By Vineet Sukumar, IFMR Capital
The Reserve Bank of India (RBI) just released its new securitisation guidelines for standard assets via a notification. Via these guidelines, the RBI aims to reduce systemic risk through the requirement of a minimum holding period and a minimum retention amount for originators. The RBI has also made an attempt at doing away with the arbitrage opportunity between “assignments” – i.e. a direct sale of assets from one financial institution to another – and securitisations, and in this attempt has created new arbitrage opportunities, this time favouring securitisations. A tantalising comment that new guideline for amortisation of credit enhancement is forthcoming will create hope amongst originators who have long been stifled by the high capital charge imposed by the earlier regulations.
We expect the new regulations to be largely positive for the creation of a true securitisation market in India. Several long awaited safeguards will enhance the quality of pass through certificates issued in a securitisation, with the minimum holding period having the maximum impact on the rating of the securities. Originators have the flexibility of retaining interest at different levels of the capital structure, however their overall interest is capped at 20%, thus enhancing the nature of the ‘true sale’. It is also likely that assignments will now take a back-seat, with the RBI disallowing first loss credit enhancements.
Minimum holding period (MHP)
RBI has amended the minimum holding period requirements significantly, in line with feedback from market participants, by differentiating the MHP as per tenor and frequency of instalment of the underlying asset being securitised.
It has imposed a minimum holding period that varies from 3 months to 12 months across loans of different tenors and repayment frequencies. Even within one tenor, the guidelines reward loans with more frequent payouts with a lower minimum holding requirement. The MHP guidelines appear to be largely in line with market practice, with some conservatism built in.
The immediate effect of the MHP guidelines will be a sharp reduction in the volume of transactions, as originators will need time to build up portfolios that qualify for a securitisation. Further, the residual average life of transactions will reduce, thus increasing the component of fixed costs that are usually applicable for a securitisation (e.g. legal fees, trustee charges etc.). It remains to be seen if rating agencies will improve ratings of securities on account of higher seasoning – which may reduce transaction pricing.
At the same time, the MHP guidelines appear to be much better than the drafts released earlier. Microfinance institutions, for one, can heave a collective sigh of relief – these institutions have depended on the securitisation market for raising 30-60% of their fund requirements in FY 20121.
Some populism has surfaced in the regulations with long term, bullet repayment agricultural loans exempted from the requirement of minimum holding. This may adversely result in an increase in the risk of priority sector portfolios currently held by banks.
Minimum retention requirement (MRR)
While the RBI has required originators to retain 5-10% of exposure (based on tenor), crucially the RBI has also permitted originators / investors / rating agencies to choose the portion of the capital structure where the originator may retain exposure. This will provide flexibility to originators as their rating improves (or as capital market history of the asset class builds up) to move their exposure from the first loss to a more senior position, i.e. sell down more risk in the market.
Significantly, while the RBI has brought assignments under the guidelines, the RBI has also mandated that originators may not provide a first loss in assignment transactions but rather hold pari-passu exposure. For most investors, the assignment route would have limited value from a risk perspective. The assignment route had been earlier actively used by banks to meet priority sector requirements towards the end of the financial year – in many cases these deals are unrated and non-transparent / off-market terms. We believe that this is an excellent development and will assist in the development of a transparent, rated securitisation market.
Maximum exposure for the originator
A further significant change in the guidelines is the cap of exposure of the originator, which now stands at 20% and includes all forms of exposure (excluding excess interest). This has far reaching implications for various asset classes, where the credit enhancement levels required for meeting rating thresholds exceeds 20%. In such cases, the role of a second loss credit enhancer is much more relevant to provide the requisite support for seeing a transaction through.
Profit booking and accounting aspects
In the 2006 guidelines, the RBI had mandated that originators recognise profit on sale from securitisations on an accrual basis, while requiring originators to recognise costs upfront. This skewed treatment has been partially relaxed with originators permitted to recognise a higher quantum of profits. However, the extent of higher profits permitted to be recognised is not meaningful.
The key addition is the treatment of profits from excess interest, which was a grey area and has now been clarified.
However, one would expect the RBI to control originators’ incentives through structural aspects (such as MHP and MRR) and not through accounting treatment, which is the domain of the ICAI. It is not clear why originators should account for expenses at the outset, especially when the originator retains exposure in the transaction via MRR through the life of the transaction
Disclosures from originators and diligence by investors
The RBI requires originators to disclose the extent of MHP and MRR in a transaction in the disclosure memorandum, and in addition provide sufficient information for investors to conduct stress test on their exposures. Additional disclosures are welcome and will only enhance transparency.
Bank investors would need to demonstrate that they have a sound understand of the inherent risk in securitisation investments, an understanding of the underlying assets, extent of possible loss arrived at through stress tests, credit enhancements available etc. These requirements are quite standard and an insistence on such minimum standard may well inhibit pure ‘priority-sector purchases’ by banks. It is also good that the RBI has not mandated that banks undertake field audits of the underlying assets, implying that the investor may rely on the originator to maintain the credit risk of the portfolio as long as the originator has sufficient skin in the game.
Treatment of assignments
It is very welcome that the RBI has brought an unregulated assignment market into the realm of these guidelines. While it is not clear why the RBI has not permitted originators to retain first loss in assignments, the consequence of this guideline may well be the end of the bilateral assignment market. The stringent due diligence and credit monitoring requirements on investors of assignment transaction may well inhibit this market. Further, the RBI has disallowed capital benefits on the basis of rating for investors in assignment transactions,
Further, this will also end the undesirable market practice of building recourse back to the originator via bilateral assignment transactions (via routes such as replacement of non-performing assets, representations taken on a continual basis, servicer liabilities etc.). The ‘true sale’ criteria for assignments are quite unequivocal and in line with the true sale requirements for securitisation.
Re-securitisations not permitted
In line with the earlier draft regulations, the RBI has not permitted re-securitisations, synthetic securitisations and securitisation of revolving loans. It is therefore clarified that there is no bar on revolving securitisations where underlying loans are amortising in nature. Further, securitisation of short term trade finance receivables (even bullet in nature) has been explicitly permitted as long as there is adequate credit history of the borrower with the originator (minimum of two cycles). This is a good and meaningful step and may help in developing the trade receivable securitisation market.
1 – IFMR Capital