Underlying Borrowers in Securitisation Market Are Now Shifting Focus to Revival from Survival: Report
The underlying borrowers in securitisation transactions would now shift focus to revival of businesses and build-up of financial cushions over the next few months, from a six-month-long push for survival of businesses, by ensuring timely liquidity, says a research note.
In the report, India Ratings and Research (Ind-Ra) says, "While the moratorium provided relief to borrowers, it was unfavourable to the securitisation market as investors stayed away from purchasing pools, given the possibility of irregular cash flows in the initial months. The market subsequently picked up in vehicle loan pools and has also seen securitisations in products such as personal and gold loan segments. We anticipate a continued revival in the securitisation market as delinquency levels stabilise by fourth quarter (4Q) of FY21."
Ind-Ra says its rated structured finance transaction ratings predominantly remained stable between March 2020 and October 2020, with the exception of 25 securitisation transactions, three lease rental discounting transactions and one pooled loan issuance credit ratings which were placed on rating watch negative (RWN). This was due to expected COVID-19 related asset deterioration and/or changes in counterparty ratings, it added.
Ind-Ra says it will continue evaluating if the available credit enhancement (CE) is adequate for the rating level stresses, given that some of the transactions have started dipping into CE post-moratorium. Along the way, the ratings agency says it will recalibrate the base case default rate and recovery rates by reassessing the possible delinquency build-up in the rated transactions.
The securitisation transactions placed on RWN have unsecured business loan pools in 14 cases, microfinance loan pools in five cases and construction equipment loan pools in six.
Ind-Ra says it relied on the collection efficiency trend to assess the performance of the portfolio during the moratorium. "However, we will now monitor the deterioration in the delinquency buckets and the expected credit cost by end-third quarter (3Q) FY21. This could result in a revision in our base case default rate and recovery rate assumptions. The pandemic’s impact on businesses and thereby on loan performance may be characterised by the two aspects – transient and structural," it added.
According to the ratings agency, the immediate policy response to COVID-19 has been to prioritise business stabilisation and support recovery of the economy after the lock-down.
Ind-Ra says it believes that its rated securitisation transactions have overcome the transient impact without much credit events due to the withdrawal of lock-down in a gradual manner, the dispensation of moratorium and associated amendments in securitisation transactions and the availability of external CE in the transactions.
"Government induced liquidity measures such as emergency credit line guarantee scheme for micro, small and medium enterprises (MSMEs) sector would have also helped borrowers to manage liquidity. Through the course of the moratorium, we saw gross collections improving, lesser transactions dipping into external CE as the economic activities revived and borrowers exited the payment deferral under the moratorium," it added.
However, Ind-Ra says, the damage caused by the pandemic to businesses and individuals is immense in some pockets and the policy and liquidity measures might not have reached some of the most impacted segments.
"Unlike the quick rebound seen post demonetisation, the microfinance segment has been hit hard in some geographies and may continue to feel the strain of the pandemic as it curtails business opportunities for MSMEs. The eastern states in India were more severely impacted due other aspects including natural disasters," the ratings agency says, adding "given the small ticket size of loans, restructuring is not preferred for this segment, as per originators".
Similarly, it says, collections in the commercial vehicle loans segment were severely impacted during April-May 2020 reflected in the high number of transactions dipping into the CE, about 33% and 41% in April and May 2020, respectively.
The business loan segment, especially loan against property, turned out to be a robust sector with collections bouncing back to pre-COVID level for originators. "This is possibly due to higher propensity to repay loans secured by one’s self-occupied home or commercial space used for running businesses," Ind-Ra says.
The ratings agency says its earlier expectation range of collection efficiency post-moratorium in its rated transactions, and actual collection metric averages (before moratorium – cumulative till March 2020, during moratorium – cumulative total collections including prepayment against pre-moratorium expectation in April-August 2020 and after moratorium – current collections against current demand in September 2020) is shown in below table.
Ind-Ra says it assumed post-moratorium collection efficiency – maximum and minimum - as depicted above was initially assumed by the agency for the stress period post moratorium. "As can be seen in all the asset classes, the average gross collections during moratorium were either better than these initial assumptions or within assumed range," it adds.
The average gross collections in the transactions, including prepayments and advance collections, in September 2020 was home loans:163%, microfinance loans: 97%, secured business loans: 212%, tractor loans: 195%, unsecured business loans: 86% and vehicle loans: 129%.
Ind-Ra says its models have recalibrated the transaction collection efficiency assumptions on the basis of the actual collections being reported by the transactions and collections in microfinance and vehicle loan pools are yet to recover significantly for some originators.
The ratings agency says it believes that the structural delinquency is here to stay as a consequence of the expected behavioural shift in the investment and consumption pattern in the medium-term impacting individuals and businesses.
It says, "The subdued aggregate demand in the urban sector, adverse productivity because of labour dislocation, and funding availability are some of the factors that can prolong, and bring in uncertainty in, the recovery. Although the spread of pandemic in the country seems to be contained for the past couple of weeks, downside risks persist with a possible renewed surge in infections exacerbated by a situation where a vaccine is not commercially ready. However, any recovery could be prolonged and uneven with the spread of the virus keeping the environment uncertain."
Given these aspects, Ind-Ra says it is closely monitoring the delinquency build-up and CE utilisation in rated transactions. The collections in September 2020 (shown in above table) indicates the trajectory of delinquency of the asset classes and a meaningful delinquency measure is expected to be visible by January 2021.
As the moratorium period ended, the ratings agency says, transactions specifically with unsecured business loans, vehicle loans and construction equipment loan pools have again started dipping into external CE for investor pay-outs as shown in above figure.
These transactions generally have the timely-interest timely-principal structure and thereby collections were short of investor pay-outs. Transactions with other asset class pools including microfinance, tractor and home loan pools have not dipped into CE due to the transaction structure or adequate collections.
Ind-Ra says its rated microfinance transactions where the collections are still catching up, have the timely-interest ultimate-principal structure and thus are not utilising CE. "We are monitoring the ultimate payout date in such transactions for possible vulnerabilities," it added.
Ind-Ra says it believes that an originator or servicer plays an important role in the Indian securitisation transactions, given the lack of a strong backup servicer market. The outbreak and subsequent lockdowns have accelerated technology adoption and the market witnessed swift re-engineering of lending models to cope up with the situation.
"As lenders continued operating with employees working from home, to the extent possible for health concerns, a range of new priorities and challenges have come up including business continuity risks, social distancing for frontline collections staff, workforce productivity and security risks," it says.
The originators had closed all their branches during the nation-wide lockdown announced in March and thus, business activities were impacted significantly due to logistical and operational challenges. As the economy opened up in a phased manner in May, originators gradually opened their branches other than the ones in containment zones and some of them operating for a few hours in a day.
"Increased focus was on collections while keeping operating costs in check with some entities almost freezing their disbursements during this period. The situation on the ground required the collections staff to be nimble and constantly adapt to changing circumstances while maintaining social distancing norms and safety," Ind-Ra points out.
It says, "Discussions with originators indicates that they have ramped-up their collection infrastructure aggressively, preferring digitisation of collections and moving staff members from other departments to collections. The originators played a key role in sensitising borrowers to repay on time by educating them about the implied cost and consequences of the moratorium, before the ex-gratia announcements."
"The originators are being prudent in selectively using support systems such as emergency credit line guarantee scheme provided by the government. The accelerated adoption of digitisation of loan documentation and customer verification could bring in efficiencies in the originator’s operating model. Due to these strategies, disbursements in select products including gold loans and two-wheeler loans remained steady even during moratorium," Ind-Ra added.
According to the ratings agency, servicers are confronted with challenges in terms of reconciliation of the borrowers’ cash flows with the investor pay-outs post the moratorium.
Structural changes such as temporary alterations in the payment mechanism from timely interest and principal payment to timely interest and ultimate principal payment, trapping of excess interest spread during the moratorium and any excess cash flows adjusted as prepayments have resulted in complications in reporting loan pool data, it says.
Furthermore, as per the regulator’s directives, lenders had to refund the difference between simple and compound interest collected on loans of up to Rs20 million during the COVID-19 loan moratorium scheme by 5 November 2020.
"This may require the originators to recalibrate borrowers’ cash flows in case they had charged compound interest on the loans outstanding in their books.
"With timeline till 31 March 2021, one-time restructuring of loans could further require originators to revise the cash flows of borrowers," the ratings agency says.