Debt Securitization in India

1.0 SECURITIZATION
Securitization is a process through which illiquid assets are transformed into a more
liquid form of assets and distributed to a broad range of investors through the capital
market. The main steps involved in the process of securitization are as under:
 Transfer of assets by the originator to a company/trust specially created for this
purpose known as a Special Purpose Vehicle (SPV).
 SPV divides this pool of assets into marketable securities called Pass Through
Certificates and resells them to various investors like banks, MFs, Central or State
Governments or the parent company of SPV.
 The issue of securities is managed by a merchant banker or a syndicate of
merchant bankers who also underwrite the issue. Apart from the SPV a trustee is
normally appointed to oversee the process of securitization.

1.01 PARTIES INVOLVED

There are three main parties involved in the process of securitization (Refer to
Annexure 1):
 Originator
 Special Purpose Vehicle
 Investors

Besides these other parties like obligor, rating agencies, administrator, agent & trustee
and structurer are also often involved in the process.

1.02 NEED FOR SECURITIZATION

There are several important reasons for securitization the more important ones are listed
below:
 Enhancing liquidity
 Attainment of capital adequacy ratio without augmenting capital in case of banking
sector
 Increased operating efficiency

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 Better risk allocation and management of project risks

 It also offers investors a set of high quality debt instruments

1.03 SECTORS WHERE SECURITIZATION CAN BE HELPFUL

Though securitization has primarily been perceived in India to be useful to the banking
sector in particular the fact is that it has tremendous potential for other sectors also some
of which are:
 Housing Finance
 Auto Finance
 Urban Infrastructure
 Power
 Telecom
 Roads and Ports

In fact any resource with predictable cash flows can be securitized. Thus credit card
receivables, hire purchase receivables, non-performing assets of a financial entity can all
be securitized.

1.04 BENEFITS OF SECURITIZATION

The main advantages arising on account of securitization are as under:
 The loan originators can raise money as soon as they create loans without the need to
hold asset portfolios till their maturity. Thus it aids multiple asset creation, routing of
funds into business and increasing profitability.
 Investor gets greater protection of his funds because the security that he buys is of a
good quality debt at higher yields and good liquidity. Also the management of the
deal is adequately secure.
 Securitized debt is generally cheaper than other forms of funding. It helps improve
the return on equity and assets at the same time ensuring greater liquidity.

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 Securitization deals help the originator beat the rating given to the company. Air India
has taken advantage of this by managing to beat the sovereign rating by securitization
of its future earning’s over the US market.
 It enables the originator to access funds at low cost and take advantage of more
profitable investment opportunities with the revenue generated through securitization.
 It enables originators to pass on or eliminate credit, interest rate and lending risks
associated with balance sheet funding. It thus improves asset management and
effectively diversifies credit risk.
 By transforming an illiquid asset on the balance sheet into cash, the originator
minimizes the accounting leverage as measured by the debt ratio and thus enables
raising more funds without impairing its borrowing ability.
 The originator derives the benefit of an increase in Capital Adequacy Ratio (CAR).

1.05 SECURITIZATION STRUCTURE

There are mainly two types of securitization structures as under:
Pass through structure: Here the investors get a proportional interest in the pool of
receivables. The investors get the share of monthly collections proportionally at the
designated time. The distinction is sometimes made as in senior and subordinate investors
for the purpose of credit enhancement. The prepayments if any are passed on to the
investors and the cash collected is not reinvested. Here the SPV acts like a passive
conduit.
Pay through structure: It is almost similar to a debt instrument the difference being that
it is treated as an off balance-sheet item. Here also the investors get a proportional share
in the pool of receivables as per the dates in the schedule of payment. Generally the
amounts received are invested in highly rated securities, which provide guaranteed
returns. Even the prepayments are reinvested in such securities. Thus, the SPV acts like
an active conduit (Refer to Annexure 2).

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2.0 CREDIT RATING

Securitization deals by nature are risky for some of the parties involved and so credit
rating can enhance the reliability and help raise greater resources. Credit rating forms an
integral part of the securitization deal. There are several credit rating agencies in India
like CRISIL, Fitch India, CARE and ICRA, which rate such instruments. These agencies
while assigning ratings consider only that part of the assets that are to be securitized
without considering the assets in the balance sheet. Thus, often it happens that the
securitization instrument floated by a company has a higher rating than the company
rating itself. All such ratings will have a “SO” suffixed to the deal to indicate that the
rated instrument is of “Structured Obligation”, which essentially means that the deal has
met all the parameters of credit rating and has been structured for the purpose of credit
rating and marketing of the instruments.

2.01 CREDIT ENHANCEMENT TECHNIQUES

Recourse Securitization: Investors are not normally prepared to take on all credit risks
associated with Asset Backed Securitization (ABS). The simplest form of enhancement
would be recourse arrangement with the originator. The institution engaged in
securitization or the SPV may enjoy recourse to the seller in case of failure of the
customers to cash flow. It becomes simply a servicer. In case of recourse securitization
the SPV enjoys lesser margin. Generally, the seller becomes the servicer. It may open an
escrow account for servicing the Participation Certificates (PCs). The servicer collects the
cash flow from lessee, hire purchaser or loaner and routes it to the SPV. The SPV merely
passes the funds to the retail investors. In this arrangement, securitized asset creates Off
Balance Sheet Liability to the seller.

External credit enhancement includes insurance, irrevocable letters of credit, third party
guarantee whereas internal credit enhancement includes spread account, cash collateral
accounts, over – collateralization, credit trenching (senior – subordinated structure) and
triggered amortization.

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Non -Recourse securitization: The securitization may be without recourse but the
collateral may be designed to have a bankruptcy remote structure to enjoy all the rights
which the seller would have enjoyed on the leased / hire purchase stock in case of failure
of the customers to pay lease rentals / hire purchase installments. The Banks and FIs who
buy securitized Participation Certificates in fact invests in a special type of debt
instruments that enjoys liquidity (if proper secondary market exists for securitized
instruments) and also accepts reinvestment risk.

3.0 CURRENT SECURITIZATION ACTIVITY IN INDIA

Presently this market can be divided into four broad areas:
 Asset Based Securitization
This is the most general class of securitization and could be for assets varying from auto
loans, lease and hire purchase agreements, credit cards, consumer loans, student loans,
health care receivables to even future asset receivable. In India on the auto loan
securitization front companies like Telco, Ashok Leyland Finance, Kotak Mahindra and
Magma Leasing have been securitizing the portfolio of auto loans to buyers like ICICI
and Citibank over the past two-three years with rating agencies like CRISIL and ICRA.
While many of the deal are bilateral portfolio buyouts, ICICI has used the SPV structure
and placed the issuance privately to corporate investors and banks. In recent past Global
Telesystems Ltd. raised nearly USD 32 million by securitizing the future receivables of
its consumer telecom business to an SPV, Integrated Call Management Centre. Tata
Finance was the sole investor in the passthrough certificates issued by the SPV.
The Rs. 4.09 billion non-convertible debenture program by India Infrastructure
Developers Ltd. (IIDL), an SPV set up for building and operating a 90 MW captive co-
generation power plant for IPCL was one of the first publicized structured finance
transactions in India. The transaction was rated AA-(SO) by CRISIL. ICICI has done
several bilateral Asset backed securitization deals including securitizing DOT receivables
from Sterlite Industries and Usha Beltron. The absence of Securitization Act, legal and
taxation uncertainties, high stamp duties has hampered the growth of ABS market.

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 Mortgage Backed Securities (MBS)

The MBS market in India is still in its nascent stage. National Housing Bank (NHB) in
partnership with HDFC and LIC Housing Finance issued India’s first MBS in August
2000. However there is tremendous potential for the securitization in India especially
with NHB actively looking towards the development of a Secondary Mortgage Market
(SMM) in the country. Such a market can help small housing finance companies with
good origination capabilities and limited Balance Sheet strength in staying profitable and
concentrate on the housing loan origination. Lack of mortgage foreclosure norms, high
incidence of stamp duty for assignment of mortgage necessary for securitization are the
major roadblocks for MBS.

 Collateralized Debt Obligations (CDO)

These were created to protect the investors from pre-payment risk. It innovatively uses a
cash flow of long maturity, monthly pay, collateral to create securities of differing- short,
intermediate and long- final maturities and expected average lives. Such transactions help
the banks in pro-actively managing their portfolio and in restructuring their stressed
assets. ICICI made an aborted attempt to do a CBO issuance in August 2000. This market
however is likely to witness slow growth due to its complexities, the taxation and
accounting treatment for the CDO’s need to be clarified.
 Asset Backed Commercial Paper (ABCP)
These are generally issued by Special Purpose Entities (ABCP Conduits) set up and
administered by banks to raise cheaper finances for their clients. ABCP Conduits are
usually ongoing concerns with new CP issuances taking out the previous ones. India’s
securitization market is not currently mature enough for such instruments.

3.01 IMPORTANT SECURITIZATION DEALS IN INDIA

 IDBI Securitization Deal

IDBI recently raised Rs.337 crores by securitizing company loans to three entities Larsen
& Toubro, National Hydroelectric Power Corp (NHPC) and Indian Farmers Fertilizers

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Co-operative. The issue opened in the last week of August 2002 and closed on 4 th
September 2002.

 The first part against receivables of Rs.76.4 crore loans given L&T had four
series:
First series raised Rs.14.3 crores has a maturity of four months and coupon of 6.65%
payable at the end of this period. CRISIL gave it the highest safety rating of “P1+(SO)”.
Second series raised Rs.12.9 crores has a maturity of 10 months and coupon of 6.85%
payable quarterly. It is also rated “P1+(SO)” by CRISIL.
The third series raised Rs.25.2 crores has a term of 22 months and carries a coupon of
7.6%. CRISIL rated it as “AA+(SO)” indicating high safety.
The fourth series raised Rs.24 crores has a 34 month term and a coupon of 7.85% payable
quarterly. CRISIL rated it as “AA+(SO)”.

 The second issue, which raised Rs.215 crores, is against the receivable on loans
given to (NHPC). It has an average maturity of 13 months carries a coupon of
7.4% payable quarterly and CRISIL gave it AA+(SO) rating.
 The third issue against the receivables from Indian Farmers Fertilizers Co-
operative has two series.
The first series raised Rs.29.6 crores has a maturity of four months and a coupon of
6.65% to be paid at the end of the period.
The second series raised Rs. 16.2 crores has a maturity of seven months and coupon of
6.85% payable quarterly.

 CITIBANK Securitization Deal

Citibank has privately placed securitization loans worth Rs.25 crores with mutual funds
including UTI. This is the second time the bank is selling the loan through securitization.
Earlier it had privately placed Rs. 20 crore securitized auto loans. The structure it used for
Rs. 25 crore was similarly to that of earlier issue. The securitized loan has been placed
through a SPV- Peoples Financial Services Ltd.- under the series entitled ‘PFSL
Certificate Series 1992-02’. The certificates are listed on the NSE and market maker is

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also appointed. Global Trust Bank has been nominated, as the investor’s representative
for the transaction to monitor the ongoing servicing. The certificates are available in
denominations of Rs. 1 crore each and were issued at a coupon of 14% and provide
monthly cash flows of principal and interest for 28 months. Since a portion of the face
value gets redeemed every month, the average duration of the instruments is only 12.2
months. The only recourse to the investors is to deposit in a cash collateral account of 7%
of the issue size.

 HUDCO’s Securitization Deal

In February 2000, Housing and Urban Development Corporation (HUDCO) took the
pioneering initiative in the field of securitization. HUDCO decided to give assets worth
Rs.1500 crores from its infrastructure portfolio for securitization. It decided to securitize
Rs.500 crore assets, including mixed stream of water supply, area development, bridges
and commercial complexes in the first phase that was over by March 2000. Citibank was
the lead advisor for the first phase while ABN AMRO bank was the same for the second
phase of securitization. Six arrangers namely ICICI securities, SBI, IDBI, DSP Merrill
Lynch, HSBC and Arthur Anderson were appointed for the deal. For HUDCO the
securitization is an ideal fit as a resource mobilization tool with its strategic financial
goals. It is the most efficient method to liquidate future flows and recycle funds for better
and more economic use, especially in light of the capital-intensive infrastructure projects
undertaken.

 Larsen & Toubro

It undertook India’s first innovative securitization deal in the power sector. L&T had to
build a 90 MW captive power plant for Indian Petrochemical Ltd. (IPCL) on Built
Operate and Transfer basis (BOT). To finance the project IDBI resorted to securitization.
This securitization deal amounted to Rs.409 crore. In this asset based securitization of the
newly completed power plant the cash flow of the power plant is securitized. L&T floated
a SPV India Infrastructure Developers Ltd. (IIDL). The project to set up captive power
plant has been transferred by L&T to IIDL; the latter will build the plant and then lease it
out to IPCL. IIDL has issued bonds to debenture holders carrying a coupon of 14.25 %

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(payable on monthly basis) for maturity of 8 years and 10 months. The instrument has no
call and put option. The monthly payment started on January, 2000 and continue till
December, 2007. The interest payment for the initial ten months will be amortized. IIDL
will pay in EMI principal and interest. This amount will flow to an escrow account. The
issue of debentures has been reportedly fully subscribed within hours of opening on 12
March, 1999.

3.02 SECURITIZATION HOW IT CAN HELP SOME KEY SECTORS

 Power Sector: For PSUs like NTPC, NHPC, REC etc., which are into generation
and financing of power generation initiatives, the financial viability of the SEBs is
of key concern. Securitization can be of help here in the following manner. It can
help reduce/rebalance the financial exposure of the various PSUs. The revenues of
the SEBs can be securitized for resource raising.
 Road Sector: This sector provides the opportunity to earn immense profits from
the toll collections. However, it is exposed to multiple risks like the construction
risk, traffic estimation risk and toll collection risk etc. Considering these multiple
levels of risk securitization can be effectively utilized for mitigating the risk at
various levels of risk and thus facilitate financial closure at an optimal cost of
capital.
 Port Sector: The revenues of typical port projects would be in the nature of
stowage and loading revenues levied on ships, which stop at the port of call. In
addition, ports tend to provide storage facilities for chemicals, cargo, petroleum
products, etc. to several large companies. The port authority/operator contract
such storage facilities for a long tenure. The port revenues of this nature are
amenable to securitization.
 Urban Infrastructure: Housing loans provide the greatest opportunity in terms of
urban development and the home loans comprise a major portion of the mortgage-
backed securities globally. The issuance of such securities results in the
dissemination of portfolio risk for Housing Finance companies and facilitates
participation of a breadth of financial investors such as provident funds.

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4.0 HINDRANCES IN THE DEVELOPMENT OF SECURITIZATION

The success or otherwise of securitization in India depends on a variety of factors. For
instance, in the past we have seen that various instruments like Certificate of Deposits,
Commercial Paper, etc. have not become popular due to the lack of an active secondary
market. Care needs to be taken to ensure that securitization does not meet the same fate.
The main factors hindering the growth of securitization market in India are as under:
1) Any asset securitization deal in India presently attracts heavy stamp duties thus
increasing the overall cost of the deal tremendously. This has been a major
drawback for the markets.
2) Mortgage securitization is hampered by the foreclosure norms that restrict the
transfer of property without the intervention of court of law, which makes
securitization of mortgages very difficult.
3) The guarantor of loan cannot mortgage his own property in case if receivables are
not properly accrued. Thus the quality of the assets is affected thereby decreasing
the quantum of homogenous quality assets for a MBS. This can be corrected only
if:
 Legal & legislative changes to make transfer of assets is eased
 Capital adequacy norms are stipulated strictly to take care of the risks
 There should be no limit on the amount of funds that can be raised through
securitization
 A separate set of guidelines for capital requirements should be laid down.
4) Investor education is also a major cause for concern and some alternative needs to
be worked out to create awareness among the investors.

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5.0 GLOBAL SCENARIO

Securitization is a new concept for India but in countries like United States of America,
United Kingdom, Japan and other developed nations it is a widely accepted instrument
and the market is also highly developed. Some of the important instruments and trends in
these countries are given below:

 United States of America

USA is the biggest market of securitization in terms of volumes, participation and
application. Approximately 75%, or more, of the global volumes in securitization are
originated from the USA. This by itself indicates the tremendous significance of USA in
global securitization market. Not only this, even securitization issues originating from
other countries, including Japan, Europe and some of the emerging markets, draw
investors from the USA. Even in terms of depth it is the only market in the world, which
draws participation from both individual and institutional investors. In USA the main
classification of the securitization market is between the mortgage-backed and asset-
backed market. The main thrust for development of this market was the need to develop a
secondary market for mortgage financing wherein the government agencies for buying
and selling federally insured mortgages acted as the catalysts. A brief history is as
follows:
 The Federal Housing Agency (FHA) was set up in 1934 to absorb the risks in
housing finance.
 Subsequently in 1938 Federal National Mortgage Association (FNMA) to buy and
sell federally insured mortgages.
 In 1968 FNMA was split in two bodies the new FNMA and the Government
National Mortgage Association (GNMA).

The initiatives of these agencies have played a vital role in the development of the
securitization market in USA.

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 Ginnie Mae’s Securitization Initiative

In 1970 GNMA did its first securitization transaction on a pass through structure backed
by mortgage, which were insured by FHA and had the backing of the government. This
scheme known as GNMA-I is still in operation.
In 1983 GNMA-II, another pass through structure was launched which has various types
of mortgages pooled in like single family loans, mobile home loans, personal loans etc.
 Fannie Mae’s Securitization Deals
FNMA introduced mortgage backed securities in 1981.
It played a vital role in the promotion of securitization of Adjustable Rate Mortgages
(ARMs) and Variable Rate Mortgages (VRMs)
 Freddie Mac’s Securitization Deal
Federal House Loan Mortgage Corporation (FHLMC) was created in 1970 to promote an
active national secondary market in residential mortgages and has been issuing mortgage-
backed securities since 1971. In USA Asset Backed Securities are widely used for a
variety of applications and is in itself a very active segment (Refer to Annexure 3). The
level of advancement and the rate at which securitization is adopted in the US market will
be made clear from the following example:

DreamWorks, the Los Angeles based entertainment group of Spielberg secured a

USD 1 billion funding by way of securitizing its future film revenues. The
securitization depends on a well-established formula, which allows several years' worth
of revenues to be accurately predicted in the first few weeks following a film's theatrical
release. Funds will be advanced in accordance with these calculations. Film funding by
way of securitization is not uncommon in USA and there are several firms active in this
area.
According to experts the reason behind the widespread usage of securitization In US
market are due to the following advantages:
 Saleability of liquid assets
 Securitization of any kind of payment flows
 Designation of securities to provide for any risk level
 Achievement of AAA rating even for risky and obscure assets

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However, there are certain disadvantages also which need to be examined carefully:
 For instance during sharp economy contractions, liquidity of securitization may
be illusionary
 Securitization can lead to creation of excessive credit
 Expectations of consumer behaviour may not be correct, and the cash flows
expected may be different.

 European Market
Though USA is widely regarded as the major player in the securitization market Europe
had this market in existence since long. Denmark had a mortgage credit system in place
well before the first securitization deal was struck in the US. Germany has a P&F Brief
Market, which is a secondary mortgage market. The Danish mortgage trading system is
very close in concept to the US concept of pass through. However, securitization in its
modern sense emerged in Europe in late 1980’s with the issuance of mortgage- backed
securities. In Europe, the previous action in the ABS market had centered mainly on
residential mortgages and, to a lesser extent, on the credit card-backed issues that are
popular in international ABS circles (Refer to Annexure 4). Over the years there has
been a certain change in this trend with an increasing proportion of CDOs in the ABS
structure and a decline in RMBS (Refer to Annexure 5). Also, it should be noted that in
Europe, unlike in the United States, all deals use an ABS-structure, making no distinction
between mortgage-backed and asset-backed securities. Initially in MBS UK acted as a
major source of collateral. However, now countries like Germany, Spain etc. have
emerged as major players. The introduction of Euro has further boosted the activities in
the securitization market. There has been a continuing broadening of the types of assets
being securitized - for example, sub-prime mortgages, student loans, soccer receivables,
pub leases etc. thus it augurs well for the future of this market. One major drawback in
Europe is the absence of GNMA, FNMA equivalents thus the growth of the securitization
market depends solely on the needs of savvy issuers and investors. United Kingdom is
the major player in the securitization market in Europe however newer players like
Germany, Italy, Netherlands etc. have also emerged (Refer to Annexure 6). In the future

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Europe is likely to see a major boost in securitization activities due to the possibility of
some favourable occurrences like:
 Introduction of Euro, which would eliminate much of the sovereign bond markets
thus shifting the investor attention to spread products like MBS and ABS due to
their high credit quality thus eliminating currency concerns.
 Several countries have initiated legal and regulatory changes to facilitate this for
instance, German banks are now authorized to securitized their own loans.
 Improvements in the MBS deal information reporting systems and greater
familiarity with cash-flow characteristics would lead to greater usage of MBS and
ABS.
 There has been an increase in the spectrum of assets, which are being securitized
like sub-prime mortgages, student loans, soccer receivables and so on.

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6.0 CONCLUSION
Securitization is a very new concept in the Indian market and there is very little
awareness not only among the investors but also among the financial experts. It has only
been in the past five years or so that there has been tremendous interest in this new tool of
raising money mainly because of the great advantages that it offers. However, for
securitization to take a deep root into the Indian financial system like it is in the USA and
other European countries there are certain fundamental and regulatory changes needed
which have already been outlined above. Nevertheless, one thing is certain securitization
has arrived in India in a big way and is here to stay. Several big financial institutions like
ICICI, HUDCO, IDBI, Citibank etc. have already struck some major deals and in the
recent years there has been an upsurge in the number of such deals. With the removal of
some bottlenecks like heavy stamp duties, strict foreclosure norms, other legal and
regulatory aspects and absence of an active trading market the activity in this segment
would surely pick up.

India in order to emerge as a real global economic power and have truly global
companies needs to adapt itself and take advantage of financial services like debt
securitization as early as possible. The process has already been initiated now it is upto
the authorities to create an environment favourable to the adoption of such an innovative
instrument which has shown spectacular results worldwide. Securitization holds the key
to several crucial problems ailing the Indian economy one of the major ones being
infrastructure financing.

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7.0 REFERENCES
1) www.economictimes.com
2) www.vinodkothari.com
3) www.sebi.com
4) www.blonnet.com
5) www.inidiainfoline.com
6) www.securitization.net
7) http://www.securitization.net/pdf/buyusbus_contents.pdf
8) www.icfai.org
9) www.adb.org/Documents/Books/Mortgage_Backed_Securities_Markets
10) Rajashekhar N., “Banking in the new millennium”, Banking series, The Insitute of
Chartered Financial Analysts of India, Hyderabad.
11) Fabozzi Frank J., “The Handbook of fixed income securities”, 5th edition, Mc-
Graw Hill, New York.
12) Gordon E, Natrajan K., “Financial markets and services”, Himalaya Publishing
House, 1st edition 1999, Delhi.
13) ICICI in Largest Securitised Deal with TELCO, News Report, Financial Express ,
Nov. 4. 1997
14) Securitisation yet to take off in India, Hindu, 3 April,1998
15) Asset-backed securitisation all set to catch on in the country, Financial Express,
September 27,1998
16) L&T Strikes Rs.409 Cr Securitised deal with IPCL, News Report, Financial
Express, March13, 1999

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