Defaults due to legal interpretation a threat to securitisation market
Such incidents, despite robust collections and cash collateral, can reduce investor appetite
Recent defaults on some securitised instruments, triggered by a particular interpretation of recent Bombay High Court orders by an originator, pose a significant risk to the securitisation market and can materially reduce investor appetite if not addressed immediately.
The instruments were backed by loans originated and serviced by Dewan Housing Finance Corporation Limited.
The defaults were not because the transactions had run into cash flow problems. The collection performance of their underlying assets was robust and there was also substantial cash collateral to service the investor payouts comfortably.
The defaults had two triggers: one, the servicer of the securitised pools of receivables (also the originator) not transferring the collections to the Collection and Payout Account (CPA) based on its interpretation of the high court orders; and, two, the inability of trustees to access the cash collateral (typically fixed deposits [FDs]) in a timely manner to pay investors on the due date.
The Bombay High Court orders, prima facie, do not explicitly restrict the originator from depositing collections from securitised assets into the CPA from which investor payouts are made. The court has imposed restrictions on payments to secured and unsecured creditors. The originator has seemingly interpreted this to include servicing of securitised transactions.
The interpretation calls into question the bases on which ratings on securitised instruments differ from the credit profiles of originators – ‘bankruptcy-remoteness’ of securitised assets arising from ‘true sale’, and ‘bankruptcy-remoteness’ of ‘assets held in trust’ from the originator / servicer. These derisking features are the bedrock of securitisation transactions not just in India, but worldwide.
Bankruptcy-remoteness ensures that neither the originator nor the servicer owns the assets – they only manage them as counterparties to a securitisation transaction. Consequently, the assets would not form a part of the liquidation estate of the originator or the servicer (see Annexure 1).
This endows a superior credit quality, which is the primary reason why securitisation volume has surged in the past one year. In the 12 months ended September 2019, volume nearly doubled to Rs 2.3 lakh crore from Rs 1.2 lakh crore, offering much-needed liquidity to non-banks struggling to raise monies through vanilla debt instruments.
Says Krishnan Sitaraman, Senior Director, CRISIL Ratings, “If there is no immediate clarity on the legal standing of securitisation transactions in relation to the liquidation estate of originators / servicers, the ability of credit rating agencies to differentiate the credit quality of securitised instruments from their servicers and originators will be affected. That can significantly impact investor appetite for securitisation transactions, and potentially limit access to funding for non-banks through this route. It can also affect the government’s recently announced partial credit guarantee scheme under which securitisation of Rs 1 lakh crore of assets is to be facilitated.”
Equally worrying is the non-adherence to transaction terms by some counterparties in these transactions (see Annexure 2). There appear to be instances where banks that held FDs as cash collateral for the safety of investors have, in contravention of transaction covenants, insisted on consent from the collateral provider (typically the originator of a securitisation transaction). That impaired the ability of the trustees to access the FDs to pay investors. In another instance, trustees apparently didn’t have access to documentation related to FDs, which led to default.
Says Rohit Inamdar, Senior Director, CRISIL Ratings, “Maintaining the structural integrity of securitisation transactions by all counterparties is quintessential to the credit quality of securitised instruments. In the long term, the securitisation market would benefit from a legislative framework for securitisation that provides legislative sanctity to all key aspects of such structured transactions.”