as the process whereby the `originator’ of the various financial assets including loans which are illiquid can transfer such assets to special purpose vehicle (SPV) which issues the tradable securities against these loans and these are issued to the investors. The arrangements can be very well structured to make these attractive for the investors. Thus the most important factor is the nature and the guarantee of the quality of the credit.
“Securitization” means acquisition of financial asset by any securitization company from the `Originator’ whether by raising of funds by such securitization company from `Qualified institutional Buyer’ or by issue of security receipts representing undivided interests in such financial assets or otherwise.Thus there will have to be some sort of understanding between the QIBs and the securitization company which can be the `Originator’ in the case of the banks and the financial institution which has extended the financial assistance to the “Obligor” who is supposed to repay the financial assistance in installments on some future dates as per the agreement entered to by it with the bank and the financial institution as the case may be. This can be referred to as the “security agreement”. It is an instrument or any other document or arrangement under which the `security interest’ is created in favor of the secured creditors including the creation of the mortgage by the deposit of the title deeds with the secured creditors.
The process of securitization starts with an entity (the originator), desiring financing, identifies an asset that is suitable to use. A special legal entity or Special Purpose Vehicles (“SPV”) is created and the originator sells the assets to that SPV. This effectively separates the risk related to the original entities operations from the risk associated with collection. When done properly the loans owned by the SPV are beyond the reach of creditors in the case of bankruptcy or other financial crisis; i.e. the SPV is a sort of bankruptcy proof arrangement. To raise funds to purchase these assets the SPV issues asset-backed securities to investors in the capital markets in a private placement or pursuant to a public offering. These securities are structured to provide maximum protection from anticipated losses using credit enhancements like letters of credit, internal credit support or reserve accounts. The securities are also reviewed by credit rating agencies that conduct extensive analyses of bad-debts experiences, cash flow certainties, and rates of default. The agencies then rate the securities and they are ready for sale, usually in the form of mid-term notes with a term of three to ten years.Finally, because the underlying assets are streams of future income, a Pooling and Servicing Agreement establishes a servicing agent on behalf of the security holders. The services generally include: mailing monthly statements, collecting payments and remitting them to the investors, investor reporting, accounting, and collecting on delinquent accounts, and conducting repossession and foreclosure proceedings. The originator, for a fee, typically services its own accounts because it already has the structures in place to do so.
Securitization has numerous advantages.
- Primarily it changed relatively illiquid assets into liquid ones.
- It is a means for an entity to access future incomes while transferring non-collection risk to others.
- It allows entities to raise money in capital markets at interest rates comparable to, or lower than, other generally available sources of funds.
- The limited-recourse nature of this financing is preferable to debt financing, which can involve personal guarantees of a borrower’s principals.
- Securitized monies are not treated as debt so it is off-balance sheet financing. This can favorably affect leverage and the debt to equity balance sheet ratio.
- Finally, securitization diversifies financing sources and allows companies to plan long-terms projects and investments.
Along with advantages securitization has certain drawbacks as well.
- Securitization is a time consuming and complex process.
- It requires financial and legal expertise with intensive documentation.
- Lawyers must render legal advice and structure the transaction according to the securities regulations while investment bankers must perform due diligence of the business and the underlying assets.
- There are also filing fees for the investment securities, fees to the credit rating agency and fees associated with the SPV.
Securitization in India is regulated by the securitization and re-construction of financial assets and enforcement of security interest act, 2002, RBI guidelines and The Credit Information Companies (Regulation) Act, 2005. Securitisation and Reconstruction of financial assets and enforcement of security interest (SRFAESI) Act 2002 is a procedural law . The Act was enacted in 2002 to enable the banks and financial institutions to recover their non-performing assets. However, supreme court in the case of Mardia Chemicals Ltd. had held section 17(2) as unconstitutional. Subsequently, the Act was amended by the enforcement of security Interest and Recovery of Debt Laws (Amendment) Act, 2004 to comply with the order of the Supreme Court. The Act has been under the scrutiny of various courts and a quite a many judgments have been passed over the last 3-4 years. The Act was envisaged to enable banks and Financial Institutions to realize long-term assets, manage problems of liquidity, asset-liability mismatches and improve recovery by taking possession of securities, sell them and reduce non performing assets (NPAs) by adopting measures for recovery or reconstruction. The SARFAESI Act has been largely perceived as facilitating asset recovery and reconstruction.
The Act has made provisions for registration and regulation of securitisation companies or reconstruction companies by the RBI, facilitate securitisation of financial assets of banks, empower SCs/ARCs to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and FIs to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default.
As per the RBI guidelines any bank or financial institution may sell financial assets to the securitization company or reconstruction company where the asset is —
(i) An NPA, including a non-performing bond/debenture, and
(ii) A Standard Asset where: —
(a) the asset is under consortium/multiple banking arrangements,
(b) at least 75% by value of the asset is classified as non-performing asset in the books of other banks/FIs, and
(c) at least 75% (by value) of the banks/FIs who are under the consortium/multiple banking arrangements agree to the sale of the asset to Securitization Company/Reconstruction Company.
Securitization has acquired a typical meaning of its own, which is at times, for the sake of distinction called asset securitization. It is taken to mean a device of structured financing where an entity seeks to pool together its interest in identifiable cash flows overtime, transfer the same to investors either with or without the support of further collaterals, and thereby achieve the purpose of financing. Though the end-result of securitization is financing, but it is not “financing” as such, since the entity securitizing its assets it not borrowing money, but selling a stream of cash flows that was otherwise to accrue to it. Thus, the present day meaning of securitization is a blend of two forces that are critical in today’s world of finance : structured finance (financial engineering) and capital markets. Securitization leads to structured finance as the resulting security is not a generic risk in entity that securitizes its assets but in specific assets or cash flows of such entity.Also the idea of securitization is to create a capital market product- that is, it results into creation of a “security” which is a marketable product.
Syed Burhanur Rahman, Attorney, New Delhi. E email@example.com
Syed Burhanur Rahman is an alumnus of St. Stephen’s College and Campus Law Center, Delhi University. A Quiz aficionado, he has featured in premier T.V Quiz shows including Mastermind India(BBC),University Challenge Quiz(BBC) and Nat Geo Genius Quiz (National Geographic Channel).