IL&FS Default Highlights Indian ABS Servicer Continuity Risk: Fitch Ratings
Moneylife Digital Team 11 October 2018
The risk of a counterparty's failure causing jump-to-default in Indian asset-backed security (ABS) transactions has been highlighted by the recent default of Infrastructure Leasing and Financial Services (IL&FS), a large Indian non-bank financial institution (NBFI), says a ratings agency. 
 
In a release, Fitch Ratings, says, "IL&FS was not itself a counterparty to any internationally rated ABS notes, but NBFIs act as the originators and servicers for most Indian ABS transactions, including those rated by us."
 
The failure of IL&FS has significantly undermined market sentiment towards the Indian NBFI sector and their ABS issuance, the ratings agency says, adding, transaction flow has stalled and we have observed a rise in yields on the securitisation notes of NBFIs.
 
The underlying asset performance of Indian ABS pools rated by Fitch remains sound. Overall, it says, delinquencies for Fitch-rated ABS transactions have remained stable at below 1.5% on average (see chart below), but performance varies according to the originator and the underlying asset class.
 
 
Fitch has to date capped ratings on Indian ABS transactions at 'BBB-(sf)' in line with the account bank replacement rating triggers of 'BBB-'. 
 
Fitch says it typically does not assign an Indian ABS transaction a 'BBB-(sf)' rating unless its account bank has a rating of at least 'BBB-'. 
 
"The rating of the ABS is linked to that of the account bank as credit enhancement for ABS transactions in India typically comes in the form of a cash deposit with one or more financial institutions. This means that the failure of the deposit bank would wipe out the vast majority of credit enhancement available to note holders and therefore could significantly undermine a transaction's CE and its rating," Fitch added.
 
According to the ratings agency, prolonged and severe stress of a transaction's servicer can disrupt collections on the underlying assets, undermining liquidity. In such an event, a transaction's liquidity coverage is usually relied upon to avoid a direct negative impact on transaction performance, it added. 
 
Fitch says it considers mitigation of servicer continuity risk to be a critical element of structured finance ratings. It says, "All Fitch rated Indian ABS transactions have liquidity coverage of at least three months, which reflects our expectation that this length of time could be needed to replace a servicer in a stress scenario. This liquidity requirement increases in cases where we believe servicer continuity risk is particularly high or that the servicer replacement time is likely to be longer." 
 
The ratings agency feels that inadequate mitigation of servicer continuity risk might lead to a cap on the ratings of notes. 
 
Recently, Fitch says it declined to rate transactions that did not have sufficient liquidity coverage, which could have led to excessive dependence on the unrated servicer and potentially exposed senior notes to jump-to-default or severe downgrade risk upon jump-to-default of the servicer.
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