Testing times for securitisation deals

 

The Indian securitisation market has faced, among other things, taxation challenges and regulatory changes. However, it has so far been immune from questions about securitability of assets, or the structure of securitisation transactions. However, sitting at the very doorstep of defaults by some major originators, and facing a spectrum of serious servicer downgrades, the Indian securitisation market clearly faces the risk of being shaken at its very core in not too distant a future.

Sale of assets to trusts

In the interim order on plaints by some mutual fund investors in Dewan Housing Finance Corporation Ltd (DHFL), the Bombay High Court made certain observations that may hit the conduct of the originator on securitisation of receivables. For example, in the interim order of October 10, 2019, in Commercial Suit No 1034 of 2019, it was contended that the receivables which were securitised by DHFL were already charged on a

pari passu basis to bondholders. The court observed that if the assigned receivables were already subject to a breach of the asset cover of the debentures which also were secured by the very same receivables, DHFL and “the banks participating in the securitisation of receivables already subjected to a charge may have some tough questions to answer.”

The practice of

pari passu “floating charge” on receivables is quite commonly used for securing issuance of debentures; almost every NBFC debenture issue is secured by such floating charge. The practice of floating charges has itself been discarded in the UK where from it emerged out of 19th century rulings. However, in India, owing to a technicality of “deposit” rules, the practice of secured debentures continues. World-over, corporate bonds are unsecured.

While bond issuance practices surely need re-examination, the burning issue for securitisation transactions is: If the DHFL interim ruling results in some final observations of the court about need for the bond trustee’s no-objection certificate for securitisation transactions, all existing securitisation transactions may also face similar challenges.

Servicer-related downgrades

Rating agencies recently downgraded several pass-through certificate transactions of a leading NBFC by two notches from AAA ratings. The rationale given in the downgrade action, among other things, cites servicer risks, on the ground that the originator has not been able to obtain continuous funding support from banks. But how does it affect servicing capabilities of existing transactions, is a curious question. Normally, the responsibility of the collection of loans still lies with the seller or originator of loans (also called the servicing agent). It seems that in addition to the liquidity issue, which is all pervasive, the rating action in the present case may have been inspired by some internal scheme of arrangement proposed by the NBFC in question.

However, what is important is that the downgrades are muddying the transition history of securitisation ratings. The susceptibility of securitisation transactions to pure originator entity risks puts a risk which is usually not considered by securitisation investors. In fact, the flight to securitisation and direct assignments after the IL&FS crisis was based on the general notion that entity risks are avoided by securitisation transactions.

The biggest jolt may be a forced servicer transition. In something like RMBS (residential mortgage-backed securities) transactions, outsourcing of collection function is still easy. However, if it comes to more complicated assets requiring country-wide presence, borrower franchise and regular interaction, if servicer transition has to be forced, the transaction will be worse than originator bankruptcy.

Questions on true sale

The market has been leaning substantially on the “direct assignment” route.

If the truth of the sale in most of the direct assignment transactions is questioned in cases such as those before the Bombay High Court, it will not be surprising to see the court re-characterise the so-called direct assignments as nothing but disguised loans. If that was to happen, not only will the investors lose the very bankruptcy-remoteness they were hoping for, the RBI will be chasing the originators for flouting the norms of direct assignment.

NBFCs are passing through a very strenuous time. Any abrupt strong action may exacerbate the problem. As for securitisation practitioners, it is time to strengthen practices and realise that the truth of the sale is not in merely getting a true sale opinion.

The writer is an author and consultant on securitisation