Risks Rise For Securitisation Market As DHFL Is Restricted From Paying Investors
India’s securitisation market is staring at a potential risk after a recent Bombay High Court interim order stayed any payments by Dewan Housing Finance Corporation Ltd. to all creditors, including investors holding units of securitised loans.
In an order dated Oct. 10, the High Court of Bombay restrained DHFL from making any payments to its creditors, in response to a petition filed by Reliance Nippon Life Asset Management Company Ltd. As a consequence, payments on six of DHFL’s mortgage-backed loan pools have been stalled, leading to a rating downgrade.
The interim order, however, raises a wider question that has investors worried. The order fails to distinguish between DHFL’s role as a borrower/lender and a collection agent, who simply collects payments on behalf of the final investor of the securitisation pass-through certificates.
Bombay High Court Observations In DHFL Case
As per the Bombay High Court’s interim order, DHFL cannot make any payments to secured or unsecured creditors, except on a pro rata basis. This, according to a company official who spoke on condition of anonymity, has prompted a halt on payments on securitised loan pools.
As part of securitisation deals, a lender sells pass-through certificates to investors, which represent individual units of a pool of loans. The lender subsequently continues to collect payments on the loans sold and puts the funds into a ‘collection and payout’ account. These funds go directly for payouts to investors, who are essentially creditors.
However, once a pool of loans has been securitised and sold to investors, the role of the originator of those loans (in this case DHFL) gets reduced to one of a collector. He collects payments on the loans and passes them through to the investors.
That distinction has been blurred by the Bombay High Court’s interim order.
“There needs to be a distinction made between a corporate debtor like DHFL, acting as a lender and debtor, and its role as a collecting agent in a securitisation transaction,” said Ajay Shaw, partner at DSK Legal.
In passing its interim orders, the court also observed that securities used by DHFL to raise funds from mutual funds and other subscribers of non-convertible debentures were also used by DHFL to back securitisation deals.
“Prima facie, I am of the view that the plaintiff has made out a case that the very securities, over which a pari passu charge has been extended in favour of mutual funds and other secured creditors/NCD subscribers, appears to have been utilized by DHFL to garner further loans by availing of these securitization option,” the Court’s interim order said.
In its affidavit to the Court, DHFL had disclosed that it had cash balances of around Rs 590 crore and fixed deposits of Rs 1,194.3 crore. Of these, Rs 1,008 crore worth of funds were held by the company for payments towards securitised loans and assets. These payments, however, have now been stalled.
A lawyer, who spoke on condition of anonymity, said this effectively means that home loan borrowers of DHFL continue making their loan repayments and the company will collect the money in its capacity as a collection agent and park it with the trustee. But investors in the pass-through certificates will have to wait till the moratorium is lifted, this person said, while adding this order “could open the flood-gates”.
Could This Hurt The Securitisation Market?
Securitisation of loans has been picking up, particularly in the last one year as non-bank lenders have faced a liquidity crunch.
Over Rs 1.9 lakh crore worth of securitisation transactions took place in FY19, and in the first half of this fiscal total securitisation volumes have already touched Rs 1 lakh crore, according to a recent report by Crisil Ratings.
Bindu Ananth, chairman of the Dvara Trust, who was part of the Reserve Bank of India’s committee on the housing finance securitisation market, told BloombergQuint, that securitisation transactions by nature are bankruptcy remote. As such, even if the loan-originator faces a solvency issue, as long as the cash-flows of the underlying loan-pools are stable, investors in pass-through certificates are not affected. In fact, these structures are attractive because a pass-through certificate of a loan pool could have a higher credit rating than the underlying originator’s rating, because of this bankruptcy remoteness.
The industry, however, has been aware of the hidden risk in the Indian securitisation market due to lack of explicit provisions in the bankruptcy law.
“Given that the Insolvency and Bankruptcy Code, 2016 does not explicitly deal with insolvency situations for financial-services firms, the committee also deliberated on the lack of a bankruptcy law for financial firms and the subsequent lack of clarity for securitisation investors,” Ananth said.
Abhishek Dafria, vice president at ICRA, also said the Indian securitisation market is exposed to co-mingling risks associated with the collection agent/servicer. “When a servicer of a securitisation transaction is itself going through a liquidity crunch, this risk becomes more acute and there is a greater possibility that the funding of the escrow account for the securitisation transaction may not happen in a timely manner,” Dafria told BloombergQuint.
The transaction documents, according to Dafria, should allow for a change in the collection agent/servicer and investors need to use this option more promptly. “Given the current environment where NBFCs are facing liquidity pressures, the investors may benefit from ensuring a quicker servicer change wherever the servicer’s credit profile itself has materially weakened though it is an operationally challenging task.”