Recycling Asset

ICICI Credit Corporation (I-Credit), which recently started with a disposable fund of Rs 250 crore, has parked as much as 90 per cent of its funds in asset-backed securities.

I-Credit is one of a growing number of lending institutions that is putting aside funds for securitisation. By the beginning of 1998, the number of outstanding asset-backed issues with Credit Rating and Information Services of India Limited (Crisil) stood at Rs 317.83 crore as against a negelible amount a year before.

Fuelling this trend is the presence of cash-rich and expanding non-banking finance companies (NBFCs) and financial institutions, which are cherry picking asset pools from other NBFCs. Players like SBI, Bank of Baroda, SBI Mutual, UTI, ABN Amro, GE Capital, Countrywide Finance and L&T Finance are already in the fray.

 

Two factors are encouraging them. First, investors are getting the opportunity to buy good quality assets at substantial discounts. Second, the spectre of a large-scale shakeout looms over the NBFC industry in the wake of changes in gearing norms.

According to a December 1997 notification of RBI, the permissible upper limit for overall gearing for NBFCs has been downsized from ten times net-owned funds (NOF) to seven times. What has set off the panic buttons is the sub-clause relating to deposit gearing.

Thus, a single A rated company can now finance its assets through fixed deposits only up to an upper limit of 1.5 times NOF. For AA and AAA rated companies the permissible limits are 2.5 and 4 times respectively.

In the past most NBFCs developed a typical skew on their liabilities side because of an over-reliance on fixed deposits. This led to over-gearing as most of the companies were backed by modest paid-up capital, avers R Shankar Raman, senior vice president, L&T Finance.

Though NBFCs have been given three years to comply with the new guidelines, they are well aware that they have few options. Under normal conditions a growing company should expand its equity. But given the state of the primary market this option hardly exists.

Therefore, the only alternative for them is to cut the flab on the liabilities side. Backed by a simultaneous reduction of assets, this means contraction of their business, interest spreads and balance sheet size. Since most performing NBFCs are well below the seven times gearing level, their problem would be limited to fixed deposits redemptions. Over-geared companies would require early pay-offs of secured liabilities as well.

In principle, there could be three ways of offloading assets. First, a company could go in for outright sale of the financed assets in which case the receivables are transferred to the buyer. This normally happens in the case of heterogeneous assets or corporate assets that have a high chance of delinquency and buyers of such assets will quote very low prices.

Smaller NBFCs with modest equity and having limited exposure in retail asset will be forced to close shop after booking losses on such sales, opines a top ranking official at Apple Finance. An estimated 2,000 companies with an asset worth Rs 10,000 crore are expected to face closure in the next three years.

The second option for the better performing NBFCs could be to go in for joint ventures with cash-rich finance companies. Apple Finance, Anagram Finance and a few others are scouting for foreign partners to hive off a part of their asset portfolio to form a separate company.

For both divestment and liquidation of equity capital the increase in the asset value of the new company will depend on the extent of the partnership and the premium over the book value at which new partner is coming in.

The basic advantage here is that while the balance sheet of the original company is reduced, the consolidated asset value of the group still expands

Apple Finance, for instance, could get rid of 45 per cent of its total assets of around Rs 1200 crore when its car finance assets are hived off..

But only the strongest NBFCs can opt for this route. That is why securitisation of assets emerges as a strong option. For this, the seller issues pass-through certificates (PTCs) against a pool of homogenous assets (receivables) that have the best recovery levels.

While future payments to PTC investors are safeguarded by the cash collateral account (the cash collateral varies between 10-15 per cent of the asset value) held by the trustee (normally a bank), the scheduled payment to investors are met from the recovery account (also held by the trustee).

The originator of the PTC, however, holds the responsibility of recoveries. Since these deals have a recourse clause, the discount on future income inflows are lower than an outright sale. Hence, with many top rated companies facing the prospect of tightening liquidity, this option is likely to whip up a lot of interest.

Securitisation, however, doesnt come without its minus points. Sanat Kumar, vice president treasury of Lloyds Finance admits that the company has securitised a part of its car finance assets, to L&T Finance and Countrywide. says that the spreads the market demands are too severe at present. Depending on the asset grade NBFCs would face a spread of five to six per cent today. This response to securitisation reflects opportunism on the part of the lenders who want to take advantage of the poor financial state of NBFCs, says Kumar.

But there are operational problems as well. In absence of a benchmark discounting rate, asset securitisation deals are mostly closed in favour of the investor.

Since the cash inflows involved in these assets are spread over a period of time the discounting of the asset is measured as the difference between the internal rate of return (IRR) of the assets in the hands of the originator and the (IRR) at which the asset is sold to the investors.

For an asset pool of lower quality this difference would be large. According to sources at Apple Finance, which has done both outright sale and securitisation of assets, an auto loan would be sold at an IRR of 15-16 per cent compared to the IRR of 19-20 per cent of the underlying asset. Kumar of Lloyds also expects a discounted IRR in the range of 15-18 per cent in the current.

Remarks Subodh Shah, executive director Crisil, "Institutions are getting aggressive when they buy such papers because they are getting excellent returns of 16-17 per cent over the cost of the assets."

On the flip side, while the investing companies will see improving asset quality, the originator will be left will low grade assets because they would have knocked off the best of their assets from the balance sheet. Hence, the originator would be faced with the threat of a rating downgrade.

The implication is best summed up by Raman: "Diversification of the asset portfolio has to go hand in hand with diversification on the liabilities side. Recycling financial assets, he says, will have a levelling effect with good NBFCs with a low gearing gaining in size. Once this happens, only those companies that have the ability to tap diversified funding sources and expand their equity base will pull ahead.