Securitisation Analysis

Securitisation:

Securitisation is the process of pooling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors.Securitisation has emerged as an important means of financing in recent
times. 

A typical securitisation transaction consists of the following steps:
1. creation of a special purpose vehicle to hold the financial assets underlying the securities;
2. sale of the financial assets by the originator or holder of the assets to the special purpose vehicle, which will hold the assets and realize the assets;
3. issuance of securities by the SPV, to investors, against the financial assets held by it.

This process leads to the financial asset being take off the balance sheet of the originator, thereby relieving pressures of capital adequacy, and provides immediate liquidity to the originator.

The legal framework for securitisation in India with the enactment of the “The Securitisation and Reconstruction of Financial Assets And Enforcement of Security Interest Ordinance, 2002” (The Act). Its purpose is to promote the setting up of asset reconstruction/securitisation companies to take over the Non Performing Assets (NPA) accumulated with the banks and public financial institutions. The Act provides special powers to lenders and securitisation/ asset reconstruction companies, to enable them to take over of assets of borrowers without first resorting to courts. The Reserve Bank of India (“RBI”) has recently notified the following guidelines under the Act for the regulation of securitisation companies:

1. The Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003.
2. Guidelines to banks/FIs on sale of Financial Assets to Securitisation Company (SC)/ Reconstruction Company (RC) (created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and related issues, 2003.
 

This article attempts to analyze the implications of these guidelines
The Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003 (“Guidelines”).

Policies and plans required to be framed:

The Guidelines require that a Securitisation (or  Reconstruction) Company shall formulate policies for asset acquisition, including valuation procedure, rescheduling of debts of borrowers (to be supported by an acceptable business plans, projected earnings and cash flows of the borrower), settlement of debts due from borrower, and plans for realisation of assets.

Classification as Non-performing Asset (“NPA”):

The Guidelines seem to have made a significant departure from the definition of the NPA under the existing Reserve Bank of India (“RBI”) guidelines. Receivables are to be treated as NPAs if the same remain overdue for a period of 180 days or more. 

While this is in accordance with existing RBI norms for classification of debts as NPAs, 

section 3(vi) of the Guidelines also states that the board of directors of a Securitisation (or Reconstruction) Company may, on default by the borrower, classify an asset as a non-performing asset even earlier that the said 180 days for the purposes of facilitating enforcement as provided for in section 13 of the Act. 

As per section 13, where any borrower makes a default in repayment of a secured debt and his account is classified as an NPA, the secured creditor (or as the case may be the
Securitisation Company) becomes entitled to exercise the recovery rights under the Act, after providing for a 60 day  notice to the borrower. The Guidelines therefore permit a
Securitisation (or Reconstruction) Company to classify a debt as an NPA and proceed to give the aforesaid 60 day notice
under the Act immediately upon default by the borrower,without having to wait for the aforesaid 180 day period.

Registration under the Act:

The Guidelines clarify that a Securitisation (or Reconstruction) Company that has obtained a certificate of registration issued by the RBI under the Act can undertake both Securitisation and Reconstruction activities. The Guidelines also clarify that an entity that is not registered
with the RBI may conduct the business of Securitisation or Asset Reconstruction outside the purview of the Act. This is a significant clarification as the Act is silent in this regard. In
view of this clarification, banks and financial institutions that were engaged in securitisation activities prior to the Act can continue the same without having to obtain a certificate
of registration under the Act. The benefits of the enhanced enforcement rights under the Act however, will not be available to them.

Restrictions on raising monies from the public:

The guidelines prohibit a Seuritisation (or Reconstruction) Company from raising monies by way of deposit. A Securitisation Company is permitted to raise funds from qualified institutional buyers (as defined in the Act) by issuing security receipts to them. It has been clarified that
the security receipts would be transferable/assignable only in favour of other qualified institutional buyers.

Issue of security receipts:

The Guidelines state that security receipts are to be issued thorough one or more trusts set up exclusively for the purpose.The trusteeship of such trusts is required to vest with the
Securitisation (or Reconstruction) Company. The Securitisation (or Reconstruction) Company is required to transfer the financial assets to the said trust at the price at which those were acquired. It is important to note that this transfer of assets will double the incidence of stamp duty, as stamp duty will have to be paid in respect of the transfer of the financial asset from the originator to the Securitisation (or Reconstruction) Company, and also for the transfer of the financial asset from the Securitisation (or Reconstruction) Company to the trust.

Change or take over of management/sale or lease of the business of the borrower:
The Act allows lenders and securitisation companies to change or take over the management of the borrower and sell or lease the business of the borrower for the purpose of recovery of loans. However, the Guidelines state that no Securitisation (or Reconstruction) Company shall take any measures for change or take over of management/sale or lease of the business of the borrower until the RBI issues necessary guidelines in this behalf.

Enforcement of Security Interest:
While taking recourse to the sale of secured assets, it has been clarified that a Securitisation (or Reconstruction) Company may itself acquire the secured assets only if the sale is concluded through a public auction.

Deployment of funds:
The Guidelines impose restrictions upon the permissible modes of deployment of funds by Securitisation (or Reconstruction) Companies. A Securitisation (or Reconstruction) Company is permitted to invest in the equity share capital of another Securitisation (or Reconstruction) Company, as a sponsor and for the purpose of establishing a joint venture.

A Securitisation (or Reconstruction) Company is allowed to deploy any available surplus in government securities and deposits with scheduled commercial banks in accordance
with a policy framed in this regard by its board of directors. No Securitisation (or Reconstruction) Company is allowed to invest its owned funds in land and building. However,
this restriction would not apply to funds borrowed as also to owned funds in excess of the minimum prescribed.

Other requirements:

The Guidelines also provide for provisioning requirements, income recognition norms, disclosures required to be made in balance sheets, etc.Guidelines to banks/FIs on sale of Financial Assets to Securitisation Company (SC)/ Reconstruction Company (RC) (created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and related issues (“Sale Guidelines”) These guidelines are applicable to the sale of financial assets by banks and Financial Institutions (“FIs”) for asset reconstruction
and securitisation under the Act.

Financial assets which can be sold:

As per the Sale Guidelines, the following classes of assets can be sold by banks/FIs to Securitisation (or Reconstruction) Companies:
1. An NPA;
2. A standard asset (i.e., an asset that is not an NPA) where:
>a. the asset is under consortium /multiple banking arrangements,
>b. at least 75% by value of the asset is classified as NPA in the books of other bank/FIs, and
>c. at lease 75% by value of the banks/FIs who are under the consortium/multiple banking arrangement agree to the sale of the asset to the Securitisation (or
Reconstruction) Company.

Procedure for sale:

The sale of financial assets from a bank/FI may be on a “without recourse” basis, i.e., with the entire credit risk associated with the financial asset being transferred to the Securitisation (or Reconstruction) Company, as well as on a “with recourse” basis, i.e., subject to the unrealized part of the asset reverting to the seller bank/FI. Banks/FIs are however, required to ensure that the effect of the sale of the financial assets should be such that the asset is taken off the
books of the bank/FI and after the sale there should not be any known liability devolving on the bank/FI. It has also been clarified that under no circumstances can a transfer to the Securitisation (or Reconstruction) Company be made at a contingent price whereby in the event of shortfall in the realization by the Securitisation (or Reconstruction) Company, the banks/FIs would have to bear a part of the shortfall.

Further, in the case of specific financial assets, where it is considered necessary, banks/FIs may enter into agreements with the Securitisation (or Reconstruction) Company to share,

in agreed proportion, any surplus realised by the Securitisation (or Reconstruction) Company on the eventual realization of the concerned asset.

In the case of financial assets that cannot be revived, the Sale Guidelines recognize that a Securitisation (or Reconstruction) Company may not take over these assets but act as an agent for recovery for which it will charge a fee. In such a case, the assets will not be removed from the books of the bank/FI but realizations as and when received will be credited to the
asset account. Securities offered by the Securitisation (or Reconstruction) Company to the banks/FIs The securities offered by the Securitisation (or Reconstruction) Company to the banks/FIs are required to satisfy the following conditions:
1. The securities must not have a term in excess of six years.
2. The securities must carry a rate of interest which is not lower than 1.5% above the Bank Rate in force at the time of issue.
3. The securities must be secured by an appropriate charge on the assets transferred.
4. The securities must provide for part or full prepayment in the event that the Securitisation (or Reconstruction) Company sells the asset securing the security before the maturity date of the security.
5. The commitment of the Securitisation (or Reconstruction) Company to redeem the securities must be unconditional and not linked to the realisation of the assets.
6. Wherever the security is transferred to any other party, notice of transfer should be issued to the Securitisation (or Reconstruction) Company.

Other provisions:
The Sale Guidelines also provide various prudential normsfor the sale transaction, including provisioning/valuationnorms, capital adequacy and exposure norms and disclosure requirements.
The Sale Guidelines also provide that in the event of consortium/multiple banking arrangements, if 75% (by value) of the banks/FIs accept the offer for purchase of financial assets from a Securitisation (or Reconstruction) Company, than the remaining banks/FIs will be obligated to accept the offer.

Conclusion:
The new RBI guidelines seek to provide healthy and uniform directions for regulating securitisation activities. While these guidelines and the enhanced enforcement rights provided
to Securitisation Companies under the Act will provide an impetus to securitisation in India, many legal impediments remain. Prominent among these legal impediments are the
excessive stamp duty rates applicable to securitisation transactions in several states. Also, a number of cases including the Mardia Chemicals case, are currently pending at the Supreme Court, where the constitutionality of the Act has been challenged. These cases remain pending till date with no indications as to the possible outcome of the challenge.

Source:-------> BSE India.com