WhaL uoes SecurlLlzaLlon Mean?

1he process Lhrough whlch an lssuer creaLes a flnanclal lnsLrumenL by comblnlng oLher flnanclal asseLs
and Lhen markeLlng dlfferenL Llers of Lhe repackaged lnsLrumenLs Lo lnvesLors 1he process can
encompass any Lype of flnanclal asseL and promoLes llquldlLy ln Lhe markeLplace

SLCu8l1lSA1lCn Cl uL81 SLCu8l1lSA1lCn Cl uL81 ln18CuuC1lCn llnanclal sysLem ls ln rapld
LransformaLlon uue Lo Lhls caplLal money and Lhe debL markeL are geLLlng wldened and deepened
uevelopmenL of debL markeL lncreases Lhe efflclency of a caplLal markeL uebL markeL should have boLh
prlmary and secondary markeLs

MLAnlnC Cl SLCu8l1lSA1lCn MLAnlnC Cl SLCu8l1lSA1lCn SecurlLlzaLlon means Lechnlque by whlch
a long Lerm nonnegoLlable and hlgh valued flnanclal asseL llke hlre purchase ls converLed lnLo
securlLles of small values whlch can be Lradable ln Lhe markeL [usL llke shares ueflnlLlon"SecurlLlsaLlon
s noLhlng buL llquefylng asseLs comprlslng loans and recelvables of an lnsLlLuLlon Lhrough sysLemaLlc
lssuance of flnanclal lnsLrumenLs" SecurlLlzaLlon helps Lhem Lo recycle funds aL a reasonable cosL and
wlLh less credlL rlsk As from Lhe rlsk managemenL polnL of vlew Lhe lendlng flnanclal lnsLlLuLlons have
Lo absorb Lhe enLlre credlL rlsk by holdlng Lhe credlL ouLsLandlng ln Lhelr own porLfollo SecurlLlsaLlon
offers a good scope for rlsk dlverslflcaLlon 1he enLlre LransacLlon relaLlng Lo securlLlsaLlon ls carrled ouL
on Lhe asseL slde of balance sheeL

MCuuS CL8Anul MCuuS CL8Anul 1he orlglnaLor A speclal purpose vehlcle (Sv) or a LrusL A
merchanL or lnvesLmenL banker A credlL raLlng agency A servlclng agenLrecelvlng and paylng agenL
(8A) 1he orlglnal borrowers or obllgors 1he prospecLlve lnvesLors le Lhe buyers of securlLles 1he
varlous sLages lnvolved ln Lhe worklng of securlLlsaLlon are ldenLlflcaLlon sLage / process 1ransfer sLage
/ process lssue sLage / process 8edempLlon sLage / process CredlL raLlng sLage / process

ldenLlflcaLlon rocess ldenLlflcaLlon rocess Lendlng flnanclal lnsLlLuLlon a bank or any lnsLlLuLlon for
LhaL maLLer whlch decldes Lo go ln for securlLlsaLlon of lLs asseLs ls called Lhe orlglnaLor CrlglnaLor has
goL varlous asseLs Commerclal morLgages Lease recelvables Plre purchase recelvables CrlglnaLor has Lo
plck up from varlous asseLs whlch lncludes homogeneous naLure conslderlng Lhe maLurlLles lnLeresL
raLes lnvolved and markeLablllLy 1he process of a selecLlng a pool of loans and recelvables from Lhe
asseL porLfollos for securlLlsaLlon ls called 'ldenLlflcaLlon rocess'

18AnSlL8 8CCLSS 18AnSlL8 8CCLSS 1he process of passlng Lhrough Lhe selecLed pool of asseLs by
Lhe orlglnaLor Lo a Sv ls called Lransfer process and once Lhls Lransfer process ls over Lhe asseLs are
removed from Lhe balance sheeL of Lhe orlglnaLor lSSuL 8CCLSS AfLer Lransfer process Lhe Sv
converLs Lhese asseLs ln varlous Lypes of maLurlLy Sv spllLs lndlvldual securlLles of smaller values and
Lhey are sold Lo lnvesLlng publlc Sv geLs relmbursed by sales proceeds Lhe securlLles lssued by Sv
are known as 'ay Lhrough cerLlflcaLes' ass Lhrough CerLlflcaLes ' 'lnLeresL only cerLlflcaLes' 'rlnclpal
only cerLlflcaLe'Lhey are sLrucLured ln such a way LhaL Lhe maLurlLy of Lhese securlLles may synchronlse
wlLh Lhe maLurlLles of Lhe securlLlsed loans

8LuLM1lCn 8CCLSS 8LuLM1lCn 8CCLSS 8edempLlon and paymenLs of lnLeresL on Lhese
securlLles are faclllLaLed by Lhe collecLlon recelved by Lhe Sv from Lhe securlLlsed asseLs CollecLlon of
dues ls generally enLrusLed Lo orlglnaLor or speclal servlclng agenL and pald wlLh cerLaln of
commlsslon 1hey are responslble for collecLlon of lnLeresL and prlnclpal on asseLs pooled C8Lul1
8A1lnC 8CCLSS ass Lhrough cerLlflcaLe has Lo be publlcly lssued Lhey requlre credlL raLlng by good
credlL raLlng agency so LhaL Lhey become more aLLracLlve and easlly accepLable Lhey should be raLed by
one credlL raLlng agency on Lhe eve of Lhe securlLlsaLlon lssue can be guaranLeed by exLernal guaranLor
llke merchanL banker whlch would enhance credlL worLhlness of cerLlflcaLes 1hese are Lradable ln
secondary markeL Lhls are negoLlable securlLles

8CLL Cl ML8CPAn1 8AnkL8S 8CLL Cl ML8CPAn1 8AnkL8S MerchanL or lnvesLmenL bankers play a
blg role ln asseL securlLlsaLlon Lhey acL as speclal purpose vehlcle (Sv) Many lssues are lnvolved llke
1lmlng of lssue of pass Lhrough cerLlflcaLes rlclng of Lhese cerLlflcaLe for markeLlng underwrlLlng of Lhe
lssues ln prlvaLe placemenLs Lhey acL as agenLs for Lhe lssuer connecLlng Lhe sellers and buyers 1hey
lnvolve ln sLrucLurlng Lhe lssue Lo see legal regulaLory AccounLlng Lax and oLher requlremenL MerchanL
bank has a deflnaLe role Lo play MosL of Lhe lssue ls underwrlLLen by popular merchanL banker whlch
adds credlL Lo LhaL lssue and become more aLLracLlve from lnvesLors polnL

8CLL Cl C1PL8 A81lLS 8CLL Cl C1PL8 A81lLS 1PL? A8L 1PL C8lClnAL 8C88CWL8S Anu 1PL
8CSLC1lvL lnvLS1C8S C8lClnAL 8C88CWL8S A8L CALLLu Cbllgors lnfacL Lhe success of Lhe
securlLlslon process depends upon Lhese orlglnal borrowers and lf Lhls process falls Lo meeL lLs
commlLmenL Lhen lLs ln danger Lhe recelpLs of cash flows from orlglnal borrowers and passed Lo Lhe
lnvesLors Lhe prospecLlve buyers are noLhlng buL publlc aL large

S18uC1u8L lC8 SLCu8l1lSA1lCn /1?LS Cl SLCu8l1lLS S18uC1u8L lC8 SLCu8l1lSA1lCn /1?LS Cl
SLCu8l1lLS SecurlLlsaLlon ls a sLrucLured LransacLlon whereby Lhe orlglnaLor Lransfers or sells some of
lLs asseLs Lo a Sv whlch break Lhls asseLs lnLo Lradeable securlLles of smaller values whlch could be sold
Lo Lhe lnvesLlng publlc 1he general prlnclple ls LhaL Lhe securlLles musL be sLrucLured ln such a way LhaL
Lhe maLurlLy of Lhese securlLles may colnclde wlLh Lhe maLurlLy of Lhe securlLlsed loans 1here are Lhree
Lypes of lmporLanL securlLles ass Lhrough and pay Lhrough cerLlflcaLes referred sLock cerLlflcaLes
AsseLs based commerclal papers

Sllde 10 ass Lhrough and pay Lhrough cerLlflcaLes aymenLs Lo lnvesLors depends upon Lhe cash flow
from Lhe asseLs backlng cerLlflcaLes ln oLher words as and when cash (prlnclpal+lnLeresL) ls recelved
from Lhe orlglnal borrower by Sv lL ls passed on Lo holders of cerLlflcaLe aL regular lnLervals ln pay
Lhrough cerLlflcaLes have a mulLlple maLurlLy sLrucLure dependlng upon Lhe maLurlLy paLLern of
underlylng asseLs 1he securlLles lssued are of shorL medlum and long Lerms 1hey are lssued on
lnvesLors demand for varylng maLurlLy paLLerns 1hls Lype ls more aLLracLlve from lnvesLors polnL of vlew
1hls are offered aL a dlscounL referred sLock cerLlflcaLes Subsldlary companles buy Lhe Lrade debLs
and consumer recelvables of parenL companles converL Lhem lnLo shorL Lerm securlLles and help Lhe
parenL companles Lo en[oy llquldlLy Lhls securlLles are backed by guaranLees by merchanL banks Lhls are
normally shorL Lerm ln naLure

AsseLbased commerclal papers1hls Lype of sLrucLure ls mosLly prevalanL ln morLgage backed
securlLles1he Sv purchases porLfollo of morLgages from dlfferenL sources and comblned lnLo a slngle
group on Lhe basls of lnLeresL raLes maLuruLy daLes and underlylng collaLerals1hen lL ls Lranferred Lo a
LrusL whlch ln LrusL lssues cerLlflcaLe Lo Lhe lnvesLors Lhls are shorL Lerm ln naLure cerLlflcaLe holder are
enLlLled Lo parLlclpaLe ln Lhe cash flow from underlylng morLgages Lo Lhe exLenL of lnvesLmenLsCLher
Lypes 1)lnLeresL only cerLlflcaLes2)prlnclpal only cerLlflcaLes AsseLbased commerclal papers1hls Lype
of sLrucLure ls mosLly prevalanL ln morLgage backed securlLles1he Sv purchases porLfollo of morLgages
from dlfferenL sources and comblned lnLo a slngle group on Lhe basls of lnLeresL raLes maLuruLy daLes
and underlylng collaLerals1hen lL ls Lranferred Lo a LrusL whlch ln LrusL lssues cerLlflcaLe Lo Lhe lnvesLors
Lhls are shorL Lerm ln naLure cerLlflcaLe holder are enLlLled Lo parLlclpaLe ln Lhe cash flow from
underlylng morLgages Lo Lhe exLenL of lnvesLmenLsCLher Lypes 1)lnLeresL only cerLlflcaLes2)prlnclpal
only cerLlflcaLes

SLCu8l1lSA8LL ASSL1S SLCu8l1lSA8LL ASSL1S ALL ASSL1S A8L nC1 Sul1A8LL lC8 SLCu8l1lSA1lCn
CnL? ln 8A8L CASLS 1PL? A8L SLCu81lSLu LC referred SLock CerLlflcaLe 1he followlng asseLs are
generally securlLlsed by Lhe flnanclal lnsLlLuLlons Lerm loans Lo flnanclally repuLed companles
8ecelvables from governmenL deparLmenLs and companles CredlL card recelvables hlre purchase loans
llke vehlcle loans Lease flnance MorLgage loans eLc

8LnLll1S Cl SLCu8l1lSA1lCn 8LnLll1S Cl SLCu8l1lSA1lCn AddlLlonal source of funds CreaLer
roflLablllLy LnhancemenL of caplLal Adequacy 8aLlo Spreadlng of credlL rlsk Lower cosL of fundlng
rovlslon of mulLlple lnsLrumenLs Plgher raLe of reLurns revenLlon of ldle caplLal 8eLLer Lhan LradlLlonal
lnsLrumenLs CLher beneflLs

SLCu8l1lSA1lCn Anu 8AnkS SLCu8l1lSA1lCn Anu 8AnkS 1here ls a vasL scope for commerclal banks
Lo go ln for securlLlsaLlon due Lo followlng facLors lnnovaLlve and Low cosL source of funds 8eLLer
CaplLal Adequacy norms CreaLlon of more credlL lncreased roflLablllLy 1ool for asseL llablllLy
managemenL and rlsk managemenL
ChapLer 2 Meanlng and SLrucLure of SecurlLlsaLlon 1ransacLlon
21 Meanlng
Cne of Lhe mosL promlnenL developmenLs ln lnLernaLlonal flnance ln recenL decades and Lhe
one LhaL ls llkely Lo assume even greaLer lmporLance ln fuLure ls securlLlsaLlon SecurlLlsaLlon
ls Lhe process of poollng and repackaglng of homogenous llllquld flnanclal asseLs lnLo
markeLable securlLles LhaL can be sold Lo lnvesLors 1he process leads Lo Lhe creaLlon of
flnanclal lnsLrumenLs LhaL represenL ownershlp lnLeresL ln or are secured by a segregaLed
lncome produclng asseL or pool of asseLs 1he pool of asseLs collaLerallses securlLles 1hese
asseLs are generally secured by personal or real properLy (eg auLomoblles real esLaLe or
equlpmenL loans) buL ln some cases are unsecured (eg credlL card debL consumer loans)
1here are four sLeps ln a securlLlsaLlon (l) Sv ls creaLed Lo hold LlLle Lo asseLs underlylng
securlLles (ll) Lhe orlglnaLor or holder of asseLs sells Lhe asseLs (exlsLlng or fuLure) Lo Lhe Sv
(lll) Lhe Sv wlLh Lhe help of an lnvesLmenL banker lssues securlLles whlch are dlsLrlbuLed Lo
lnvesLors and (lv) Lhe Sv pays Lhe orlglnaLor for Lhe asseLs wlLh Lhe proceeds from Lhe sale
of securlLles 1he LouchsLones of securlLlsaLlon are
Legal Lrue sale of asseLs Lo an Sv wlLh narrowly deflned purposes and acLlvlLles
lssuance of securlLles by Lhe Sv Lo Lhe lnvesLors collaLerallsed by Lhe underlylng
asseLs
8ellance by Lhe lnvesLors on Lhe performance of Lhe asseLs for repaymenL raLher Lhan
Lhe credlL of Lhelr CrlglnaLor (Lhe seller) or Lhe lssuer (Lhe Sv)
ConsequenL Lo Lhe above 8ankrupLcy 8emoLeness" from Lhe CrlglnaLor
AparL from Lhe above Lhe followlng addlLlonal characLerlsLlcs are generally noLlced
admlnlsLraLlon of Lhe asseLs lncludlng conLlnuaLlon of relaLlonshlps wlLh obllgors
supporL for Llmely lnLeresL and prlnclpal repaymenLs ln Lhe form of sulLable credlL
enhancemenLs
anclllary faclllLles Lo cover lnLeresL raLe / forex rlsks guaranLee eLc
formal raLlng from one or more raLlng agencles
A securlLlsaLlon LransacLlon generally lnvolves some or all of Lhe followlng parLles (l) Lhe
lnlLlal owner of Lhe asseL (Lhe orlglnaLor or sponsor) who has a loan agreemenL wlLh Lhe
borrowers (obllgors) (ll) Lhe lssuer of debL lnsLrumenLs who also ls Lhe Sv 1he sLrucLure
keeps Lhe Sv away from bankrupLcy of Lhe orlglnaLor Lechnlcally called 'bankrupLcy
remoLe' (lll) Lhe lnvesLmenL bankers who asslsL ln sLrucLurlng Lhe LransacLlon and who
underwrlLe or place Lhe securlLles for a fee (lv) Lhe raLlng agencles who assess credlL quallLy
of cerLaln Lypes of lnsLrumenLs and asslgn a credlL raLlng (v) Lhe credlL enhancer posslbly a
bank sureLy company or lnsurer who provldes credlL supporL Lhrough a leLLer of credlL
guaranLee or oLher assurance (vl) Lhe servlcer usually Lhe orlglnaLor who collecLs paymenLs
due on Lhe underlylng asseLs and afLer reLalnlng a servlclng fee pays Lhem over Lo Lhe
securlLy holders (vll) Lhe LrusLee who deals wlLh lssuer credlL enhancer and servlcer on
behalf of Lhe securlLy holders (vlll) Lhe legal counsel who parLlclpaLes ln Lhe sLrucLurlng of
Lhe LransacLlon
1
and (lx) Lhe swap counLerparLy who provldes lnLeresL raLe / currency swap lf
needed A Lyplcal securlLlsaLlon sLrucLure ls glven belowllgure 1 1yplcal SecurlLlsaLlon SLrucLure22
arLles Lo a SecurlLlsaLlon 1ransacLlon
1here are prlmarlly Lhree parLles Lo a securlLlsaLlon deal namely
a 1he CrlglnaLor 1hls ls Lhe enLlLy on whose books Lhe asseLs Lo be
securlLlsed exlsL lL ls Lhe prlme mover of Lhe deal le lL seLs up Lhe necessary
sLrucLures Lo execuLe Lhe deal lL sells Lhe asseLs on lLs books and recelves Lhe
funds generaLed from such sale ln a Lrue sale Lhe CrlglnaLor Lransfers boLh Lhe
legal and Lhe beneflclal lnLeresL ln Lhe asseLs Lo Lhe Sv
b 1he Sv 1he lssuer also known as Lhe Sv ls Lhe enLlLy whlch would
Lyplcally buy Lhe asseLs (Lo be securlLlsed) from Lhe CrlglnaLor 1he Sv ls
Lyplcally a lowcaplLallsed enLlLy wlLh narrowly deflned purposes and
acLlvlLles and usually has lndependenL LrusLees/dlrecLors As one of Lhe maln
ob[ecLlves of securlLlsaLlon ls Lo remove Lhe asseLs from Lhe balance sheeL of
Lhe CrlglnaLor Lhe Sv plays a very lmporLanL role lnas much as lL holds Lhe
asseLs ln lLs books and makes Lhe upfronL paymenL for Lhem Lo Lhe CrlglnaLor
c 1he lnvesLors 1he lnvesLors may be ln Lhe form of lndlvlduals or
lnsLlLuLlonal lnvesLors llke lls muLual funds provldenL funds penslon funds
lnsurance companles eLc 1hey buy a parLlclpaLlng lnLeresL ln Lhe LoLal pool of
recelvables and recelve Lhelr paymenL ln Lhe form of lnLeresL and prlnclpal as
per agreed paLLern
8esldes Lhese Lhree prlmary parLles Lhe oLher parLles lnvolved ln a securlLlsaLlon deal are
glven below
a) 1he Cbllgor(s) 1he Cbllgor ls Lhe CrlglnaLors debLor (borrower of Lhe orlglnal loan)
1he amounL ouLsLandlng from Lhe Cbllgor ls Lhe asseL LhaL ls Lransferred Lo Lhe Sv 1he
credlL sLandlng of Lhe Cbllgor(s) ls of paramounL lmporLance ln a securlLlsaLlon
LransacLlon
b) 1he 8aLlng Agency Slnce Lhe lnvesLors Lake on Lhe rlsk of Lhe asseL pool raLher Lhan
Lhe CrlglnaLor an exLernal credlL raLlng plays an lmporLanL role 1he raLlng process would
assess Lhe sLrengLh of Lhe cash flow and Lhe mechanlsm deslgned Lo ensure full and Llmely
paymenL by Lhe process of selecLlon of loans of approprlaLe credlL quallLy Lhe exLenL of
credlL and llquldlLy supporL provlded and Lhe sLrengLh of Lhe legal framework
c) AdmlnlsLraLor or Servlcer lL collecLs Lhe paymenL due from Lhe Cbllgor/s and passes lL
Lo Lhe Sv follows up wlLh dellnquenL borrowers and pursues legal remedles avallable
agalnsL Lhe defaulLlng borrowers Slnce lL recelves Lhe lnsLalmenLs and pays lL Lo Lhe Sv
lL ls also called Lhe 8ecelvlng and aylng AgenL
d) AgenL and 1rusLee lL accepLs Lhe responslblllLy for overseelng LhaL all Lhe parLles Lo
Lhe securlLlsaLlon deal perform ln accordance wlLh Lhe securlLlsaLlon LrusL agreemenL
8aslcally lL ls appolnLed Lo look afLer Lhe lnLeresL of Lhe lnvesLors
e) SLrucLurer normally an lnvesLmenL banker ls responslble as sLrucLurer for brlnglng
LogeLher Lhe CrlglnaLor credlL enhancer/s Lhe lnvesLors and oLher parLners Lo a
securlLlsaLlon deal lL also works wlLh Lhe CrlglnaLor and helps ln sLrucLurlng deals
1he dlfferenL parLles Lo a securlLlsaLlon deal have very dlfferenL roles Lo play ln facL flrms
speclallse ln Lhose areas ln whlch Lhey en[oy compeLlLlve advanLage 1he enLlre process ls
broken up lnLo separaLe parLs wlLh dlfferenL parLles speclallslng ln orlglnaLlon of loans ralslngfunds from
Lhe caplLal markeLs servlclng of loans eLc lL ls Lhls klnd of segmenLaLlon of
markeL roles LhaL lnLroduces several efflclencles securlLlsaLlon ls so ofLen credlLed wlLh
More deLalls of varlous agencles are glven ln ChapLer 8
23 ass and ay 1hrough SLrucLures
1he naLure of Lhe lnvesLors' lnLeresL ln Lhe underlylng asseLs deLermlnes wheLher a
securlLlsaLlon sLrucLure ls a 'ass 1hrough' or 'ay 1hrough' sLrucLure ln a pass Lhrough
sLrucLure Lhe Sv lssues 'ass 1hrough CerLlflcaLes' whlch are ln Lhe naLure of parLlclpaLlon
cerLlflcaLes LhaL enable Lhe lnvesLors Lo Lake a dlrecL exposure on Lhe performance of Lhe
securlLlsed asseLs ay Lhrough on Lhe oLher hand glves lnvesLors only a charge agalnsL Lhe
securlLlsed asseLs whlle Lhe asseLs Lhemselves are owned by Lhe Sv 1he Sv lssues regular
secured debL lnsLrumenLs 1he Lerm 1Cs has been used ln Lhe reporL referrlng Lo pass
Lhrough as well as pay Lhrough cerLlflcaLes
ay Lhrough sLrucLures permlL desynchronlzaLlon of servlclng of Lhe securlLles from Lhe
underlylng cash flows ln Lhe pay Lhrough sLrucLure Lhe Sv ls glven dlscreLlon (albelL Lo a
llmlLed exLenL) Lo relnvesL shorL Lerm surpluses a power LhaL ls noL avallable Lo Lhe Sv ln
Lhe case of Lhe pass Lhrough sLrucLure ln Lhe pass Lhrough sLrucLure lnvesLors are servlced as
and when cash ls acLually generaLed by Lhe underlylng asseLs uelay ln cash flows ls of course
shlelded Lo Lhe exLenL of credlL enhancemenL repaymenLs are however passed on Lo Lhe
lnvesLors who Lhen have Lo Lackle relnvesLmenL rlsk A furLher advanLage of Lhe pay Lhrough
sLrucLure ls LhaL dlfferenL lssues of securlLles can be ranked and hence prlced dlfferenLlally
24 AsseL and MorLgage 8acked SecurlLles
SecurlLles lssued by Lhe Sv ln a securlLlsaLlon LransacLlon are referred Lo as AsseL 8acked
SecurlLles (A8S) because lnvesLors rely on Lhe performance of Lhe asseLs LhaL collaLerallse Lhe
securlLles 1hey do noL Lake an exposure elLher on Lhe prevlous owner of Lhe asseLs (Lhe
CrlglnaLor) or Lhe enLlLy lssulng Lhe securlLles (Lhe Sv) Clearly classlfylng securlLles as
'asseLbacked' seeks Lo dlfferenLlaLe Lhem from regular securlLles whlch are Lhe llablllLles of
Lhe enLlLy lssulng Lhem
ln pracLlce a furLher caLegory ls ldenLlfled securlLles backed by morLgage loans (loans
secured by speclfled real esLaLe properLy whereln Lhe lender has Lhe rlghL Lo sell Lhe properLy
lf Lhe borrower defaulLs) Such securlLles are called MorLgage 8acked SecurlLles (M8S) 1he
mosL common example of M8S ls securlLles backed by morLgage houslng loans All
securlLlsed lnsLrumenLs are elLher M8S or A8S
23 CredlL LnhancemenL
lnvesLors ln securlLlsed lnsLrumenLs Lake a dlrecL exposure on Lhe performance of Lhe
underlylng collaLeral and have llmlLed or no recourse Lo Lhe CrlglnaLor 1hey hence seek
addlLlonal comforL ln Lhe form of credlL enhancemenL a Lerm used Lo descrlbe any of Lhe
varlous meLhods by whlch rlsks lnLrlnslc Lo Lhe LransacLlon are reallocaLed uL slmply lL
refers Lo any of Lhe varlous means LhaL aLLempL Lo buffer lnvesLors agalnsL losses on Lhe asseLs
collaLerallslng Lhelr lnvesLmenL 1hese losses may vary ln frequency severlLy and Llmlng and
depend on Lhe asseL characLerlsLlcs how Lhey are orlglnaLed and how Lhey are admlnlsLered
CredlL enhancemenLs are ofLen essenLlal Lo secure a hlgh level of credlL raLlng and for low cosL
fundlng
8y shlfLlng Lhe credlL rlsk from a lesswellknown borrower Lo a wellknown sLrong and
large credlL enhancer credlL enhancemenL correcLs lmbalance of lnformaLlon beLween lender
and borrower CredlL enhancemenLs are elLher exLernal (Lhlrd parLy) or lnLernal (sLrucLural or
cashflowdrlven) varlous klnds of credlL enhancemenLs are elaboraLed belowl) LxLernal CredlL
LnhancemenLs
lnsurance lull lnsurance ls provlded agalnsL losses on Lhe asseLs 1hls LanLamounLs Lo a 100
per cenL guaranLee of a LransacLlon's prlnclpal and lnLeresL paymenLs 1he lssuer of Lhe
lnsurance looks Lo an lnlLlal premlum or oLher supporL Lo cover credlL losses
1hlrd parLy guaranLee 1hls meLhod lnvolves a llmlLed/full guaranLee by a Lhlrd parLy Lo
cover losses LhaL may arlse on nonperformance of Lhe collaLeral
LeLLer of credlL lor sLrucLures wlLh credlL raLlngs below Lhe level soughL for Lhe lssue a Lhlrd
parLy provldes a leLLer of credlL for a nomlnal amounL 1hls may provlde elLher full or parLlal
cover of Lhe lssuer's obllgaLlon
ll) lnLernal CredlL LnhancemenLs
CredlL 1ranchlng (senlor/subordlnaLe sLrucLure) 1he Sv lssues Lwo (or more) Lranches of
securlLles and esLabllshes a predeLermlned prlorlLy ln Lhelr servlclng whereby flrsL losses are
borne by Lhe holders of Lhe subordlnaLe Lranches (aL Llmes Lhe CrlglnaLor lLself) AparL from
provldlng comforL Lo holders of senlor debL credlL Lranchlng also permlLs LargeLlng lnvesLors
wlLh speclflc rlskreLurn preferences
CvercollaLerallsaLlon 1he CrlglnaLor seLs aslde asseLs ln excess of Lhe collaLeral requlred Lo
be asslgned Lo Lhe Sv Cash flows from Lhese asseLs musL flrsL meeL any overdue paymenLs
ln Lhe maln pool before Lhey can be rouLed back Lo Lhe CrlglnaLor
Cash collaLeral 1hls works ln much Lhe same way as Lhe overcollaLerallsaLlon 8uL slnce Lhe
quallLy of cash ls selfevldenLly hlgher and more sLable Lhan Lhe quallLy of asseLs yeL Lo be
Lurned lnLo cash Lhe quanLum of cash requlred Lo meeL Lhe deslred raLlng would be lower Lhan
asseL overcollaLeral Lo LhaL exLenL
Spread accounL 1he dlfference beLween Lhe yleld on Lhe asseLs and yleld Lo Lhe lnvesLors
from Lhe securlLles ls called excess spread ln lLs slmplesL form a spread accounL Lraps Lhe
excess spread (neL of all runnlng cosLs of securlLlsaLlon) wlLhln Lhe Sv up Lo a speclfled
amounL sufflclenL Lo saLlsfy a glven raLlng or credlL quallLy requlremenL Cnly reallsaLlons ln
excess of Lhls speclfled amounL are rouLed back Lo Lhe CrlglnaLor 1hls amounL ls reLurned Lo
Lhe CrlglnaLor afLer Lhe paymenL of prlnclpal and lnLeresL Lo Lhe lnvesLors
1rlggered amorLlsaLlon 1hls works only ln sLrucLures LhaL permlL subsLlLuLlon (for example
rapldly revolvlng asseLs such as credlL cards) When cerLaln preseL levels of collaLeral
performance are breached all furLher collecLlons are applled Lo repay Lhe fundlng Cnce
amorLlsaLlon ls Lrlggered subsLlLuLlon ls sLopped and Lhe early repaymenL ls an lrreverslble
process 1rlggered amorLlsaLlon ls Lyplcally applled ln fuLure flow securlLlsaLlon
26 luLure llow SecurlLlsaLlon
261 lnLroducLlon
A fuLure recelvable securlLlsaLlon as Lhe Lerm lmplles ralses funds based on expecLed fuLure
cash flows LhaL have noL aL Lhe close of Lhe LransacLlon been generaLed
2
1hese Lypes of
LransacLlons can be spllL lnLo Lwo dlsLlncL areas long Lerm conLracL recelvables and fuLure
cash flows Lxamples of long Lerm conLracL recelvables would be Lerm offLake agreemenLs
for Lhe supply of goods or servlces such as Lhe exporL of commodlLles (eg oll coffee or sLeel)
or paymenL for clearlng servlces ln Lhls caLegory Lhe volume of Lhe recelvables wlll be
known or aL leasL be seL aL a mlnlmum Powever Lhe prlce of Lhe recelvables may be
varlable 1o Lhe exLenL LhaL Lhe recelvables are generaLed from Lhe sale of commodlLy
/producL Lhere may be an opporLunlLy Lo provlde some Lype of prlce floor Lhrough Lhe use of
hedglng lnsLrumenLs 1he fuLure cash flow caLegory would lnclude recelvables LhaL are noL
only sub[ecL Lo prlce varlaLlons buL also Lo varlaLlons ln volume (le Lhere ls no mlnlmum
conLracLed volume) 1hese would lnclude Lelecom recelvables LlckeL recelvables and worker
remlLLance paymenLs All Lhese caLegorles wlll have no mlnlmum volumes over Lhe llfe of Lhe
lssue buL wlll depend on boLh Lhe performance of Lhe seller and macroeconomlc evenLs lnLhese cases
Lhe raLlng agencles wlll assume a base case for Lhe volume of recelvables over Lhe
llfe of Lhe LransacLlon 1hls wlll Lhen be sub[ecLed Lo sLresslng elLher by applylng an overcollaLerlsaLlon
mulLlple or by reduclng Lhe base case cash flows progresslvely over a number
of years 1hls cash flow ls Lhen asslgned as collaLeral for Lhe repaymenL of debL lnsLrumenLs
sold ln Lhe caplLal markeLs 1he naLure of LhaL cash flow Laken LogeLher wlLh a sLrlng of oLher
sLrucLural credlL enhancemenLs generally ensures LhaL Lhe LransacLlon ls raLed above Lhe
unsecured debL raLlngs of Lhe borrower As a resulL under a securlLlsaLlon LransacLlon Lhe
borrower ls able Lo achleve flner prlclng and/or longer Lenors Lhan ls oLherwlse avallable from
oLher fundlng sources
262 AsseL Classes SecurlLlsed
A8Ss have been consLrucLed based on fuLure lncome sLreams LhaL arlse from Lhe use of
physlcal asseLs (eg LelecommunlcaLlon neLwork Loll charges on roadways) lncome arlslng
due Lo regulaLlons (eg revenue Laxes of munlclpal auLhorlLles) lncome from sale of naLural
resources (eg oll and naLural gas) eLc PlsLorlcally flve Lypes of asseL classes have
generaLed Lhe bulk of fuLure flow securlLlsaLlon 1hese are
l) LxporLs of commodlLles or commodlLyllke producLs
ll) CredlL card recelvables (generaLed from Lhe use of vlsa and MasLerCard credlL
cards by LourlsLs ln Lhe hosL counLry)
lll) 1elephone Loll recelvables arlslng from lnLernaLlonal Lrafflc servlce
lv) Workers remlLLances and
v) ro[ecL flnance based LransacLlons
WlLh respecL Lo exporL securlLlsaLlon LransacLlons have been concluded for Cll Cas Copper
Alumlnum SLeel ulp Lnergy Cold Sllver ulamonds Crange [ulce Soybean WheaL
even llsh eLc Less lmporLanL classes lnclude alrllne LlckeL sales alrporL landlng fees and Lhe
exporL of semlflnlshed goods
263 MoLlves for luLure llow SecurlLlsaLlon
(a) CosL of lunds 1he mosL convlnclng argumenL Lo borrowers as Lo why Lo engage ln fuLure
flow securlLlsaLlon remalns cosL of funds MosL fuLure flow securlLlsaLlon achleves
slgnlflcanLly hlgher raLlngs Lhan unsecured vanllla corporaLe debL 1hls raLlng lmprovemenL
usually resulLs ln lower spreads Lo Lhe borrower 1he exacL beneflL however can be
someLlmes dlfflculL Lo demonsLraLe 1hls ls because ln many cases Lhe borrower does noL or
cannoL lssue long daLed corporaLe bonds
(b) ulverslflcaLlon of lundlng Sources !usL as lmporLanL as reduclng cosL of funds ls
dlverslfylng access Lo fundlng sources Many borrowers ln Lhe emerglng markeLs (LMs) rely
heavlly on elLher bank flnanclng or unsecured bonds ?eL ln Llmes of flnanclal crlses Lhese
fundlng sources can qulckly dry up 1he percelved hlgher quallLy of Lhe securlLlsed
LransacLlons ensures LhaL lnvesLor demand wlll conLlnue for Lhe paper even ln Llme of greaL
sLress A good example of Lhls ls Lhe Mexlcan eso crlsls of 1994 noLwlLhsLandlng Lhe
llquldlLy crlsls ln Mexlco and Lhe Lremendous sLress LhaL Lhe flnanclal secLor underwenL
Mexlcan banks were able Lo access sevenyear money based on securlLlsaLlon of Lhelr vlsa
and MasLer Card recelpLs
(c) Longer 1enure SecurlLlsaLlon can serve Lo exLend Lhe Lenure of flnanclng avallable Lo
borrowers uependlng on Lhe asseL class Lenures of up Lo 30 years can be achleved Longer
daLed LransacLlons are generally avallable for securlLlsaLlon supporLed by oll gas or mlnerals
(d) LlmlLed 8ecourse Many securlLlsaLlons are sLrucLured as a sale Lo lnvesLors of fuLure
recelvables 1he recourse Lo Lhe borrower ln Lhe evenL LhaL such recelvables are noL generaLed
or collecLed or Lhe producL ls noL dellvered can be llmlLed 8oLh lnvesLors and raLlng
agencles assess Lhe sLrengLh of Lhe LransacLlon Laklng lnLo accounL such rlsks Clven LhaL lnmany
lnsLances Lhe fuLure asseLs or cash flow belng securlLlsed ls Lhe hlghesL quallLy of asseLs
LhaL a borrower may have general recourse ls noL consldered Lo enhance Lhe LransacLlon from
a credlL perspecLlve lnsLances where recourse wlll however be requlred lnclude nonperformance by
Lhe borrowers of Lhelr obllgaLlons (or covenanLs) under Lhe LransacLlon a loss
of Lhe rlghLs of Lhe lnvesLors ln Lhe asseL and bankrupLcy proceedlngs
264 8lsks
(a) 8ankrupLcy / erformance 8lsk Slnce fuLure flow LransacLlons rely on Lhe fuLure
generaLlon of cash flow Lo repay lnvesLors Lhe conLlnued exlsLence and performance of Lhe
borrower LhroughouL Lhe Lenure of Lhe LransacLlon are crlLlcal conslderaLlons Lo lnvesLors
lndeed Lhls rlsk generally acLs as Lhe llmlLlng consLralnL on Lhe raLlng of Lhe LransacLlon and
consequenLly deLermlnes Lhe Lenure as well as Lhe prlclng
1he ulLlmaLe raLlng may be enhanced by aL mosL one noLch above Lhe local currency raLlng of
Lhe borrower ln case Lhe securlLlsaLlon consLlLuLes a Lrue sale LransacLlon under Lhe bankrupLcy
laws of Lhe borrower ln oLher words should Lhe borrower become lnsolvenL no credlLors of
Lhe borrower would be able Lo make a clalm agalnsL Lhe recelvables sold Lo lnvesLors So long
as Lhe borrower conLlnues Lo operaLe (even ln bankrupLcy) lnvesLors wlll recelve paymenLs on
Lhe recelvables on Llme and unhlndered ln Lerms of mlLlgaLlng Lhls rlsk Lhere ls very llLLle
LhaL can be done sLrucLurally wlLhouL obLalnlng Lhe supporL or guaranLee of a raLed Lhlrd parLy
(b) CeneraLlon 8lsk 1here sLlll ls anoLher rlsk relaLed Lo Lhe susLalned generaLlon of Lhe
recelvables aL cerLaln levels from a hosL of facLors ouLslde of Lhe conLrol of Lhe borrower eg
anLlclpaLed reserves may noL maLerlallse or seasonal varlaLlons ln Lhe anLlclpaLed levels of
recelvables may occur 1hls rlsk ls mlLlgaLed Lhrough adequaLe overcollaLerallsaLlon
lurLher ln order Lo proLecL lnvesLors agalnsL more susLalned longLerm decllnes ln Lhe levels
of recelvables generaLed early amorLlsaLlon Lrlggers are usually bullL lnLo Lhe LransacLlon LhaL
wlll Lrlgger Lhe repaymenL of Lhe securlLles on an acceleraLed basls lf a predeflned Lrlgger
level ls breached
(c) rlce 8lsk and CffLake 8lsk 1hese refer Lo llkely prlce varlaLlons or Lhe concern LhaL Lhe
Cbllgors ln Lhe fuLure cease buylng or reduce Lhelr purchaslng level of Lhe goods or servlce
from Lhe seller
263 CLher ConslderaLlons
(a) 1rue Sale 1here are some quesLlons relaLed Lo wheLher sale of recelvables yeL Lo be
generaLed ls legal valld and blndlng and cannoL be dlsrupLed by a llquldaLor of Lhe seller ln
bankrupLcy ln many [urlsdlcLlons lncludlng Lhe uS such sales are noL enforceable
Powever many oLher [urlsdlcLlons such as Mexlco 8razll or 1urkey do allow for such a
Lrue sale of fuLure recelvables ln lndla Loo aL presenL lL ls dlfflculL Lo perfecL Lhe securlLy
lnLeresL ln respecL of fuLure recelvables for Lhe beneflL of Lhe lnvesLors and ulLlmaLely
LransacLlons may have Lo be sLrucLured wlLh some recourse Lo Lhe CrlglnaLor ln evenLs of
defaulL
(b) negaLlve ledges lnvesLors cannoL have a general recourse Lo Lhe seller for all evenLs
leadlng Lo a shorLage ln cashflow from Lhe recelvables 1hey may only have recourse ln
slLuaLlons LhaL were under Lhe conLrol of Lhe seller (such as falllng Lo produce Lhe goods or
servlces ln sufflclenL volumes) LvenLs deemed ouLslde Lhe conLrol of Lhe seller are prlce rlsk
llquldlLy rlsk and credlL rlsk 1hese rlsks can be mlLlgaLed somewhaL by Lhe Lechnlques
dlscussed above buL ulLlmaLely Lhey musL lle wlLh Lhe lnvesLors ln all securlLlsaLlon
LransacLlons wheLher of exlsLlng recelvables or of fuLure flows
(c) AccounLlng 1reaLmenL 1hough a fuLure flow securlLlsaLlon may noL always be LreaLed as
debL for regulaLory negaLlve pledge or Lax purposes lL almosL always has Lo appear as allablllLy on Lhe
balance sheeL of Lhe seller 1hls ls because Lhe seller ls selllng fuLure asseLs
LhaL were noL on Lhe balance sheeL on Lhe closlng daLe of Lhe LransacLlon 1he seller wlll
recelve Lhe prlnclpal amounL of Lhe LransacLlon as cash and a correspondlng enLry has Lo be
made on Lhe llablllLy slde of Lhe balance sheeL LhaL reflecLs Lhe sellers obllgaLlons Lo dellver
fuLure goods or servlces Lo Lhe Sv
266 lndlan conLexL
Accordlng Lo one vlew fuLure flow recelvables of exporL / peLroleum / oll exploraLlon eLc are
noL consldered sulLable for securlLlsaLlon aL presenL ln lndla for Lhe followlng reasons
lL ls a relaLlvely recenL phenomenon even ln Lhe lnLernaLlonal markeL and ls fraughL
wlLh rlsks whlch revolve around Lhe deflnlLlon ascerLalnablllLy and quanLlflablllLy of
securlLlsable cash flows Such rlsks may noL be well undersLood by lnvesLors lls need Lo
develop Lhe requlred compeLence ln analysls of such rlsks before geLLlng Lhemselves
exposed
8epaymenL Lo lnvesLors ouL of fuLure sales could erode Lhe currenL asseLs hypoLhecaLed
Lo worklng caplLal bankers or Lhe capaclLy of Lhe CrlglnaLors Lo servlce Lerm loans / meeL
oLher presslng obllgaLlons
1herefore exLreme cauLlon ls called for when Lhe flnanclal lnsLlLuLlons book asseLs based on
fuLure cash flow or Lhey guaranLee Lhe repaymenL of Lhe underlylng obllgaLlons Powever
Lhere ls huge poLenLlal for securlLlslng fuLure recelvables ln lnfrasLrucLure secLor ln lndla as
deLalled ln ChapLer 4

1
Shenker !oseph C and ColleLLa AnLhony ! 'AsseL SecurlLlsaLlon LvoluLlon CurrenL lssues and new
lronLlers'ln 1exas Law 8evlew 691369 (1991) p1374
2
lnLernaLlonal SecurlLlsaLlon A8n Amro May 1998