The momentum in the securitization market is likely to remain strong in the current fiscal as it is emerging as an important tool for retail-focused NBFCs for raising funds at reasonable costs while simultaneously providing a hedge against asset-liability mismatches. A visual trend of the market over the years can be seen below:. Looking at the figure above, we can see a sharp surge in the direct assignment volumes in FY A majority of the issuances comes from the third quarter with around Rs.
However, wary of the credit quality of the NBFCs and HFCs, the banks have shown more interest in the underlying loan portfolios than on the originator itself. Through direct assignment and securitization, these institutions get upfront cash payments against selling their loan assets. This helps these institutions during the cash crunch.
Funds raised by NBFCs and HFCs through this route helped the financiers meet sizeable repayment obligations of the sector in an otherwise difficult market. Another reason that explains this sudden surge in the volume of direct assignment or securitization volumes is the relaxation of the minimum holding period MHP criteria for long-tenure loans by the RBI. This increased the quantum of assets eligible for securitization in the system.
More details about this can be found here. Primarily, priority sector lending PSL requirements were the primary drivers for securitization. The number of financial institutions participating in securitization were quite low. This not only made them explore a new mode of funding, but also solved other problems like asset liability mismatches.
This is the solvency risk or the default risk or credit risk. The raised money is then used to extend loans to borrowers for the long term 5 years. This means that NBFC's will return lenders their money within three months but will receive money from the borrower after five years. Only because short-term loans are cheaper, and long-term loans are expensive, NBFC's take advantage of the situation and earn an interest rate margin. To make this system work well, NBFC's go for rollover. Say, for example, an NBFC owes payment to its lenders for commercial papers after three months.
To ensure complete repayment without default, the NBFC will issue new commercial papers to another set of lenders. The raised money will then be used to repay the earlier lenders. This is the Rollover Strategy. This goes on and on to ensure liquidity.
To repay its previous lenders, it will approach its borrower asking for repayment. But, the borrower won't be able to repay the NBFC since all of its money would be invested in his project. This situation gives rise to what is popularly known as the Liquidity Crisis.
The recent liquidity crisis is going to impact the sentiments of particularly Mutual Funds since any default in interest, or principal payments would ultimately have to be borne by the investors. What is Securitization? To get a better understanding, consider the following example: Suppose, a small bank ABC with an existing loan portfolio of crores wants to raise a loan of 50 crores by monetizing its current assets.
Direct Assignment Direct Assignment involves buying a loan book at a fixed interest rate. Why would banks be buyers? However, NBFC's can charge various rates from customer i. Here, both PLR and Spread are variable.
In simple terms, an asset is something that gives the holder cash flows in the future. For example, for an entity such as a bank or non-banking finance company NBFC , loans are assets since they earn interest cash flow. Securitization of such assets refers to converting them into paper securities and selling them to another entity and thereby transferring the future cash flows to the buyer for a price.
Part of the reason for the sub-prime mortgage crisis in the US was the widespread securitization of mortgage-backed loans. According to the Reserve Bank of India RBI , the securitization market is primarily intended to re-arrange and diversify the credit risk away from the loan originators to a number of investors who can bear it, thus giving some financial stability and an additional source of funding.
The main reason for undertaking securitization is liquidity. Once an asset is converted into a marketable security, it is sold to an investor. The interest and principal is then paid to the investor at agreed intervals.
Typically, the originator will pool loans in one category and sell that to the buyer. Technically securitization is a reference where assets are being pooled and a special purpose vehicle SPV is created which issues the tradable securities such as pass through certificates PTCs or bonds to buy assets.
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