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Mortgage BackedMortgage Backed
SecuritisationSecuritisation
Mr V S Rangan
Executive Director
Housing Development Finance Corporation Limited
September 10, 2011
• Basics of Securitisation
• Overview of Securitisation markets
• Mortgage Backed Securitisation Process
• Accounting for Securtisation
• Current Trends : – Emergence of Direct Assignment Structures
– RBI regulations
– Covered Bonds
What is What is SecuritisationSecuritisation? ?
• Securitisation is a process by which commercial or consumer loans are pooled and sold in the form of financial instruments
• Sale of specific loans to a special purpose vehicle (SPV) / trust
• Issuance of Pass Through Certificates (PTCs) by the SPV to investors
• Securities serviced from the payment streams of the loan pool• Securities serviced from the payment streams of the loan pool
• Typically, Credit support built in the structure, however investors have no recourse to the Originator
When the loans (being securitised) are secured by mortgages (immovables), the financial instruments are called Mortgage
Backed Securities (MBS)
The The SecuritisationSecuritisation StructureStructure
Why Why SecuritisationSecuritisation??
Advantages for Originator
• Alternate source of funding - new investor base
• Improves Capital Allocation Efficiency
• Asset Liability Management
• Better Rated Product - Rating Arbitrage
• Limited Recourse Financing
• Efficient management of risk profile of the originator - reduction
of credit concentration
• Accounting Benefits - Upfront profits
Why Why SecuritisationSecuritisation??
Advantages for Investors
• Safety: higher rating than originator
• Yields: generally higher to compensate for the novelty of the
instrument and the prepayment risk.
• Flexibility: can be structured to suit the investor’s needs, in terms of
tenor and periodicity of payment
• Reliability: closely monitored on a monthly basis by the rating
agency and the trustees
Risks Perceived in Risks Perceived in SecuritisationSecuritisation ProcessProcess
Risks
• Credit Risk
• Recovery Risk
• Prepayment Risk
Risk Mitigants
Tranching, cash reserves, over- collateralization
LTV, IIR, mortgage insurance
Seasoning, passing prepayments to the
subordinate tranche
• Liquidity Risk
• Unclear Regulatory/
Accounting guidelines
• Lack of proper legal/tax
framework
subordinate tranche
Liquidity Support
Transaction to be structured as IFRS compliant
Legal Opinions
Overview of
Securitisation marketsSecuritisation markets
• Securitisation in U.S. began in 1970’s – MBS introduced (guaranteedby GNMA)
• ABS market developed in US in early 1990s – CMBS and consumercredit ABS
• By 2006, US issuances accounted for 75% of world-wide ABS/MBSissuances – volumes surpassed USD 2 trillion
• European ABS sector in existence since 1990s, volumes picked up
Evolution of Evolution of SecuritisationSecuritisation
• European ABS sector in existence since 1990s, volumes picked upsince 1999 after the introduction of Euro; touched Euro 546 bn in 2006
• Global securitisation activity slowed down since summer of 2007
• In 2010, the net securitisation issuances in US was USD 645 bncomprising 81% of worldwide issuances; Europe still lagging
Important to understand causes to avoid history Important to understand causes to avoid history repeating itself !!repeating itself !!
Securitisation provided a liquid market for previously unmarketable long-
term assets. However :
• Structures created where mechanics of risk transfer were clouded by a
variety of customised terms
• Overreliance on rating agency risk models
• Mortgage brokers, originator’s employees paid commission on sale of
loan but not exposed to subsequent lossesloan but not exposed to subsequent losses
• Originators minimally exposed to risks of default
• Rating Agencies, merchant bankers provide “Qualified opinions”; no
accountability/participation in future losses
• No attention paid to importance of proper documentation; Hazy
Documentation now leading to difficulties in enforcement of mortgages,
ongoing legal tangles
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act)
• Risk Retention Requirement – Sellers to retain 5% of credit risk in any
asset securitisation
• Disclosure and Reporting requirements by issuers
Reforms in the US Reforms in the US SecuritisationSecuritisation marketmarket
• Representations and Warranties to be provided by issuers and rating
agencies
• Prohibiting underwriters, placement agents, and sponsors of
securitisation from getting involved in any transaction which will result
in conflict of interest for a one year period from the date of transaction
• Tighter regulation on Rating agencies
• RMBS at USD 10.5 trillion account for approx
71% of outstanding mortgages in US
• Of the above, 50% are backed by
Government Sponsored Enterprises (GSEs –
Ginnie/Fannie/Freddie)
• GSE sponsored RMBS amount more than
US MBS marketUS MBS market
90% of the current mortgage loan originations
• Private label MBS not picking up US due to
weakness in the housing market :
• Mortgage Delinquencies at 8% – 8.5%
(delinquency in sub-prime at 24%)
• Foreclosure inventories at approx 4% -
4.5%
• Housing Prices continue to fall (Case
Shiller Index down by 66% since Q3
2006)
SecuritisationSecuritisation -- Emerging MarketsEmerging Markets
Key Players
• Latin America : Brazil, Mexico, Argentina, Columbia
• Asia : Japan, Korea, India, China, Taiwan
Challenges in Emerging Markets
• Lack of Specific Securitisation Legislation
• Volatile/Illiquid capital markets
• Insufficient historical data of borrower behaviour
• Absence of mortgage insurance
• Lack of secondary market support services – property appraisal systems/ legal, accounting expertise/ technology infrastructure
• Political risk insurance cover
• Transparency
Indian Indian SecuritisationSecuritisation Market Market
• First ABS in India in 1992 - Citibank transaction
• First MBS in India in 2000 - NHB Pilot Project - Originators -HDFC/LICHF
• Securitisation volumes peaked in FY 08 at Rs 63730 cr ; FY 11 at Rs 30,825 cr
• Good growth of ABS on the back of retail boom in India
• India is the one of the largest securitisation market in Asia after Japan and Korea
• Cross-border issuances not currently possible due to regulation
Indian Securitisation MarketIndian Securitisation Market
- 68% of incremental disbursements are securitised in the ABS market
Source: CRISIL
- Penetration of MBS low at approx 16% - direct assignment preferred due to regulations/ liquidity issues
Indian RMBS Market Indian RMBS Market
• RMBS volumes in FY 2011 were Rs 5029 cr
• Volumes in RMBS remain subdued
• Long tenures
• Basis Risk
• High Prepayment risk
• Illiquidity
• “Assignment Structure” instead of “PTC Structure” • “Assignment Structure” instead of “PTC Structure”
• HDFC accounts for 70% - 75% of total RMBS issuances in India
• Approx 9% of our assets have been securitised
• MBS used as a tool for better Asset Liability Management
• Main objective has been to broad base funding sources
Securitisation ProcessSecuritisation Process
Participants in the TransactionParticipants in the Transaction
• Banks/FIs as Originators
• Special Purpose Vehicle (SPV)
• Investment Banks – intermediaries
• Investors – banks, mutual funds, insurance companies,
pension funds, international debt investors, high net worth
individualsindividuals
• Rating agency
• Credit enhancer
• Liquidity Support Provider
• Servicing agency (usually the originator)
Steps InvolvedSteps Involved
Pool Selection
StructuringIssuance/Marketing of
Post issue servicing
Structuring
Rating
Setting up of
SPV/Trustee
Documentation
Issuance/Marketing of
PTCs
Selection of Pool Selection of Pool -- Cherry PickingCherry Picking
• Seasoning of the loans
• Geographical Distribution
• Type of borrowers
• Loan to Value Ratio (LTV)
• Income to Installment Ratio (IIR)• Income to Installment Ratio (IIR)
• Loans to be current/ have low outstandings
• Free from any encumbrances/charges
• Only one loan from the borrower
• First and exclusive mortgage
Structuring Structuring
• Gauging the investor demand in terms of tenor and pricing
• Breaking cash-flows in different time buckets to create the required maturities – to suit various types of investors
• Common Structures
– Par
– Premium– Premium
– IO/PO Strip
– Sequential Pay
• Creating a suitable “Payment Waterfall”
• Structure to comply with “True Sale” and “Bankruptcy remoteness” criteria
Rating Rating
Information required by Rating
Agencies
• Portfolio level/ Loan level data
� Data on customer characteristics,
payment history, loan attributes,
geographical dispersion, age,
maturity etc
• Historical data on defaults and
Types of Credit Enhancements
• Built into the Structure
� Senior/subordinate structure
� Over-collateralization
� Cash collateral
� Spread Reserve account
• Historical data on defaults and
delinquencies
• Assumptions on prepayments,
defaults, arrears
• Interest Rate History
• External to the structure
� Corporate undertaking by originator
� Third party guarantee/ monoline insurers
Setting up of SPV/ TrusteeSetting up of SPV/ Trustee
• Purpose of SPV – to isolate identifiable assets into a stand-alone self sustained entity
• Do not have any substantive operations except acting as a conduit between Originator and Investors
• Can be in Pass-through or Pay-through form
Pass
Through
Form
Pay-
Through
Form
Documentation Documentation
• Information Memorandum
• Other Legal Documents
– Deed of Assignment/Transfer
– SPV/Trust arrangement
– Servicing Agency Agreement
– Credit Enhancement/Liquidity Facility arrangement
• Risk Factors to be suitably • Risk Factors to be suitably
disclosed
• All documents ensure
“Effective Transfer”
and “Isolation of Assets”
Issuance/Marketing of PTCsIssuance/Marketing of PTCs
- Role of Merchant Bankers
- Factors affecting pricing of PTCs
� Originator Rating and Bond pricing
� Rating of the issue
� Demand-Supply, Liquidity� Demand-Supply, Liquidity
� Structures - Par / Premium
� Pricing tends to be higher than a normal bond issue of the same rating
� Investors demand markup due to prepayment risk
Post Issue ServicingPost Issue Servicing
• Need for Strong MIS both pre and post securitisation
• Specific data required by the investors, rating agency,
regulator and management
• Track information on securitised loans separately in
case originator continues to act as a servicer
Accounting Accounting
ICAI Guidance NoteICAI Guidance Note
• Currently, Accounting for Securitisation governed by the “Guidance Note
on Accounting for Securitisation” issued by ICAI
• Derecognition of assets – Principle of surrender of control
• Criteria to assess existence of control :
� Right of the Originators’ creditors to attach/deal with the securitised
assetsassets
� SPE’s rights to pledge/sell/assign or exchange the securitised assets
� Originator right to reassume control of securitised asset unless it is
entitled to do so by a Call option at fair value or it is a Clean-up Call
• Originator continuing to remain a Servicer does not impact dereocgnition
ICAI Guidance NoteICAI Guidance Note
• Recognition of Profit/Loss permitted if the derecognition criterion met
• Credit enhancement provided by Originator - Where Originator has
accepted recourse or similar obligation, the same to be accounted as per
AS 4 – “Contingencies and Events occuring after the Balance Sheet Date”
• Accounting by Investor as per AS 13 : Accounting for Investments• Accounting by Investor as per AS 13 : Accounting for Investments
• Disclosure Requirements for Originator :
• Nature and Extent of securitisation transactions
• Nature and amounts of new interest created
• Basis of determination of fair values, wherever applicable
MBS – Current TrendsMBS – Current Trends
Recent Trends in MBSRecent Trends in MBS
• Demand mainly for “Priority Sector” housing loans
• Most issues have single investor
• Floating Rate linked to Originator PLR so as to avoid basis risk
• Preference for “Direct Assignment” route
o MBS being long term in nature is preferred by banks instead of MFs
o No mark to market
• Par Structures only• Par Structures only
o Volatility in prepayments and “conversion” option with borrowers
o Recent RBI directive notifying banks to consider only the par value of loans
for getting priority sector benefit
o Par structures have an EIS which serves as additional credit enhancement
Draft guidelines issued by RBI on Draft guidelines issued by RBI on MHP and MRRMHP and MRR
• Draft guidelines for banks issued in April 2010; similar guidelines for
NBFCs in June 2010
• Aimed to ensure no compromise by Originators in due diligence of
loans
• Discourage the “originate to distribute” model
• Greater alignment between the interests of issuers and investors
• Proposed Minimum Holding Period (MHP) for MBS transactions• Proposed Minimum Holding Period (MHP) for MBS transactions
� 12 months from the date of full disbursement/date of
commencement of EMI
• Proposed Minimum Retention Requirement (MRR) for MBS
transactions:
� 10% of book value of loans being securitised
� Minimum first loss exposure of 5%
� Balance can be as pari-passu investment in the securities being
issued by SPV
Covered Bonds Covered Bonds
• Hybrid between MBS and normal secured corporate bonds
• Developed in Europe ; extensively used in countries such as Denmark,
Germany, France , Spain etc
• After the subprime crisis and issues with MBS, countries such as USA,
Australia, New Zealand are creating legislative platforms for covered bonds
• Salient Features :• Salient Features :
o On balance sheet financing
o Bankruptcy remoteness: assets segregated in case of insolvency
o Dual Recourse - Collateral Pool AND additional recourse against the
issuer too
o Dynamic Pool : Issuers are allowed to replace assets that have either lost
quality or have been repaid early
o No prepayment risk to investors - cashflows to investors on pre-fixed
dates
o Unlike MBS, originator retains “skin-in-the game”
o Less Complex – both in terms of structuring and accounting
Thank YouThank You