Securitisation 2007: More needs to be done
A new bill to allow the listing and trading of securitised debt instruments should help to stimulate India's securitisation market. However, regulators will also need to ease some restrictive regulations and expand the investor base if they want this market to be a viable funding source for the country’s huge infrastructure funding needs. Shankar Ramakrishnan reports.
On May 14, the Lok Sabha (India’s lower house of Parliament) passed the Securities Contracts (Regulation) Amendment Bill 2007, which provides the legal framework for listing and trading of pass-through certificates (PTCs). The Bill now has to be ratified by the Rajya Sabha (upper house) and the President.
Under previous regulations, instruments backed by assets and issued by an SPV (the purchaser of assets from the originator for legal separation and to insulate investors from financial risk associated with the originator) were not considered as securities.
These instruments – called PTCs because the proceeds from the securitised assets (the monthly payouts) are passed through to investors – are an interesting innovation because they carry the flexibility to be structured to cater to the different investor appetites in regard to maturity, yield or risk. So far, there have been PTCs with a specific coupon rate, structured PTCs and PTCs with different payback periods.
But their lack of recognition as securities under the Securities Contracts (Regulation) Act has meant that a large section of the market – such as provident funds and foreign institutional investors – could not invest in them.
So this change in the law is expected to help in the creation of a secondary market, increase appetite for long-tenor securitised instruments and help in better price discovery.
Most PTCs are currently priced at a 50bp-100bp premium over the spread paid by a similar tenured and credit-rated instrument in the corporate debt market, to compensate for their illiquidity. With a more active secondary market, this premium is expected to narrow.
“We are not expecting a sharp jump in issuance volumes because of the latest Parliament move, but pricing should improve and that could encourage more issuers to look at the securitisation market more favourably,” said one banker.
However, issuers will be encouraged to issue only if the market is deeper and the investor base wider than currently, according to bankers. That will require India's regulators become more amenable to the idea of foreign investors investing in Indian debt.
Expand the investor base
“There are many issues inhibiting the development of the Indian securitisation market, so while this law change is positive, it may not drastically change the market unless there are other enabling regulations,” said Kaustubh Kulkarni, head of debt capital markets at Standard Chartered Bank. “One small change could be to allow increased foreign investor participation, thus increasing the depth of the market.”
Currently rupee corporate debt is allowed to be listed, but secondary market activity remains muted because the investor base is limited to mutual funds, provident funds/insurance companies and banks. Depending on the movements in interest rates at any point of time at least half of these investor groups are absent, creating illiquidity for issuers and those issues that are listed.
Market players have been calling for expansion of the investor base through an increase in the currently miniscule investment limits for foreign institutional investors in debt, but the regulators have not been forthcoming.
The regulators' concern is that such debt investments could be speculative and pose a systemic risk. In an interview with IFR in 2006, the Reserve Bank of India said: “The objective has been to manage any vulnerability that may be faced by the financial system on account of speculative capital flows. Since the policy choices are restricted when it comes to regulating the capital flows in the form of Foreign Direct Investments and Portfolio Investments, the option would therefore be to regulate the debt flows.”
This reluctance to encourage foreign investment in Indian debt markets does not encourage participation by a sophisticated investor base that would add to the vibrancy of the local securitisation market. It also negates the potential for these investors to bring to the local market structures adopted in more matured securitisation markets.
“They could create a separate investment limit for FIIs interested in securitised debt, and that could be outside the current limit on overall corporate debt,” said one banker.
“Though regulatory over-cautiousness about foreign investments in debt could be understandable in the context of systemic risk concerns, it is still difficult to understand local regulations that prevent large-scale participation by some large groups of local investors, and they could now be removed,” he added.
A large group of investors – insurance companies and pension funds – do not buy securitised instruments because PTCs are not approved investments. Nationalised banks have also been inconsistent in their investment interest, and they are yet to enter the market in a big way as originators.
Issuer base also needs to widen
A lack of issuers is also a major issue, and that is also mainly due to restrictive regulations.
In 2006-2007, the top three originators accounted for 90% of issuance compared with 75% in the previous year. In 2007, most of the large issuers, like IndusInd Bank, Mahindra & Mahindra Finance, Centurion Bank and Citicorp Finance, were not active.
Although volumes jumped to a record in 2004-2005 (April-March), they slumped by over 35% in fiscal 2005-2006 and remained depressed in 2006-2007 due to the restrictive guidelines issued by the Reserve Bank of India in February 2006. Unsurprisingly then, bankers are clamouring for an easing of current regulations that restrict new issuance.
The new RBI rules said that profit on securitisation transactions should be amortised over the life of the securities issued by the SPV, even though there is a true sale of assets. This took the market by surprise, as profit recognition was one of the motivations to securitise for many originators.
The RBI also required that first-loss portions of deals (usually cash collateral to take transactions up to investment grade) had to be deducted from the capital funds – 50% from Tier 1 and 50% from Tier 2 – of the credit enhancement provider (whether that is the originator or a third party). The capital deduction is capped at the level that would have applied had the underlying assets not been securitised.
However, with second-loss pieces (usually cash collateral to take the deal up to a Triple A rating), third parties get preferential treatment versus originators. Third parties have to set aside capital up to the 9% capital adequacy limit, while originators will have to write off the entire amount of the second-loss piece, which is more than 9%.
Furthermore, the capital write-off on the second-loss piece for originators is without the cap available in case of the first-loss piece. This is deemed to be an encouragement for third parties to provide second-loss and liquidity facility and tranching of transactions for credit enhancement rather than use of cash collateral.
There have been few deals meeting the RBI’s guidelines, but most have been direct assignment transactions (45% of issuances) and others were mostly single-loan exposure securitisations.
A recent report by rating agency Crisil backed the view that the regulators would have to ease some of these regulations to create greater structural flexibility, ease capital pressures and improve deal viability for originators.
“Reset of credit enhancements – either through cash collateral resets or regular payments to subordinate tranches – should be allowed,” said Prasad Koparkar, head of structured finance ratings at Crisil.
“The amount of reset should be based on pool credit performance to ensure that senior investors are adequately protected in case of deterioration in the pool collections.”
Another suggestion is that the RBI should allow the flow back of excess interest spread to originators. Currently regulations do not allow this until the PTCs have been fully redeemed. That means that unutilised excess spread, which at most times is a sizeable component, remains with the SPV as a credit enhancement for the entire tenor of the instrument. This has a negative impact on the originator.
Crisil also suggested allowing put options, with a minimum tenor of four to five years to build the MBS market.
“A developed MBS market is becoming increasingly important given the growth in the housing loan sector and the asset-liability mismatches faced by banks/housing finance companies,” said Koparkar.
“Allowing put options will enable originators to target medium-term investors and widen the investor base for MBS issuances. At the same time, the restriction to at least four to five years before which the options cannot be exercised will ensure that there is a genuine market for long-term issuance.”
Meanwhile the market currently remains heavily under-penetrated, with MBS accounting for less than 3% of the new mortgage originations and ABS accounting for just 40% of vehicle loans disbursed. There is also a lack of sophistication. There have been no CMBS transactions although a booming real estate market should have prompted developers to use the asset class.
The debate is also important because the development of the securitisation market is significant in the context of India’s burgeoning infrastructure funding needs – estimated at US$320bn in the next five years. The National Highways Development Programme is said to require investment of about Rs2,200bn (US$54bn) up to the end of 2012, while ports and airports need about Rs1,000bn. Receivables from these essential infrastructure projects could be securitised.