A Long-Felt Need

The National Housing seminar, held recently in New Delhi, identified a funds requirement of Rs 1,51,000 crore in the Ninth Plan period. Similar estimations for the infrastructure sector are in the region of Rs 2,20,000 crore. Both sectors need funds for very long tenures at very low costs, widely disproportionate to the size and depth of the capital markets of our country.

The first impulse would be to set up institutions which fulfil this need. But there are limitations to this. For one, local institutions cannot mobilise funds in such large quantities. Also, it is possible that such investments may not be viable in the absence of either a secondary market or hedge instruments to protect the long term rates.

 

Looking at the housing sector, the Ninth Plan demands a contribution to the tune of Rs 52,000 crore from the formal sector. The Eighth Plan had projected a mobilisation of Rs 25,000 crore from the organised sector. However,the first three years saw a mobilisation of only Rs 12,551 crore and a shortfall at the end of Rs 5,300 crore. The challenges on the infrastructure side are even more daunting.

The solution lies in re-interpreting the role of institutions in the light of the capital scarcity in the economy. In any market, the capital required of a firm as per adequacy norms is disproportionate to the risk of default in its loan portfolios (typical losses are 0.5 per cent to 2 per cent in retail portfolios but capital required is 8 per cent). This is because capital is meant not only to cover this risk of default but also to cushion the other risks, namely concentration risks, discretion risk, which arises since the creditor finances the `future loans and non-credit risks, such as interest rate and prepayment risks which are more difficult to remove. Securitisation effectively reallocates these risks to entities to whom such risks serve as a natural hedge.

Thus, the effective capital required to support the portfolio is reduced, which, in turn, lowers the costs for the issuer and the extent of funds that can be raised for a given level of capital also multiplies. Seen numerically, if nodal institutions such as NHB or HUDCO with a Rs 100 crore corpus were to provide loans directly,the flow of funds to the housing sector would be only Rs 92 crore. In setting up HFIs and providing refinance for half the portfolio, the funds flow is effectively doubled.

However, if the institutions were to merely offer credit enhancement for the instruments (provide loss guarantees), at a level of 4 per cent, the funds made available to the sector would catapult to Rs 2,500 crore! With increased familiarity, the capital charge would only reduce. This is a compelling equation.

The key role for NHB and HUDCO or Infrastructure Development Finance Company and IL&FS for infrastructure must clearly therefore be to provide credit support to various agencies associated with housing or infrastructure investments and provide market making support to reduce the interest rate and liquidity risks associated with such long tenure investments. In such a framework, down marketing of credit is facilitated since local co-operatives, housing boards, HFIs, rural banks, and even NGOs can issue instruments based on the credit quality of their portfolio without being constrained by their own credit rating or balance sheet strength. The government can continue to focus on strengthening nodal institutions.

Looking at the global scenario, over two-thirds of the house-owning population own homes through mortgage financing; in India the number is considerably less. The share of participants in mortgage origination , the world over, has changed visibly. For example, while savings and thrift institutions accounted for a market share of 47 per cent in 1983, this dropped to 19 per cent in 1995. On the other hand, the share of commercial banks grew marginally from 21 per cent to 25 per cent during the period. In the case of mortgage companies, the growth was phenomenal, from 30 per cent in 1983 to 55 per cent in 1995.

In the seventies, the US government set up three nodal agencies to spearhead the growth of the secondary markets.The MBS (mortgage backed securities) market in the US grew to over Rs 60,00,000 crore. The argument that India is different only lends credence to the cause of securitisation since our capital scarcity is far greater than that of OECD countries.

There is however the issue of directing funds to a sector that can't pay for it. The complexity of the instrument prevents raising funds directly from retail investors. The professional markets for long tenure bonds are shallow. Despite this, if funds must be raised at low, off market yields, only two options are available provide tax incentives to holders of the instrument (or issuers) or allow investors a share in the upside on revenues or appreciation in underlying investment. For example, in a securitised instrument consisting of a pool of toll receivables, the instrument can pass through the actual toll receipts, which, if higher than forecasts will give investors spectacular returns.

While the equation is universally accepted, the argument has always been that existing laws in India do not support issuance of securitised paper and that the large potential investor bases are ineligible to invest or do not consider the investments viable.

A separate act is required to cover not only various structures and issuers but also to qualify investment by insurance companies, pension funds, trusts, PSUs etc. who are currently prevented from subscribing to this instrument since their investment guidelines did not visualise such instruments.

Fortunately, the political will required to change laws and guidelines does exist. The Ninth Plan projects Rs 2,500 crore to be raised through securitisation for housing. The absence of a specific law is not an insurmountable obstacle, however. The reality is that many laws,as also investment guidelines are archaic and did not visualise such instruments.It is possible to issue instruments with a structure that abides by the spirit of law, by using a beneficial assignment structure or by using legal asignment with perfection of security interest pending change in notation, re-purchase in the event of foreclosure(subject to recourse provisions), and return of voluntary servicer advance on the maturity of the transaction.

The problem here is that documentation is cumbersome and untested in courts. Besides, investors prefer laws to be spelt out, given the long tenures. Without this, they would tend to have unrealistically high yield expectations that makes issuance non-viable. The only solution to this lies in leading institutional investors stepping up and endorsing the instrument by making even a token investment in an issue of securitised paper. This will provide confidence to the investor community. In fact,commercial practice is the most reliable method of sanctifying changes in outdated laws.

Above all, changes in the Maharashtra Stamp Act and Sebis regulations on mutual funds suggests that securitisation is finally more than just a buzzword.

Sriraman Jagannathan is assistant vice president (treasury), Citibank. The views expressed here are his own.