Replenishing structures have gained traction since the Reserve Bank of India accorded formal recognition to these in its Master Directions on Securitisation of Standard Assets, issued in September 2021. Replenishing structures is a variant of securitisation that involves sale of a pool of retail loans by an originator to a special purpose vehicle (SPV) trust, which then issues pass-through certificates (PTCs).
As much as Rs 5,000 crore of PTCs with replenishing structures were rated last fiscal alone.
The evolution of replenishing structures is in sync with that of the broader securitisation market in India, which saw issuances totalling Rs 1.8 lakh crore last fiscal, up 33 percent on-year and on top of a whopping 50 percent growth in the previous fiscal as the post pandemic recovery gathered steam.
The originator base in securitisation also expanded by 20 percent last fiscal, and newer asset classes such as personal loans and small and medium enterprises loans gained momentum.
With the broader securitisation market expected to maintain its growth trajectory, replenishing structures are set to grow further, aiding development of the overall market and setting the stage for more innovative structures to take root.
What sets these apart
Replenishing structures offer multiple benefits to both investors and originators over a typical securitisation transaction. They enable long-dated PTCs to be issued, backed by shorter-tenure retail loans, providing avenues for investors with long-term investment horizons to take exposure to retail asset classes with shorter maturities, reduce re-investment and prepayment risks for investors, and enable better asset liability maturity management and cost efficiencies for originators.
In a typical securitisation transaction, PTCs amortise monthly, in line with the pool repayment schedule.
In a replenishing structure, cash flows from the underlying pool are used to purchase new assets and maintain a collateral cover during a pre-defined period instead of amortising the securitised instrument. Only interest payouts are made to investors during this initial ‘replenishment’ period. The PTC gets amortised subsequently, mirroring the repayment schedule of a pool in a typical securitisation transaction.
Hence, unlike a normal securitisation transaction where the tenure of the PTCs is typically co-terminus with the underlying loans, replenishing structures enable issuance of PTCs with tenures longer than underlying loans.
Replenishment periods can also be customised to align the instrument tenures with the requirements of investors. Additionally, given the monthly principal payouts along with prepayments in a typical securitisation transaction, investors are required to frequently reinvest those proceeds, and that could also shorten the average life of the PTC.
Replenishing structures provide protection against prepayments and reinvestment risks during the replenishing period when the underlying pool’s cash flows are used to recycle the collateral pool and not to amortise the PTCs.
Replenishing structures can, therefore, attract investors such as mutual funds, pension and insurance funds looking for stable cash flows over the medium to long term.
Banks, being dominant investors in the securitisation market, stand to benefit, too. They can conform to priority sector lending (PSL) requirements over a longer period by investing in PTCs backed by replenishing pools of PSL-compliant loans.
These structures provide opportunities for investors to lock into the typically high risk-adjusted returns offered by securitisation transactions over longer tenures, while also limiting prepayment and reinvestment risks.
Wider acceptance of these structures by investors will also help originators of securitisation transactions. Financiers with stable disbursement pipelines can offer larger securitisation issuances through replenishing structures, backed by their ability to generate new loans that can be added to the replenishing pool, instead of floating multiple vanilla issuances at different points in time. This can improve liquidity management and bring efficiency of scale for the originator by reducing the transaction cost associated with securitisation.
What to look out for
For all the benefits they offer, replenishing structures do entail additional risks. Fortunately, there are structural features that can help address these risks. For instance, the underlying pool quality could vary during the replenishment period after the addition of new loans to replace existing loan amortisations.
New loans added to the replenishing pool must, therefore, adhere to well-defined eligibility criteria to ensure consistent pool quality. Such criteria are centred around factors that determine pool performance such as seasoning profile, credit scores, ticket sizes, interest rates, repayment track record and loan-to- value ratios for secured loans.
Moreover, unlike a typical securitisation transaction where credit enhancement levels build up as a percentage of the outstanding pool as the instrument amortises, credit enhancements remain static during the replenishing period. Any undue risk accumulation in the pool during the replenishment period could reduce the loss-absorption cushion provided by the credit enhancement.
To prevent build-up of risk during the replenishment period, early amortisation triggers can be incorporated into the transaction. Such triggers are typically linked to the ability to add new loans, delinquency levels in the pool, credit
rating levels of the servicer and the instrument, and the utilisation of credit enhancement. In case of a breach in these triggers, the instrument is typically amortised at an accelerated pace through ‘turbo-amortisation’.
—The author, Krishnan Sitharaman, is Senior Director and Chief Ratings Officer, CRISIL Ratings. the views expressed are personal.
(Edited by : C H Unnikrishnan)
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