A V Rajwade: The securitisation market

WORLD MONEY

Several interesting developments have taken place in the securitisation market in recent weeks "" both domestic and international. Domestically, the big news is the RBI's issuance of final guidelines on the subject. Internationally, Asian and European countries are taking enthusiastically to the instrument, while Wall Street has found the ultimate nirvana of corporate finance.

First, some issues in the RBI guidelines. These, and the promised amendment to the Securities Contract Registration Act (SCRA), place the legal and regulatory framework on a far sounder basis. Considering that the first securitisation issue took place in India as far back as 1992, the guidelines and the amendment, which would permit debt instruments resulting from securitisation to be listed and traded on stock exchanges, were surely overdue.

On the general subject of securitisation ("process of pooling and selling existing assets in the books of a lender/creditor "" the originator "" to a special purpose vehicle, and repackaging them into tradable securities"), it will be useful to keep a few perspectives in mind:

Even as the pressure on the banking system's capital resources increases because of both Basle II and a sharp growth in credit, it is facing larger mismatches in its asset-liability structure, resulting from increased lending to the housing and infrastructure sectors. Both these need long-term finance for maturities way beyond the liability portfolio of commercial banks. Worldwide, therefore, financial intermediaries have played the role of originators of such loans, with the objective of securitising them, and getting them off the books, at a suitable, early opportunity.

The debt servicing record of securitised paper in India has been very good.

In the still, generally low interest rate scenario, securitised paper provides the attraction of a slightly higher yield as compared to yield on similarly rated, straight bonds.

While, in general, the RBI guidelines are to be welcomed as providing a sound basis for securitisation issues and clarifying some grey areas, there are a few points that perhaps need a review.

The guidelines prescribe that any profit made by the originator "" this would happen in a falling interest rate scenario where the face value of the securitised paper may exceed the principal of the loan amounts "" should be accounted in the books of the originator, "over the life of the securities". This does seem too restrictive. Surely, when an asset has been sold, and a profit results, it should be accounted immediately? The parallel which occurs to me is the sale of a bond at a profit. In such cases, the profit is accounted for immediately "" and not over the balance life of the bond. Having prescribed stringent "true sale" criteria, the RBI should allow any profit to be immediately accounted.

The second issue is about the capital charge on credit enhancements. While the capital charge on the "first loss facility" is identical whether the credit enhancement is provided by the originator or a third party, such is not the case in respect of the "second loss facility". In the latter case, if the originator provides the credit enhancement, it is to be deducted from his capital; on the other hand, if the enhancement is provided by a third party, the capital charge is equivalent to that on a loan. Variation in capital charges, depending on who provides the enhancement, does not seem very consistent.

India and other Asian countries are seeing increasing activity also in the sale of non-performing assets. While only a few transactions have taken place in India, Chinese banks have gone ahead much more aggressively, as a preparation for public issues. Securitisation is also popular in Taiwan and South Korea. The UK Financial Services Authority has come out with clarifications on issue of so-called covered bonds, or mortgage backed securities, which would give a fillip to securitisation of housing finance. Many European banks have announced securitisation of SME loans. And, Greece and Belgium, following Portugal, are looking at securitising tax arrears to reduce fiscal deficits and conform to Eurozone limits.

The case of Germany's union-owned AHBR, a big, troubled mortgage lender, is interesting from two different angles. For one thing, the prices of securitisation issues originated by it have fallen because of worries about their "bankruptcy remoteness". Second, apart from bad property loans, AHBR is in trouble because of some complex derivatives it had contracted to manage the interest rate risks. Meanwhile, some investment banks have reached nirvana in structured finance: bonds which are debt for tax purposes but quasi-capital for rating purposes!

Tailpiece: The Shiv Sena, as has now become customary, tried its best to disrupt Valentine's Day functions and sale of cards/gifts in Mumbai. It considers such western practices as harmful to our culture. I recall having seen on a news channel the Sena Supremo cutting a cake on his birthday "" part of the Indian cultural tradition?

avrco@vsnl.com