Indian Securitization Market: A Tale Of Two Crisis
Securitization transactions have been an alternative means to access debt capital for lenders across asset classes including microfinance, vehicle finance, housing finance among others. During the course of this blogpost, we will attempt to decipher the plausible answers to the questions listed below which couldn’t be more pertinent given the state of securitization market on account of Covid19 pandemic.
· What are the trends in securitization volumes? Do securitization markets behave differently during different crisis?
· What are the key noticeable trends in pricing across ratings and sectors? How does the risk reward equation get affected during different crisis?
· Comparison of pricing of structured products and NCD issuances pre & post crisis period.
· Periodic collection efficiencies across microfinance loan pools arranged by Cred Avenue to understand the asset quality trends in MFI securitization.
For this article, we have taken the recent two financial crisis which have crippled financial markets — a) IL&FS liquidity crisis b) COVID 19 pandemic . We will try to understand how these crises impacted the securitization markets in different ways.
Key takeaways:
Listing down the key takeaways post our analysis of securitization market transactions that has happened over the last 5 years basis the market information reports published by Credit Rating Agencies (CRA):
· Securitization market has been muted post COVID 19 in terms of volumes, securitization market has witnessed a steady growth over the last five financial years till Q3 FY’20, post which we have observed a huge drop owing to Covid19 related uncertainties on transaction execution & asset quality concerns.
· Flight to safety- PTC market is majorly dominated by vehicle finance securitizations followed by Housing finance transactions. Post Covid19, there has been a significant increase in gold securitization and PTC issuances by prime and high rated (AAA and AA Long term Rating) originators- traditionally considered as safer avenues for investment and the volumes of other sectors like MSME, Consumer or Microfinance where perceived asset quality concerns are high; the volumes nosedived.
· New to securitization- The last three financial years have witnessed many new entrants in the market , new asset classes (Education, Warehouse receipts, Equipment Lease Rentals etc.), new products (Covered bonds, replenishing PTCs, PAR CABSEC etc.), new stakeholders (arrangers, originators and investors)
· Impact during stress events- Basis our analysis, we observed that the IL&FS crisis and COVID 19 related stress have had very divergent impact on the securitization market.
- IL&FS crisis- Though this event did not have an impact on the transaction volumes, it had a significant impact on the pricing (steep spike in spreads over GSecs). This was perceived to be a liquidity crisis by the market and the focus was largely on ALM mismatches of originators rather than the asset quality concerns
- COVID 19 related stress- Since there are huge uncertainties around how COVID 19 will have an impact on asset quality of issuers post moratorium, there has been a huge drop in the transaction volumes. The prolonged lockdown and the challenges surrounding the borrower repayment behavior post moratorium added to the uncertainty. However crucial interventions both on fiscal & monetary policies by GOI and RBI ensured that the key market participants were flush with liquidity and hence this crisis had much lower impact on pricing on a relative basis.
- Pricing trends- On comparing the spreads of new bond issuances and PTC issuances over periods, below are our key findings.
-Across all rating categories, we can witness a significant spike in PTC pricing post IL&FS default event, whereas in new NCD issuances the spike is not very significant excluding Non-IG bond issuances.
-Prior to IL&FS default event crisis, across rating categories, PTCs have offered a better pricing compared to bonds (higher spreads over GSecs).
- Collection efficiency trends- Across periods, the collection efficiencies have remained in the range 92% to 99%. The lower collection efficiencies have been observed majorly during the times of flood. Since the MFI pools arranged by Vivriti are well diversified across geography the impact on asset quality of certain geographies did not cause a huge impact on the overall collection efficiency of the pool. The asset quality of the MFI pools dropped significantly post Covid, but also recovered swiftly (this can be observed through a V- shape recovery in the chart towards the end of the blogpost).
PTC Volume trends:
The below chart depicts the trend in PTC volumes (quarter on quarter) over the last five financial years.
Post IL&FS liquidity crisis , the perceived risk on securitization transactions had increased which led to increase in pricing ask by the investors, whereas the volume trends largely remained intact because the perceived increase in risk got compensated by an corresponding increase in pricing as well- since there were no major concerns on asset quality of the issuers. The government policy push by introducing Partial Credit Guarantee (PCG) also help in boosting the securitization volumes. Additionally, the securitization instruments were viewed as natural hedge against ALM mismatches and hence a lot of issuers flocked towards off balance sheet products to correct for liquidity mismatches on their balance sheet which also helped in maintaining securitization volumes
On the other hand, COVID 19 pandemic has introduced a great deal of uncertainty around the asset quality of the loans originated by lenders. Since the situation is still evolving post moratorium, cautious investors are staying away from the PTC markets until there is clarity on the performance of underlying loans. Apart from investors being cautious, the other factor that has kept the volumes low is the muted retail loan disbursements growth majorly by non- bank lenders and hence the eligible pool of loans necessary for these transactions remains unavailable.
In terms of deal size, 85%-90% of the market is majorly dominated by small sized deals (less than 100 Cr) and mid-sized deals (100 to 500 Cr) and we see this trend to continue even post crisis periods. In terms of sector, prior to COVID 19, the securitization market was majorly dominated by vehicle finance, mortgage finance and microfinance lenders, whereas post COVID 19, we have observed an increase in volumes of gold securitizations, whereas the volumes in microfinance has stayed muted; indicating flight to safety approach being adopted by lenders
In last three financial years, the volumes have peaked in the third quarter (Oct’20 to Dec’20).
Securitization market was majorly dominated by Prime & High Grade Rated lenders till FY’17. Post which there was an increase in lower rated originator issuances till Q2 FY’19. But after IL&FS crisis the issuances by low rated entities started decreasing. Now again around 80% of the market is dominated by Prime & High rated entities issuance only.
In terms of PTC instrument ratings, investors are taking comfort mostly in Prime & High Rated issuances only and this trend has become more prominent post Covid19 as well.
Comparison of PTC Volumes vs NCD Issuance Volumes-
Though the securitization volumes are very low compared the bond issuance volumes, it is evident from the above table that PTC volumes are growing at a much faster pace.
Pricing Trends:
The spread over G Sec across rating categories are depicted in the below chart. Spread for a particular PTC issuance is determined based on yield on the PTC — G Sec yield for a particular tenor.
We can observe a significant spike in pricing post IL&FS crisis, whereas there is no such significant spike post Covid19 crisis. Having said that; it is too early to comment whether these trends will persist considering that a large part of loans were under moratorium and the impact on the asset quality is still unclear. Across asset classes, the spreads of Prime & High Grade PTC issuances has shot up from 0.5% to ~3.5% post IL&FS crisis.
Comparing the spreads of PTCs against the Bond issuances on similar ratings, it is evident that the spreads over GSecs on bond issuances have not spiked post IL&FS default event similar to PTCs. Also, the spreads across rating categories were slightly lower for PTCs compared to Bond issuances till IL&FS default event, post which PTC market seems to offer higher yield spread across rating categories compared to Bond issuances.
MFI Collection Efficiencies- Periodic trends:
The periodic collection efficiencies of MFI loans are impacted majorly by floods and local political events across certain geographies. Since the MFI pools arranged by Cred Avenue are well diversified across geography the impact on asset quality of certain geographies did not cause a huge impact on the overall collection efficiency of the pool. The asset quality of the MFI pools dropped significantly post Covid19, but also recovered swiftly (this can be observed through a V- shape recovery in the chart).
Conclusion:
IL&FS crisis was largely perceived as a liquidity event and the securitization market volumes had largely ballooned on account of government policy intervention and securitization product acting as panacea for all liquidity mismatch related troubles faced by issuers. Since there was an adequate supply of the pools; investors were able to command a risk premium in the market across rating categories. It is important to note that the fiscal and monetary measures were directed towards issuers in this crisis.
COVID 19 pandemic has affected securitization volumes adversely and the volumes have dipped alarmingly. The nature of crisis is very different from IL&FS crisis on account of uncertainty on recovery path of loan books, perceived asset quality concerns on originators and time required to return to normalcy. Interestingly, the fiscal and monetary policies were largely directed towards investors (TLTRO, PCG 2.0) to infuse liquidity in the market and incentivizing banks to transmit this liquidity to these issuers. Since there are asset quality concerns this time around and with no clear benefit in sight for securitization products, the road to recovery to normalcy for securitization markets looks far. Next few months of investor behavior with country largely coming out of lockdown and economy limping towards normalcy will be crucial in determining the state of securitization markets in India.
