Securitisation has become a mainstay of the Indian bond market in the last few years, but the publication of rules for ABS has caused a slowdown. While the technique still offers benefits, banks will have to adapt their practices to make securitisation worthwhile, reports Chris Dammers.
India's securitisation market has been booming since 2002, when the government enacted a securitisation law mainly aimed at helping lenders enforce security.
Falling interest rates have driven rapid growth in mortgage lending while strong demand for vehicles has provided a steady supply of auto loans for securitisation.
Securitisation issuance grew from just Rp20bn in the financial year of 2002 to over Rp250bn ($5.6bn) in FY2005, nearly half of the total corporate bond market. Draft rules published by the Reserve Bank of India (RBI) in April 2005 triggered a slowdown, however, with an estimated Rp160bn of issuance during FY2006.
According to Fitch Ratings, ABS (typically auto loans and equipment leases) made up two-thirds of the securitisation market in 2005, with collateralised debt obligations (CDOs) providing a quarter and residential mortgages a third. There is no commercial mortgage securitisation in India because of differing and often onerous stamp duty regimes in the various states, making it difficult to amass a large, geographically diverse portfolio and uneconomical even for a single jurisdiction.
As well as being dominated by a couple of asset classes, the ABS market is dominated by a handful of banks who do most of the primary lending. Between them Citigroup, ICICI Bank and HDFC Bank account for more than three-quarters of ABS issuance.
This balance should change sharply with the entry of the State Bank of India (SBI), the country's largest bank. In March the bank announced plans to securitise up to 30% of its Rp2.5tr credit portfolio over the next few years. The SBI hopes to improve its deteriorating capital ratios as growth in lending has outstripped deposit growth.
The RBI's publication of final rules on securitisation in February 2006 has slowed down the boom even further, however, as banks take in the implications and work to adapt structures to meet the new requirements.
IndusInd Bank, for example, which has been a heavy issuer of ABS in the past, has put its securitisation programme on hold after the publication of the rules. The effect of the new rules is so significant that rating agency Crisil put the bank's rating on review for downgrade as a result.
Among its many provisions, the new framework imposes hefty capital charges on both first and second loss positions held by the originator, requiring full deduction for both. While the rules will not generally be applied retroactively to securitisations executed before April 2005, the RBI will look at such deals on a case-by-case basis, posing a risk to IndusInd as it would breach the regulatory capital requirements if the full charges were applied to all of its securitisations.
It will be difficult for banks to adapt to the rules quickly because there are few buyers for mezzanine debt in India, meaning that first loss pieces have to be large. The lack of a mezzanine market will also make it hard for banks to take advantage of another provision of the final rules. Whereas the draft rules made no distinction, in the final version second loss positions provided by a third party attract only a 100% risk weighting rather than a full deduction from capital when provided by the originator.
Nevertheless the rules will provide a strong incentive from the sell side to develop a mezzanine market.
These rules conflict with the capital requirements under Basel II, scheduled to be implanted in India from 2007, which dictates that the capital treatment for securitisation positions other than a first loss depends on the credit rating of the exposure and the granularity of the underlying portfolio.
Crisil notes: "Although efficient originators will continue to enjoy capital savings as a result of securitisation, the need for securitisation will be driven centrally by funding requirements, reduced borrowing costs, and better liability matching."
In another burdensome departure from the draft guidelines, the final rules forbid originators from recognising a gain on sale upon transfer to the special purpose vehicle (SPV), requiring instead an amortisation of any profit over the life of the transaction. This reduces another motivation for securitisation.
On the other hand, other planned changes in the law should provide a boost to securitisation. At the moment the pass-through certificates issued by securitisation SPVs are not classed as securities. This means some investors cannot purchase them, they cannot be traded on an exchange and all issuance must be in the form of private placements. The government has proposed to amend the Securities Contracts Regulation Act to reclassify PTCs as securities, which should greatly increase the liquidity of securitisations.