non-performing as- sets (NPAs) on onetime restructuring. The real estate firms have been hit hard by the liquidity crunch and are asking banks to rollover the loan, following which CEOs of many banks have asked RBI to relax the restructuring norms of these realty firms. Banks feel that these companies should be given an option of additional line of credit or rescheduling of loans so that their NPAs do not mount up.
Although this concession has been granted to commercial real estate the decision to grant it to the severely hit real estate sector should not be delayed.
