Securitization of Standard Assets Guidelines

The rules establish a regulatory framework for banks, All India Term Lending and Refinancing Institutions, and Non-Banking Financial Companies to securitize standard assets (including RNBCs). All of the above institutions would be included in the definition of ‘bank’ in the guidelines.

Securitization is selling assets to a bankruptcy-remote special purpose entity (SPV) in exchange for quick cash. The cash flow generated by the underlying pool of assets is utilized to service the SPV’s securities. As a result, securitization is done in two stages. In the first stage, a single asset or a pool of assets is sold to a ‘bankruptcy-remote special purpose vehicle (SPV) in exchange for an immediate cash payment, and in the second stage, security interests representing claims on incoming cash flows from the asset or pool of assets are repackaged and sold to third-party investors via the issuance of tradable debt securities.

“Securitization exposures” refers to a bank’s exposure to a securitization transaction. Exposures to securities issued by the SPV, credit enhancement facility, liquidity facility, underwriting facility, interest rate or currency swaps, and cash collateral accounts are all examples of securitization exposures.

The following are broad definitions of several terminologies used in these guidelines. These terms have been supplemented as needed in various relevant parts of these recommendations.

  1. The term “bankruptcy remote” refers to the rarity of an entity that is subject to voluntary or involuntary bankruptcy procedures, including by the originator or its creditors.
  2. An SPV is given ‘credit enhancement’ to offset the losses connected with the pool of assets. The enhancement level will be reflected in the rating granted by a rating agency to the securities issued by the SPV (PTCs).
  3. A ‘first loss facility is the initial level of financial assistance provided to an SPV as part of bringing the SPV’s securities to investment-grade status. The majority (or all) of the risks connected with the assets held by the SPV are borne by the facility provider.
  4. A “second loss facility” is a credit enhancement that provides an SPV with a second (or subsequent) tier of loss protection.
  5. ‘Liquidity facilities’ allow SPVs to guarantee timely payments to investors. One of them is the smoothing of timing disparities between interest and principal payments on pooled assets and payments due to investors.
  6. An ‘originator’ is a bank that, as part of a securitization transaction, transfers a single asset or a pool of assets from its balance sheet to an SPV, which may include other firms in the consolidated group to which the bank belongs.
  7. A process through which a single performing asset or a pool of performing assets is sold to a bankruptcy-remote SPV and moved from the originator’s balance sheet to the SPV in exchange for an immediate cash payment is referred to as securitization.
  8. “Service provider” refers to a bank that performs (a) administrative activities relating to the cash flows of the underlying exposure or pool of exposures in a securitization on behalf of the SPV; (b) funds management, and (c) investor servicing on behalf of the SPV.
  9. ‘SPV’ refers to any company, trust, or other entity formed or established for a specific purpose, whose (a) activities are limited to those necessary to achieve the company’s, trust’s, or other entity’s stated purpose; and (b) is structured in such a way as to isolate the corporation, trust, or entity, as the case may be, from an originator’s credit risk, making bankruptcy unlikely;
  10. ‘Underwriting’ refers to a pre-issue agreement. A bank undertakes to buy a particular amount of securities in a new issuance on a specific date and at a specific price if no other buyer is found.

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In a securitization structure, the isolation of assets or ‘true sale’ from the originator to the SPV is necessary for the transferred assets to be removed from the originator’s balance sheet. Suppose the assets are transferred to the SPV in complete compliance with the genuine sale conditions listed below. In that case, the transfer will be recognized as a ‘true sale,’ and the originator will not be required to hold any capital against the value of the assets transferred from the date of the transfer. The transfer’s effective date should be stated explicitly in the existing agreement. The transferred assets would be judged to be on the originator’s balance sheet if they did not meet the “true-sale” criteria, and the originator would be required to retain capital for those assets. The true-sale criteria listed below are intended to be illustrative rather than exhaustive.

Assets that meet the conditions for a “True Sale.”

  • The sale should result in the originator being legally separated from the assets sold to the new owner, the SPV. After transfer to the SPV, the assets should be separated from the originator, i.e., put out of reach of the originator and their creditors, even if the originator goes bankrupt.

  • The originator should effectively transfer all risks, rewards, rights, and duties associated with the asset to the SPV. The originator should not have any beneficial interest in the asset after it is sold to the SPV. The actual sale condition would not be violated by an arrangement entitling the originator to any surplus income on the securitized assets after the term of the securities issued by the SPV. The SPV should be granted complete freedom to pledge, sell, transfer, trade, or otherwise dispose of the assets without restriction.

  • Following the sale of the assets, the originator will have no economic interest in the assets. The SPV will have no recourse against the originator for any expenses or losses other than those specifically permitted under these guidelines.

  • Except in the case of a violation of warranties or representations made at the time of sale, the originator shall have no responsibility to repurchase or fund the repayment of the asset or any portion of it, substitute assets held by SPV, or supply additional assets to the SPV at any time. The originator should be able to show that a notice to this effect was sent to the SPV and that the SPV confirmed that no such duty existed.

  • The originator can keep the option to repurchase fully performing assets after the securitization scheme if the residual value of such assets has declined to less than 10% of the original amount sold to the SPV (‘clean up calls’) as allowed by paragraph 10.

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