|Securitization |
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|Project for Final Evaluation |
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|6/13/2009 |
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|Priyanka and Baljeet |

This project with International Autotrac Finance Ltd as a combination of hard works & challenges and was both exciting and simulating. No project being individualistic efforts, this is one too is a combination of the efforts and views of many people. I would like to express my gratitude to all.

First I would like to thanks Dr. Gurwinder who has given me the opportunity to do summer training in Sonlaika International Tractors Limited.

I am very thankful to Mr. Rohit Mohan (Manager Finance cum Company Secretary), without his efforts it would have been impossible for me to get and complete project. I want to pay my regards to Ms Richa Gautam for being my corporate guide and as well as for continuous encouragement and guidance which he has given me during the course of the project.

I also wish to convey special thanks and reverence to other colleagues of the IAFL department who has provided valuable acumen into project.

Last but not the least would like to express my gratitude to the faculty at ICFAI National College for conducting our course with utmost sincerity.

As a matter of fact every MBA student has to go for practical training in some business organization and being the MBA student of ICFAI National College, its compulsory for every student to have the training of 13 weeks. On the completion of MBA degree student have hand on experience, which proves very helpful in future business environment.

During our training we were in the finance department of Sonalika(International Autotrac Finance Limited) which deals in financing vehicles and there we learnt the disbursement process, cash management system and securitization process which means to convert illiquid assets into liquid assets. Even our project was on the topic Securitization.

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• Overview of Company

• Overview of Securitization

• Objective of Securitization

• Process of Securitization

• Diagram of Securitization

• Diagram of Credit Enhancement

• Types of Securitization

• Types of assets can be securitized

• Case Study of Financial Institution

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Established in 1969, Sonalika group from the very beginning has tried to understand customer need so that they get better value for their money, hard earned. Sonalika has state of manufacturing, spread in acres, located at Hoshiarpur and tax free zone at Amb in Himachal Pradesh. Sonalika is the one of the top 3 tractor manufacturing companies in India, other products include of, multi utility vehicles, engines and various farm equipments. Today the group stands tall with an approximate turnover of 3200 core INR. An average growth of 30% makes it one of the fastest growing corporate in India. Its also one of the few debt free companies. Group has strength of about 2000 employee & technocrats. History reveals that innovation is the key to continued progress and when applied to technology that touches human life, it can unfold a whole new economic phenomenon that has the power to change the world. With unique initiatives like the thought leadership forum, leadership forum, we have been able to create a unique platform for learning through success stories of industry leaders.

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• International Tractors Limited

• International Cars and Motors Limited

• International Autotrac Finance Limited

• Sonalika Agro Industries Corporation

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Securitization is a process through which illiquid assets are transformed into more liquid form and distributed to a broad range of investors through capital markets. The process involves packaging of individual homogenous loans and distributed among various investors in the form of Coupons or Pass through certificates or Pay through certificates through a SPV.

For the purpose of distinction, the conversion of existing assets into marketable securities is known as asset-backed securitization and the conversion of future cash flows into marketable securities is known as future-flows securitization.

The process of Securitization in India is governed by The Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
(often referred to as Securitization Act).

Securitization Act defines Securitization as ‘acquisition of financial assets by any
Securitization Company or Reconstruction Company (SPV) from any Originator, whether by raising of funds by such company from Qualified Institutional Buyers
(QIBs) by issue of security receipts representing undivided interest in such financial assets or otherwise’.

A lender has to normally wait for recovery of principal and interest over a period of time. When securitization is done, he sells his right to receive future payments and receives upfront payment at a discounted value. He can use these funds once again for advancing loans. By this process his long term illiquid assets are converted into current assets. Some of the assets that can be securitized are loans like car loans, housing loans, ticket sales, credit card receivables, lease finance receivables etc.

Modus Operandi (as per provisions of Securitization Act)
The following steps briefly describe the working of this technique:
1. Originator sells the loan (or other financial asset) to the SPV at a discounted value. 2. SPV raises the money from investors by raising debt instruments which are listed on stock exchanges. (The securities are rated by credit rating agencies like
CRISIL etc)
3. Money raised by SPV is given to the Originator.
4. SPV collects from the borrower the principal and interest amount and repays the debt instrument held by investors.
Note: Securitisation can also be made partially i.e. only principal amount portion or only interest portion or only a part of the loan (say) 75% of the loan amount is securitized. [pic]

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Is the company ready for ABS?

θ Does the originator currently face a high cost of funding assets that would be recognized as sound, cash-generating assets if taken in isolation? θ Does it have a regulatory or capital constraint that makes freeing up the balance sheet important? θ Does it have data about the assets (required by rating agencies and financial guarantors)? θ Does it have the servicing process and systems that can meet the more demanding standards of the asset backed market? θ Is the originator willing to undertake a complex, time consuming transaction to obtain a broader, potentially cheaper, ongoing source of funding?

Are the Assets Suitable?

The Pool of assets should have:

• Volume which is sufficiently large and homogenous to facilitate statistical analysis • A stable history of rates, defaults, delinquencies, prepayments and so forth • Sufficient diversification--for example, geographic and socio- economic-to reduce vulnerability to economic stresses • Basic lender’s credit quality standards that are capable of being evaluated and approved by rating agencies and specialized financial guaranty companies • Assets must be transferable and unencumbered
In short, the assets themselves must be sufficiently strong to support a high credit rating without the backing of the originating lender

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gdHire Purchase Payments

M Payments

Monthly ABS Payments

Servicing Fees

Trustee Responsibilities Guarantee Responsibilities

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Hire Purchase Agreement

Top Rating

Servicing Agreement

Sales of assets Asset Backed Securities

Proceeds Proceeds

Trust Agreement Guarantee Agreement

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There are three principles of securitization

1 True Sale: In a true sales securitization, a company sells assets to a special purpose vehicle/company which funds the purchase by issuing bonds to capital markets.

2. Synthetic Securitization: In a synthetic securitization, the company does not sell any assets, but transfers the risk of loss associated with certain of its assets to an SPV or an bank against payment by such company of a premium or fee to the SPV.

3. Whole business securitization: It is essentially a secured loan granted by an
SPV to the relevant company. To grant the loan, the SPV uses proceeds of bonds issued into the capital markets whereby the company grants security over most of its assets in favor of the bondholders. This Position Paper deals primarily with true sale securitization.

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In principle, any assets representing future (predictable) cash flows can be securitized to the extent that they can be effectively transferred to the SPV through a true sale. In this respect, securitization of auto loans, credit card receivables, computer leases, unsecured consumer loans, residential and commercial mortgages, franchise/royalty payments, and other receivables relating to telecom, trade, toll road and future export have gained prominence. [pic]

International Autotrac Finance Limited

International Autotrac Finance Limited (IAFL) is a non – deposit taking non banking finance company. In 2007 Sonalika group incorporated the company IAFL, to provide finance in auto sector in rural, semi – urban and urban areas. Group plans to diversify their asset base to different sources later on. IAFL has its origin in Sonalika group, which has business interests into farm equipments, tractors and MUVs. Sonalika group happens to be third largest manufacturer of tractors in India with exports to many countries.

Snapshot of International Autotrac Finance Limited

Objective of Securitization: To convert long term illiquid assets into current assets.

The following diagram will explain securitization transaction of IAFL

[pic] ������ Benefit to Originator: • Securitization helps convert illiquid assets into liquid, marketable assets. • Securitization can be used as a strategic tool by corporate. • Use of securitization as an alternative funding tool by corporate • Securitization enables financial institutions free up their capacity for further lending. • Securitization helps improve balance sheet efficiency. This process leads to the financial asset being taken off the balance sheet of the originator, thereby relieving pressures of capital adequacy, and provides immediate liquidity to the originator. ������ Benefit to investors: Investor experience of investing in securitized paper has Internationally been quite good, for primarily 3 reasons: • Securitization being a structured finance instrument can be more closely aligned to investor needs. Investors can invest in exactly what suits their investment policy the best. • Securitization asset classes have shown much higher rating resilience. Rating transition histories have been published by both Moody's and Standard and Poor's depicting this. Recently, Fitch also came out with a rating transition history of ABS to prove this point. • Default history of securitization transactions is much safer - there have been very few defaults over the past 16 years. • Default recovery rate of securitization transactions has been significantly higher than in case of defaulted corporate bonds. • The debt instruments issued by the SPV are generally rated by credit rating agencies like CRISIL hence are much safer.

������ Benefit to the economy:

Securitization benefits the economy as a whole by bringing financial markets and capital markets together. Financial assets are created in the financial markets, e.g., banks or mortgage financing companies. Securitization connects the capital markets and financial markets by converting these financial assets into capital market commodities. The agency and intermediation costs are thereby reduced.

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The key parties involved in a securitization and their roles3 are as follows (further parties may be involved depending on the structure of the individual transaction):

• Originator—owner and “generator” of the assets to be securitized. Examples of Originators are: banks and other financial institutions, corporates, governments and municipalities. • Seller—seller of the assets to be securitized. In many cases, the Seller and the Originator in a transaction is identical. This is however not necessarily the case. For instance, an entity may purchase assets from its affiliates and then act as central Seller in a securitization. • Purchaser—a special purpose vehicle (SPV) which purchases the assets to be securitized. The Purchaser funds the purchase price by issuing asset-backed securities into the capital markets (in this capacity, the Purchaser is also referred to as the Issuer) • Servicer—services the assets to be securitized (frequently the Originator retains this role). Where receivables are securitized, the Servicer will collect, administer and, if necessary, enforce the receivables. • Back-up Servicer—will service the assets in the event the Servicer is unable to service them, or in the event the Purchaser exercises its right to remove the Servicer (for instance, as a result of the insolvency of the Servicer). • Liquidity Facility Provider—provides a liquidity facility in relation to certain tranches of the asset-backed securities. Typically, a liquidity facility is provided in conduit transactions where the Purchaser issues revolving short-term commercial paper to fund the purchase of the assets. The Purchaser may draw upon the liquidity facility if it is unable to refinance maturing commercial paper because of a market disruption. The liquidity facility thus secures commercial paper investors against a default in such a case. Liquidity facilities are also sometimes required in standalone securitizations. • Investors—purchasers of the asset-backed securities. Examples of investors in the securitization market are: pension funds, banks, mutual funds, hedge funds, insurance companies, central banks, international financial institutions and corporate. • Lead Manager—arranger and structurer of the transaction (in the context of conduit transactions, also referred to as Programme Administrator). The Lead Manager is often the primary distributor of the asset-backed securities in a particular transaction. Individual distributors are also referred to as Managers. • Rating Agencies—rate the asset-backed securities. The three key rating agencies in securitization are Standard & Poor’s, Moody’s and Fitch. • Hedge Providers—hedge any currency or interest rate exposures the Issuer may have. • Cash Administrator—provides banking and cash administration services to the Issuer. • Security Trustee—acts as a trustee for the secured creditors of the Issuer (notably, holds the Issuer’s assets granted to it as security for the Issuer’s obligations, on behalf of the Investors). • Note Trustee—acts on behalf of the holders of the asset-backed securities. • Auditors—if necessary they audit the asset pool as may be required under the documentation of the relevant transaction.
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Securitization is expected to become more popular in the near future in the banking sector. Banks are expected to sell off a greater amount of NPAs to ARCIL when they have to shift to Basel-II norms. Blocking too much capital in NPAs can reduce the capital adequacy of banks and can be a hindrance for banks to meet the Basel-II norms. Thus, banks will have two options- either to raise more capital or to free capital tied up in NPAs and other loans through securitization.

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What Pool?

What legal structure?

What credit enhancement?

Finance Companies Customers

Rating Agency

Finance Company Limited Seller

Investors

Special Purpose Company

Trustee

Financial Guarantee Provider

Rating Agency

Financial Guarantee Provider (if required

Trustee

Investors

Special Purpose Company

Financial Company Limited Seller

Financial Company Customers

IAFL

Finance Amount

Letter of Credit

ICML

PDCs transfer to IAFL (Repayment)

Dealers

Margin Money & other documents

Vehicle

Customers

Vehicle

Cash flows after securitization

Borrowers

Cash flows before securitization

Interest and Principal

Asset Sale

IAFL (Originator)

Investors

IDFC (Special Purpose Entity)

Sale price of securities

Sale Price

Profit Extraction

CRISIL (Rating Agency)

Guarantee Agreement with IAFL (Fixed Deposits)