CAIIB RB Unit 21 - Securitisation - Mortgage Backed Securities

'Securitisation' means the conversion of existing or future cash inflows to any person into tradable security which then may be sold in the market.

The market players have different characteristics, relating to:

1. Risk Appetite:
2. Maturity
3. Return Expectations
4. Periodicity
5. Liquidity of Promissory Note

Structuring a mortgage backed securitisation effort would be unique and would depend upon :

1. The quality of the home loans (mortgages), the security value, the receivable quality.
2. The history of collections, delinquencies.
3. The home loan lender's credit rating.
4. The probable rating for the proposed security, by a rating agency.
5. Issue costs, including credit enhancement costs, trust management costs etc.

Securitisation - Concept & Rationale

The process of converting mortgage loans (any loan for that matter) together with future receivables into negotiable securities or assignable debt, is called securitisation.

Securitisation is a process by which a selected pool of homogenous and quality credit assets (loans) of a lending institution is sold to investors through a trust/intermediary by packaging them in the form of securities, which are transferred by way of Pass Through or Pay Through Certificates (PTC).

Asset-backed securities (ABS) can be structured in two different ways

Pass Through Structure
Generally used for loans with a tenure of more than one year, such as, car or housing loans. In a Pass Through Structure, a bunch of loans are converted into ABS. The maturity of the ABS is usually comparable to the tenure of the loans. The returns on ABS are paid directly from installments of the loans.

Pay-Through Structure
Generally used for loans of short maturity such as credit card receivables.

Mortgage Backed Securitisation (MBS)

The home-loan assets are bundled into securities and sold to investors. These are called mortgage-Backed Securities (MBS) because the pool of receivables sold to the SPV is supported by the mortgaged home-loans.

The MBS have not been popular in India on account of two reasons

1. Lack of stringent foreclosure laws
2. Conversion of assets into securities attracts high stamp duty

In the case of NHB the process of securitisation of home loan receivables works as a two-stage process.

1. First stage: Transfer of mortgage debt from the primary lending institution (Originator) to a Special Purpose Vehicle (NHB SPV Trust set up by NHB through declaration) with or without the underlying security.
   
   
2. Second stage: The mortgage debt so acquired will be converted into tradable debt instruments (say in the form of pass through Certificates) without any recourse to the originator or the SPV.

Securitisation of Mortgage Debt: NHB SPV may purchase and convert the housing loans into securities/ PTCs concurrently and issue them in the capital market for investment by investing institutions.

Execution of Memorandum of Agreement with NHB: Based on the willingness to sell or securities its portfolio of housing loans, the Primary Lending Institution is required to enter into an umbrella agreement (called Memorandum of Agreement) with NHB to sell/securities its portfolio of housing loans. The Memorandum of Agreement encapsulates the entire MBS transaction and entitles NHB to take necessary steps to purchase or securities an identified pool of housing loans, including circulation of the Information Memorandum and collection of subscription amount from investors, as the case may be.

Selection of Pool of Housing Loans: The pool of housing loans would be selected by the Primary Lending Institution from its existing housing loans based upon a 'pool selection criteria'.

Valuation of the Pool and Consideration of Assignment

NHB will consider making payment of purchase consideration to the Primary Lending Agency under the following methodology:

1. Per Pricing Methodology
2. Premium Pricing Methodology
3. Discount Pricing Methodology

Credit Enhancement

The credit enhancement may be provided in various forms such as setting aside a cash pool (called cash collateral account), limited corporate guarantee, third party guarantee, setting aside an additional mortgage pool (called over-collateralisation), investment in sub-ordinated MBS paper (in the event of securitisation) etc.

Custody of Mortgage Documents

While the mortgage debt or the receivables pertaining to the MBS transaction will be legally transferred to NHB/SPV Trust, the originator (primary lending agency) will continue to physically hold the title documents in respect of the housing properties obtained as security on the loans issued, in the capacity of a custodian to NHB/SPV Trust.

Hierarchy or Appropriation of Collection mounts (Payment "Waterfall")

The hierarchy of payments shall generally be as follows :

1. Payment to Service Providers viz. Trustee, Servicing Agent, Rating Agency, & other service providers'
2. Payment of Interest to Senior Class RMBS (Class A PTC) holders
3. Payment of Principal to Senior Class RMBS (Class A PTC) holders
4. Replenishment of Cash Collateral/Guarantee/such other form of credit enhancement
5. Payment of Principal to Subordinate RMBS (Class B PTC) holders
6. Payment of Residual income to Subordinate (Class B PTC) holders