Investment Banking - Securitization

Securitization:

Securitization means taking illiquid or a group of assets,which is transformed into a security by using financial engineering.Example of securitization is a mortgage-backed security(MBS),which is types of assets based security that is secured by collection of assets.
Basically,it is type of process in which iiliquid assets are packaged and sold them into third party investors.Investors have a right to recover debt from the borrowers,lender don't have right on this types of aseets.

Securitization in India:

This technique is of recent development in india,ICICI is leading in this area.In 1991,City Bank has introduce first securitization concept by introducing Securitising Auto loan.

From 1992-98,large number of transactions,which is 35% is related to Hire Purchase recievables of Truks.Main hindrances of growth of  securitization in india are leagal,accounting and tax related matters.Also,absence of active secondary debt market is also it's limitation.

Most of the Credit rating agencies like CRISIL,ICRA,Standard & Poor's(S&P) ect.are doing there job to popularise this concept of Securitization.

Upto the period of 1998,Housing loans were not securitised,afterwards this sector is also came under the securitization concept.In the year 2002 Securitization act 2002 and Securitization & reconstruction of financial assets & enforcement of security interest act 2002 has made.By this period Housing Finance companies and cooperative banks also covered under Securitization act 2002.In this process of securitization,individual investors are not been permitted to participate.

Needs for Securitization:

1.Asset-Liability Management(ALM):Main needs of Securitization is to manage the mismatch of assets and liabilities of financial institutions(specially to Banks and NBFC's) because if there is a mismatch in ALM then there is financial and liquidity crises arises in financial institutions.Sometimes they don't have funds to give cash to the big withdrawals because of liquidity shortage.

2.To Control NPA's: Securitization also helps financial institutions to control NPA's because large numbers of NPA's affect creditworthiness of financial institution.Also NPA's somethime lead Financial institution to default.Many NPA's are used as to securitized and create new asset or remove these NPA's,which improve balance sheets of the financial instituions. 

Factors responsible for NPA's:

(A) Internal Factors :

1.Project appraisal deficiency:Many a times Financial institutions giving credit or loans to the firms,which do not evaluate project during the structure level of project appraisals.Also sometime financial institutes finance the projects which are unviable.

2.Project management deficiency:Sometimes firms do not have good management team to manage the operation of the running project,which hence lead to going project in losses.This has lead to default the loan instalments payment of financial instituions and hence incrases the NPA's.

3.Ineffictive credit monitoring:Many a times Financial instituions not have good credit monitoring policies,which lead to not tracking defaulters correctly and hence lead to occure problem of NPA's.

4.Follow up Mechanism:Sometimes financial instituions not have good follow up mechanism to take follow up of customers,which make customers lassy for paying loan installments.

(B) External Factors:

1.Economic slowdown:If there is a Economic slowdown at domestic and global level,then there is a problem of increasing NPA's beacuse of lots of loan defaulters arises.

2.Non availability of Raw materials:If any company of firm not get raw material for there production then it reduce the sales and hence profit,which leads to default of loan payments of firms.

3.Power shortage:If any company running on the basis of  power then if power is not available,which stop it's productions and hence fall in profit,which lead to incease in NPA's of finance institutions.

4.Operation Hinderances:If there is any operation hindrence of firms due to factors like labour strike then it lead to stop production and hence fall in profit,which lead to growing NPA's.

5.Natural Calamities:Any types of natural calamities like flood and drought lead to rise in NPA's specially in Agricultural loans.

6.Market Saturation:If Financial instituions given loans to any business sector which is going at satutated level then it lead to loans defaults from that sector firms and hence leads to NPA's.

7.Product Obsolescence:If any product of any firm is obsolete and not going to sold in the market then it lead to increase NPA's of the Financial institutes which given loans to that sector.This is happen in Electronic and Electrical sector.

8.Slow Judiciary system:In india judiciary system is slow.if any Financial institutions file a case against defaulters then it takes lots of years to come judgement.By that time loans is going under NPA's .

Steps in Securitization:

1.Organization:First step of Securitization is to identify the organisation or firm,whose assets are beign securitise.

2.Pooling of assets:After that identify the assets which are non performing and then pooled them into for the further process of securitization.

3.Spliting up in marketable lots:Then the pooled assets are beign split into a different marketable lots for selling into different investors.

4.Enhancing Creditability:Therefore,afterward enhance creditability of the product formed into different lots by providing enough information to the investors related to the mortgagged assets backed by this types of products.

5.Sales to Investors:Afterward,final securitized product formed is sold to the investors.

6.Final Settlement: Hence,finally the securitized products is formed by the debts are  recovered by the investors who bought this types of products.

Pre-Requisites for Securitizations:

1.In the the process of Securitization,the assets which are securitisied should be highly in quality.Means loans have been provided to the borrowers,after satisfying the credit worthiness of the borrowers by the lenders.

2.The default rate are not existence or it is very low.It means borrowers repay the principle amount and interest on time or on date of pre-schedule structure.

3.The database related to the information about the borrowers should be available related to the performance of loans  assets,so that it can helps in evaluating the various aspect related to the borrowers.

4.There should be the requirement of secondary debt market for the trading of securitized debt instruments.

5.There should be well supportive and legal normas required for the protection of different parties involve in securitization process.

6.Beside above, there should be sound capital and money market are been operation.Also, there should be stable interest rate structure are been used.Further,standardised document are been used.

Benefits to Originator fom Securitization:

1.Reduced Cost of Capital:During the time of liquidity crunch,originators(like banks) take fund from other Banks or Financial institutions at higher interest rate.So if Banks raised fund through Securitizations then it would reduce the cost of capital.

2.Exemption from Capital adequacy requirements:The originator who raised funds throughSecuritization are exemption to maintain Capital adequacy requirements.

3.Assets Liability Management(ALM):Securitization hepls originators(like Banks,NBFC's) to manage there assets liability requirement.The got fund through securitization and fullfill there liquidity requirements.

4.Increase liquidity:Securitisation helps to increase liquidity to the Banks,NBFC's ect. for there future lending purposes.

5.Achieving Expertise:Securitization helps Originators(Banks) to achieve special expertise related to the process of securitization like maintaining investors relations,assets valuations ect.

6.Up fronting profits:Sometime originators of securitizations give his service related to the securitization to the third party (other Banks) on charging upfront commissions.

Securitisable Assets:

1.Housing loans:This loan is the widely used in the securitization purposes because of big loan amount.

2.Mortgage loans:The assets kept as a mortgaged is also used under securitization purpses and sell it to other investors.

3.Auto loans:These loans are also very large in number and lots of NPA's are coming under this loan,so this is also used for securitization in order to incrase liquidity by the issuer.

4.Credit card recievables:This is also another types of securitized assets,used for selling to the investors for reducing  credit card defaulters.

5.Trade recievable:Sometimes,trade bills are not paid on time,so these bill are used under securitization in order to increase cash flow to the traders.

6.Consumer loans:These loans are very risky for the lenders,so it can used it under securitization for minimizing defaulters.

7.Education loans:This is a safer types of but still it is used under securitization in order to increase liquidity to the lenders.

8.Leases:In some rare cases this assets are used under securitization.In a case when lessee unable to pay lease to lessor then lease is come under securitize assets.

9.Hire purchase agreements:This is another types of securitized assets used under securitizations.

10.Students fees:In very rare cases student fees are come under securitization.if parents are unable to pay fees then this case is come into picture.

11.ElectricityBills:This is also another types of securitized assets,but in india it use in very rare cases(only to corporates electricity bills) because of electricity department is under government.

12.Central & State taxes:It is also use in very low in india.

13.Road Taxes &Toll Taxes: Sometimes,this assets are used under securitizations in india.

SECURITISATION STRUCTURES:
1.Pass Through Structure(PTS):It is a most common structure of Securitization,where ownership is transferred to SPV/Trust.The ownership certificate is known as PTC's,which are sold directly to investors.Each PTC represent a claim of entire portfolio and investors have direct ownership of entire assets pooled in portfolio.After assets are tranfered they are not appears on originator's balance sheet.Originator or other service institution collect interest and principle amount and pass it to the investors after charging there commission.
2.Assets Backed Security(ABS):The Originator sell assets directly to it's own Subsidary created for this purpose and it's ownership is retained by the Corporate group of the originator.Assets sold is appear in the Consolidated balance sheet of the Subsidary.Then Subsidary sell assets to the investors and collect revenue fron the assets and transfered to the trustee for the disbursment to the investors.
3.Pay Through Structures(PTS):Here, all cash flow recieves by originator are reinvested by the SPV in securities which bear fixed return on interest.Return recieved by the SPV from such investment are distribute to the investors.In this structure assets appear in the balance sheet of the Originator.
4.Stripped Derivatives Structures(SDS):In this structure cash flow from the SPV are broken into two parts,Principle only(PO) and Interest only(IO) amounts.Payments to Principle only(PO) investors from principle amount and payment to Interest only(IO) investors from interest amount.

Benefits of Assets backed Security(ABS) over Conventional instruments:

1.ABS are claimes against Pool of assets:In ABS,if claim is made it would be against a pool of assets rather than claim against issuer.Here Trustee can proceeds against underlying Borrowers.Also,investors do not have claim against any corporate entity.

2.Difference due to Rating:ABS are rated by one and more Rating agencies on other hans convestional instruments are without rated.Also in ABS there are a good quality assets and legal intergrity are present .

3.ABS are highly rated:Due to credit enhancement in the form of cash collateral,lettar of credit,over collateralization ect ABS are highly rated by Rating agency.

4.Bankrupcy Remote:In event of liqidation of Originator,official liquidator  would not have any claim on pool of assets Securitised.Wherease in case of Traditional instruments it is not so.

5.Timely Payment and better monitoring:In ABS, the payment of principle and interest amount is done on time,Also there are better monitoring of assets in ABS.

6.Amortization period:In ABS,there is monthly amotization so that investors get monthly repayment of principle rather than half yearly basis in case of Conventional Instruments.