The International Growth Centre at the London School of Economics (LSE) is an institution that offers independent advice on economic growth to governments of developing countries. Bringing top policy-makers and researchers together, it endeavors to support policymaking with thorough research evidence as the foundation.

As a part of its growth initiative the IGC recently convened “Growth Week” between 19th to 21st September at LSE, a 3-day conference which brought together a diverse set of policy-makers and researchers from Africa & South Asia. Viral Acharya organized the session on Finance, Colin Mayer chaired the part on Macrofinance and Greg Fischer chaired the part on Mobile Banking. The focus of the session was on identifying areas of academic research on policy issues that practitioners and policymakers are seeking to address in relation to finance in developing countries and emerging markets.

Kshama Fernandes represented IFMR Trust and participated on the panel on “Ideas for growth: Macro Finance” along with Dr. Subir Gokarn, Deputy Governor, Reserve Bank of India & Ms. Shyamala Gopinath, former Deputy Governor, Reserve Bank of India.

Talking about the past, present and future role of commercial banks in India, Dr. Gokarn spoke of the efficiencies and inefficiencies of the system and the challenges they pose in the present context. While suggesting that there was a need to build on the existing penetration of banks, banks would continue to remain the principal channel of intermediation as far as lending is concerned.  However other financial intermediaries could have a significant role to play in the financial inclusion space by developing business models that were designed to address the specific needs of their customers.

In her presentation, Ms. Gopinath pointed out that while financial innovation definitely does have an impact on growth, it needs a precise framework to function in the desired manner. The basic framework required was:

• Reasonable sophistication of participants (Financial literacy)
• Sound legal framework for dispute resolution
• Robust market infrastructure
• Reasonably liquid and deep cash market
• Financial Stability

Kshama Fernandes presented the Financial Systems Design framework based on a bottom-up approach with high quality origination, orderly risk transmission and robust risk aggregation as the three pillars of a well-functioning financial system.

The presentation below describes the key issues, the enabling infrastructure and some research questions that were discussed during the session.

The panel was attended by a large number of academics, researchers and some practitioners and generated a lot of discussion and interest on potential areas for future research. The broad areas that came up for research included: Finance and Growth (investment, bank lending, venture capital); Financial Systems and Stability (asset markets, securitization, financial regulation); and Financial Inclusion and Access by the Poor to Financial Services (savings, borrowing, payments).

As a follow-up to the Growth Week and an effort to advance these research areas, there will be a meeting of all academics associated with the Finance Programme of IGC on Tuesday November 15 at the LSE in London.

By Vineet Sukumar, IFMR Capital

The Reserve Bank of India yesterday released a fresh set of draft guidelines governing securitisation and assignment transactions. While the draft was released by the Department of Banking Operations and addressed to banks, it is expected that a similar draft will be issued for NBFCs as well.

The draft guidelines are comprehensive and cover various aspects of a securitisation including minimum holding period (MHP), minimum retention or risk (MRR), accounting treatment, true sale, credit enhancement requirements and due diligence by the purchaser. Further, the RBI seeks to cover assignment transactions under the ambit of its regulations.

Securitisation and assignment transactions have emerged as preferred financing routes for NBFCs in the last few years. On the whole, banks have been net buyers, acquiring largely priority sector portfolios from NBFCs. Given the stringent first loss requirements imposed by the RBI in the 2006 guidelines (marked off against Tier I and Tier II Capital, fixed till maturity of the transaction), banks issuers have been rare.

At the same time, securitisation has emerged as a viable route for non-traditional originators to access the capital markets. Microfinance institutions (MFIs) have raised substantial funds through this route, with the first rated assignment in 2004 and the first rated securitisation in 2009. In October 2010, the microfinance sector faced headwinds after the Andhra Pradesh government issued an ordinance curtailing microfinance activities. Post the ordinance, securitisation has emerged as the largest source of financing for MFIs, with an estimated INR 15 billion raised via this route¹.

We will attempt to highlight the key changes / inclusions in the draft guidelines and potential implications on issuances

• Minimum Holding Period (MHP)

MHP for loans is distinguished on two parameters:  a) frequency of repayment schedule (quarterly or more frequent) and b) tenor of loan (less or greater than 24 months). While the logic behind including the former is understandable and a good move, it is unclear why the RBI has split the market on a 24 month tenor basis. It would be significantly better from a regulatory perspective  to assess MHP requirements based on the average life of the underlying loans. This would prevent the possibility of having a 6 month MHP on a loan with weekly repayments and tenor of 12 months.

Imposing a high MHP will, in effect, prevent securitisation of lower tenor loans completely. Potentially, this could disincentivise originators from providing lower tenor loans due to lack of financing, thus increasing balance sheet risk.

• Minimum Retention of Risk (MRR)

The guidelines also advise a MRR of 5%. This is a welcome inclusion and in line with global practices. The concept of a dynamic cash collateral and reduction of the MRR through the transaction tenor is a good step that should bring bank originators back into the market. Further, this will force rating agencies to model and monitor asset behavior more closely.  It would be better, in our view, if the RBI allowed market forces to determine the frequency / amount of release of credit enhancement, rather than stipulate time / amount of release – given the variation in performance of different asset classes.

The draft guidelines also permit originators to invest into the equity tranche of a securitisation, unlike the existing regulation that allows originators to invest only into senior securities issued by an SPV.

• Accounting of Profits

The guidelines allow originators to recognise the cash profit on a limited basis on premium structure deals. Such profits is to be termed as “Cash Profit on Loan Transfer Transactions Pending Recognition” and maintained on a transaction basis. This divergence from regular accounting standards will encourage corporates to move away from amortisation to straight line basis. In a financial year, any loss on account of Mark to Market and write off will be adjusted in this account and net effect will be transferred to profit and loss account

• Assignments

The  RBI has finally stepped in to fill the regulatory vaccum that existed with respect to bilateral assignment of assets. Bilateral assignment is now governed by guidelines similar to that of securitisation. One major difference however, is that “external” credit enhancement by the originator is banned under the assignment route. The offered justification is that subscribers to this route are sophisticated, institutional investors who should be able to assess the risk involved and take a decision on the exposure. Disallowing credit enhancement will only increase investor discomfort in this route and prevent such transactions from taking place. The sophisticated market forces that exist under the assignment route should be able to determine the need for cash collateral.

• Purchaser due diligence

The guidelines place a greater onus on the buyer with respect to due diligence. Purchasers must carry out verification on at least 5% of the obligors. Such verification cannot be delegated to a specialized firm. The guidelines also require rigorous credit monitoring and identification of non-performing borrowers 90 days after the loans are due. Banks are required to collect information regarding default rates, prepayment rates, loans in foreclosure, collateral type and occupancy, and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification.

It is essential that buyers are aware of the assets that they are investing in and the above requirements will ensure that quality of due diligence improves.

Last year, securitisation volumes fell by 29%. This was largely believed to be a fall-out of the draft guidelines released in April 2010.  The revised draft guidelines are significantly more comprehensive and include features that could completely transform the market. However, the draft guidelines are also too prescriptve. This could stifle a sector that has just begun to find its feet in the Indian market. A nuanced regulatory policy that recognizes the varied and dynamic nature of the market and encourages financial innovation is necessary.

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1 – IFMR Capital estimates

After executing its largest Multi-Originator transaction involving 7 microfinance institutions, IFMR Capital recently closed one of its largest Single Originator transactions this financial year, with one of the leading MFIs in the country, Ujjivan Financial Services.

It recently structured and arranged a Rs. 401 million securitisation transaction backed by 45,954 microloans originated by Ujjivan Financial Services. This is the sixth capital market transaction for Ujjivan and second securitisation transaction. Ujjivan has raised debt capital through issuance of listed, secured, redeemable, non-convertible debentures in the last and current financial year.

KRIOS PIONEER IFMR CAPITAL 2011, the Special Purpose Vehicle created for the transaction, has issued two tranches of securities rated by CRISIL, India’s foremost rating agency:  an 89.5% senior tranche rated CRISIL A1(So) that was subscribed to by a NBFC and a 10.5% subordinated junior tranche that was invested into by IFMR Capital. Both tranches have an expected maturity of 9 months.

The structure created by IFMR Capital ensures that the incentives of the originator, servicer and structure are aligned. While the originator and servicer, Ujjivan, provides cash collateral as first loss. The structurer, IFMR Capital, has invested in the subordinated junior tranche. The cash collateral and the subordination of payments to junior tranche in the waterfall mechanism ensures that the senior investor is protected against losses and any first loss is borne by the originator and the second loss by the structurer.

IFMR Capital recently structured and arranged two Microloan Securitisation transactions – Aether IFMR Capital 2011 involving a single originator Grameen Financial Services Private Limited (Grameen Koota) and MOSEC 7, a multi-originator securitisation transaction involving seven Non-Banking Finance Companies.

Mosec 7

On September 7 2011, IFMR Capital concluded a Rs. 511 million multi-originator microloan securitisation backed by 49,881 microloans originated by seven Non-Banking Finance Company (NBFC)-Micro Finance Institutions (MFI), namely Asirvad Microfinance Private Limited, Disha Microfin Pvt. Ltd, Mimoza Enterprises Finance Pvt. Ltd., Satin Creditcare Network Limited , Suryoday Micro Finance Pvt. Limited, SV Creditline Private Limited and Utkarsh Micro Finance Private Limited. IFMR Capital Mosec VII, the SPV, issued two tranches of securities rated by ICRA: 85% senior tranche rated A1-LBBB+ (SO) and Series A2-Unrated.

The senior tranche has been subscribed by a Bank and HNI’s and Junior Tranche by IFMR Capital.

This is the biggest Multi Originator transaction arranged and structured by IFMR Capital involving 7 high quality Originators.

The structure created by IFMR Capital ensures that the incentives of the originator, servicer and the structurer are aligned. While the originators and servicers, provides cash collateral as first loss, the structurer, IFMR Capital, has invested in the subordinated junior tranche. The cash collateral and the subordination of payments to junior tranche in the waterfall mechanism ensure that the senior investor is protected against losses and any first loss is borne by the originators and the second loss by the structurer.

Aether IFMR Capital 2011

The Rs. 239 million single-originator securitisation transaction was completed with Grameen Financial Services Private Ltd also popularly known as Grameen Koota. Aether IFMR Capital 2011, the SPV, issued two tranches of securities backed by 23,108 microloans that were originated by Grameen Koota. Non-Banking Financial Institutions subscribed to the senior ICRA A- rated tranche and IFMR Capital invested in the subordinated ICRA BB+ rated piece.

This is the eighth capital market transaction for Grameen Koota with IFMR Capital.

The originator and servicer, Grameen Koota, provides cash collateral of 10% of the pool principal, while the structurer, IFMR Capital, has invested in the subordinated junior tranche. As in the above transaction, the waterfall mechanism ensures that here, the senior investor is protected against losses up to Rs. 240 million and any first loss is borne by the originator and the second loss by the structurer.

Udaipur-based Sahayata Microfinance has raised INR 195 Mn through the issuance of listed, secured, redeemable, non-convertible debentures (NCDs), which have now been purchased by DWM (Cyprus) Ltd., a member of the Developing World Markets group of companies. IFMR Capital is the sole financial advisor to the issue. The NCDs are listed on the Bombay Stock Exchange and have been fully subscribed.

This transaction is significant not only because it is the first time that Sahayata has raised funds through listed bonds, but also because this transaction allows the company access to newer funding sources, which will be a robust support system for the low-income households that Sahayata serves across India. With this transaction, Sahayata has demonstrated its ability to attract diversified sources of financing. This transaction also reaffirms the commitment of DWM and IFMR Capital to the microfinance sector.

Commenting on the milestone deal, Ajay Verma, Managing Director & CEO, Sahayata, said “This is Sahayata’s first listed transaction and will boost confidence amongst investors and funders. The NCD transaction has opened up new avenues for funding to the company. Thanks to the DWM and IFMR Capital team for making this possible”.

Congratulating Sahayata and IFMR Capital, Jim Kaddaras, Partner for Debt, Structuring and Legal Affairs at DWM, said, “We are delighted to have brought financing to Sahayata, in order to support thousands of low-income entrepreneurs across India. At a time of uncertainty in the Indian microfinance sector, DWM is committed to financing socially committed MFIs with strong management teams like Sahayata. We hope to provide further financing to the sector in FY2012.”

Vineet Sukumar, Head Origination and Treasury at IFMR Capital said, “This transaction is yet another milestone in IFMR Capital’s efforts to provide high quality originators access to debt capital markets. We are delighted that Sahayata Microfinance, a long standing partner and a participant in all multi-originator securitisations structured by IFMR Capital, has availed of funding from rated, listed instruments that enhance transparency for the company and the sector, and pave the way for alternative and sustainable funding sources”.