The Reserve Bank of India (RBI) plans to enable non-performing asset (NPA) securitization through the special purpose entity (SPE) route, in standard asset securitization lines, as an alternative investment route. in stressed assets.
The central bank on Wednesday released a discussion paper on the Stressed Assets Securitization Framework (SSAF) and invited comments from interested parties by February 28.
Strained asset securitization is a financial structure whereby an NPA originator sells stressed assets to an SPE that finances the acquisition by issuing securitization notes, according to the filing.
The SPE, in turn, appoints a servicing entity to manage the stressed assets, typically with a fee structure that incentivizes them to maximize recoveries on the underlying loans.
Investors are paid based on the recovery of the underlying assets, based on the cascading mechanism based on the age of the tranches.
“This could be the start of the junk bond market in India. It could also provide an opportunity for asset rebuilding companies to earn other income,” Hari Hara Mishra, Director, UV ARC.
The paper underlined that the question to be addressed regarding SSAF is whether the framework should be restricted to NPAs only or expanded to include standard assets as well, up to a maximum limit.
Securitization involving only NPA may have uncertain cash flows, mainly dependent on recoveries of the underlying assets and the issuance of securitization notes on those underlying assets may not have regular servicing, which may be a limiting factor for the universe. of investors.
Internationally, a limited window is allowed for the inclusion of non-NPA (standard) assets for structuring purposes. However, such transactions that have a mix of standard and NPA assets may give rise to regulatory arbitrage issues, valuation complexity, etc.
During preliminary interactions with a specific set of market participants, RBI said views broadly reflected global experience in terms of asset selection (stressed retail assets), mortgages, unsecured personal loans and loans taken out by MSMEs.
In these loan categories, where the borrower base is diversified, cash flows are relatively predictable even when assets are under stress, and borrowers often continue to make regular payments. With relatively predictable cash flows, the complexities involved in structuring such a transaction are reduced.
The newspaper said an additional option is to allow large stressed corporate accounts. However, the downside is that these accounts can exhibit highly uncertain cash flows; delays in decision-making by the Intercreditor Agreement/Creditor Committee that lead to impairment of the underlying value; and, representation by the administrator of the resolution of only a part of the total set of creditors.
On the other hand, these assets have significant business value backed by tangible security and can potentially attract a broader investor base. Furthermore, since these accounts form a significant part of the financial sector NPAs, their exclusion from SSAF will limit the universe of underlying pools.
In addition, in order to have a portfolio approach towards the recovery of a diverse group of stressed assets, a floor in the value of the underlying or the number of loans in the underlying assets can be considered.
The newspaper said that the economic interests of the Resolution Manager (RM) must be closely aligned with the interests of investors. He suggested that RMs, which are typically employed in a fee-based recovery mechanism, should be given incentives for early resolution and increased recovery, rather than acting as a cost center through annual fees and negligible production.
To align incentives for RMs, in a prudential manner, it may be justifiable to stipulate that RMs retain a portion of the risk by investing in securitization notes, according to the statement.
The key question, then, would be to determine who should bear the incidence of the minimum risk retention (MRR), the originator or the RM, and in what way. One option is to let the market decide through the contractual terms of the structure.
Another option is to distribute MRR between the originator and RM through regulatory guidelines. A third option may be to specify a recovery-based fee structure for RM and MRR with the originator.
Under SSAF, the resolution/recovery of stressed assets is expected to be carried out by an independent RM. The document noted that the resolution effort may require additional/interim funding to cover administrative, operational, and other expenses needed to put resolution/recovery plans in place.
RMs can finance the same through funds raised from investors, loans from lending institutions, or a combination of both.
In the event of financing by lending institutions to RM, there is a potential risk of overvaluation of the underlying assets at the time of transfer by the originator to SPE, where the originator could end up providing financing to RM in exchange for overvaluation of the underlying assets. stressed assets, he warned. paper.
Out of prudence, it may be necessary to discourage such practice of artificially leveraging the author’s books without any real added value.
The document said the credit enhancement agreements help structure and broaden the investor pool with the potential inclusion of even those investors with a slightly lower risk appetite and would set the stage for SSAF’s initial takeoff.
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