MORTGAGE BACKED SECURITISATION PROCESS

Credit Enhancement to Residential Mortgage Backed Securities (RMBS) of Primary Lending Institutions by way of NHB Guarantee

Considering the need to promote the development of secondary market for Residential Mortgage Backed Securities (RMBS) in India, the RMBS Policy of NHB envisages to introduce specialized institutional measures for providing credit enhancements for promoting the development of secondary market for residential mortgages. It may be mentioned that the presence of specialized forms of credit enhancements such as Guarantees of institutions such as Fannie Mae, Freddie Mac and Ginnie Mae in respect of the RMBS issued by these institutions, have considerably contributed to the success of RMBS in developed nations such as USA. Since such credit enhancements are presently absent in India, the Board had approved a proposal to Guarantee the Senior Classes of Residential Mortgage Backed Securities (RMBS) issued by NHB. This is expected to reduce credit enhancement costs, improving viability of RMBS transactions and encouraging the Housing Finance Companies (HFCs) and Banks to take up securitization of their home loan portfolios.

Under the arrangement, NHB would offer to provide/furnish an irrevocable Guarantee in its corporate capacity, to the RMBS issues of eligible Primary Lending Institutions (PLIs) viz. HFCs and banks, with the main intent to obtain Rating of investment grade indicating highest safety AAA(So) from an approved Rating Agency. At the same time, in order to ensure that the cashflows to the investors are sufficiently protected, it has been stipulated that there should be adequate subordination and collateral levels to the Guaranteed Class of RMBS which are commensurate with high levels of safety grade of Rating (AA(So)) for the RMBS by an approved credit rating agency. Thus the intent of the scheme is to enable the HFCs to obtain AAA(So) benefits with collaterals equivalent to AA(So) requirements.

While the major objective of NHB’s Guarantee is to enable originator(s) to derive the pricing and other benefits of a AAA(So) RMBS at AA(So) terms, it has been stipulated that layer(s) of credit enhancements such as cashflows of Subordinated Class RMBS (subscribed by originator) and Cash Collateral/reserve, etc. (as prescribed by the Rating Agency) shall act as the first level credit supports for the Senior Classes of RMBS. NHB’s Guarantee shall be only in the event of exhaustion of the initial layer(s) of such credit enhancements. Therefore, in the event of any shortfalls in the collections for payments due on senior Class RMBS holders, NHB’s Guarantee shall be invokable as last resort only after the residual income / principal of subordinate RMBS and all other forms of collaterals stipulated for the AA(So) rating have been exhausted/completed in a payout.

In a typical RMBS transaction, the size of credit enhancements would considerably be less While the major objective of NHB’s Guarantee would be to enable originator(s) to derive the pricing and other benefits of a AAA(So) RMBS at AA(So) terms, it would be quite in order to ensure that NHB’s Guarantee is invoked in a transaction only in the event of non-availability of cashflows from the securitized pool to service the senior class of RMBS guaranteed by NHB. For the purpose, the following hierarchy of payments (payment water-fall) shall be built-in to the RMBS Structure.

First in the Sequence of Payment	Service Providers (Trustees, Guarantors, Servicing & Paying Agencies, Rating Agency and other Statutory dues (if any)
Second in the Sequence of Payment	Interest to Senior Classes RMBS holders (Class A PTCs)
Third in the Sequence of Payment	Principal to Senior Class RMBS holders (Class A PTCs)
Fourth in the Sequence of Payment	Replenishment of Guarantee (to NHB) together with Interest (at Pass Through Rate p.a.), if it had been invoked in the earlier payout(s)
Fifth in the Sequence of Payment	Replenishment of Cash collateral/Credit Enhancement (provided/arranged by the Originator) to obtain >targeted rating of AA(So) without interest
Sixth in the Sequence of Payment	Payment of Principal to Subordinate RMBS holders
Seventh in the Sequence of Payment	Payment of Residual Income to Subordinate RMBS holders

In the event of any default on the part of the Borrower(s) of the securitized pool of home loans in payment/ repayment of any of the monies due on senior Class RMBS holders, NHB’s Guarantee shall be invokable only after the residual income / principal of subordinate RMBS and all other forms of collaterals stipulated for the AA(So) rating have been exhausted/completed in a payout. With the credit risk component of home loan market being very low as also due to the cherry-picking exercise adopted for selection of the best quality home loans with excellent repayment track record for securitization, this would ensure sufficient safeguard to the transaction.

Terms of NHB's Guarantee to Residential Mortgage Backed Securities (RMBS)

(i) Eligible Primary Lending Institutions:

a. Housing Finance Companies (HFCs) registered with National Housing Bank
b. Scheduled Banks

• Eligibility Criteria for HFCs for being eligible for NHB’s Guarantee:

a. The HFC should be registered with NHB to carry out housing finance activity in the country. The HFC should provide long-term finance for construction/purchase/repair/ upgradation of dwelling units by home-seekers.

b. The HFC should have been in active business of providing long term finance continuously for the preceding 5 years.

c. The Gross Non Performing Assets (NNPA) of the HFC should not be more than 5% of the Gross Advances.

d. The originating PLI should secure a minimum rating of 4-Star under the Internal Credit rating Mechanism of NHB.

• Eligibility Criteria for Scheduled Banks:

a. The Gross Non-Performing Assets of the Bank as percentage of the Gross Advances should not exceed 10% for the entire portfolio of the bank.

b. The Scheduled Commercial Bank should have been in active business of banking and finance in India, continuously for the preceding 5 years.

(ii) Eligible Pool of Residential Mortgage Loans

The Pool of Residential Mortgage Loans underlying the RMBS should satisfy NHB's Selection Criteria. Due diligence Certificate should be obtained from Statutory Auditors of the Company or a firm of Chartered Accountants acceptable to NHB, duly indicating that every individual loan in the pool of home loans being securitized, satisfy the stipulated pool selection criteria.

(iii) Eligible Structure of RMBS

NHB’s Guarantee shall be provided only in respect of senior RMBS and not for subordinated RMBS.

(iv) Limit of the Guarantee

NHB’s Guarantee to RMBS involving individual home loans of eligible PLIs, shall be limited to least of the following:

• 100%of the Size of the Senior Class of RMBS;
• A sum of Rs.100.00 crores per RMBS issue;

(v) Requirements of RMBS Structure

The Originators will be required to provide credit enhancements (by way of subordinate portion, cash collaterals etc.) to the extent necessary to ensure at least AA rating or equivalent thereof without NHB's Guarantee. NHB’s Guarantee shall be the last resort in the hierarchy of the structural credit enhancements (such as senior-subordinate structure and cash collaterals) provided in the structure of RMBS.

(vi) Validity of the Guarantee

The Guarantee shall remain valid until full discharge of the RMBS and is meant to ensure repayment of principal and interest of the senior portion if payments received from the underlying pool of housing loans are not sufficient to satisfy the amount payable to holders of the senior RMBS.

(vii) Replenishment of Guarantee Amount

In the event of invokement of Guarantee at any time during the currency of the RMBS thereby resulting in depletion of the level of Guarantee limit for the residual period of the RMBS, NHB (Guarantor) shall be entitled to be replenished from the pool collections in subsequent months in excess of the amounts payable to the holders of the senior portion. It will be ensured that replenishment of Guarantee from the pool cashflows to the extent of payments earlier met by NHB together with interest thereon, shall figure in the hierarchy of payments immediately after the payment of dues of the senior RMBS holders (for whom the guarantee was provided). On replenishment of such amount, the amount guaranteed by NHB shall stand reinstated subject however to the condition that the total liability of NHB under the guarantee at any given point of time shall not exceed the amount of senior Class RMBS outstanding.

In respect of the amount utilised for making the timely interest and / or principal payments to the RMBS holders by invokement of Guarantee, NHB (Guarantor) shall be entitled to be replenished with interest equal to the Pass-through Rate applicable to the RMBS holders (for whom the Guarantee was provided).

(viii) Guarantee Fees to NHB

Te main intent of providing Guarantee to senior Class of RMBS would be to reduce the levels of credit enhancements. The Guarantee fees to NHB will be higher of the following:

50% of the Net Saving to Originator as a result of NHB’s Guarantee, spread over the tenure of Senior Class RMBS (Guaranteed by NHB) 0.20% p.a. of the Outstanding Senior Class of RMBS Guaranteed

The 'Net Saving' to the originator as a result of NHB's Guarantee shall be determined in a transparent manner during the rating process and equally shared between NHB and the holders of the subordinate RMBS/originator. The Guarantee fees to NHB (payable alongwith payouts to service providers and holders of PTCs) shall be finalised by NHB in consultations with the originator, at the time of each issue.