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RMBS guidelines of the Reserve Bank of India
by Vinod Kothari
The RBI has issued capital guidelines for banks that would invest in RMBS paper, and in the process has virtually laid down guidelines for RMBS applicable in the country. The sequence of the guidelines goes as under:
- The RBI's letter dated 24th May permits a 50% risk weight for investment by banks into RMBS paper.
- It also permits 50% risk weight for any loans backed by residential property.
- As precondition for the 50% risk weight, RMBS must comply with certain conditions.
- Since banks are the biggest buyers of RMBS paper in the country, obvious enough, these guidelines become the preconditions for any RMBS paper to be sellable to banks.
From a reading of the conditions it is pretty clear that these conditions are appropriate to grant capital relief to the originator, rather than to allow capital relief to the investor. It is strange that such conditions should have been prescribed from the investors' viewpoint. The use of "cut-paste" technology is obvious - as the guidelines have mistakingly used the word "bank" for HFC!
The main requirements of the guidelines are discussed below:
- The 50% risk weight is applicable to RMBS only and not to CMBS.
- The loans and receivables being securitised must "irrevocably" be assigned in favour of an SPV. There are two things being said here - one, that any securitisation without an SPV does not qualify as RMBS - for example, a direct sale of a bunch of loans to the investing bank. Two, the transfer must be by way of irrevocable assignment. This takes care of the dubious practice being followed by some players of making a "revocable" transfer to achieve certain tax consequences.
- The underlying mortgages should also be transferred and held by the SPV. [Para 3 (b)] This might often seem to be a difficult proposition as (a) the mortgage might, in most cases, be an equitable mortgage itself; and (b) the transfer of the mortgage might be a logistically difficult scene. It should have been better if the present practice of holding the mortgages with the originator as trustee for the SPV would have been allowed.
- From para 3 (c), a possible meaning that might emerge is that the RMBS should necessarily be a pass through and should reflect the same pay-back as the underlying mortgages. This would be least desirable. As the market grows, pay through should be the norm, as it is globally.
- Originator must not hold any equity or preference capital in the SPV, or be its beneficiary.
- The SPV's name should not reflect association with the originator.
- The originator must either not have any director on the board of the SPV, or where the SPV has at least 3 directors, the originator can have a minority.
- The originator should not directly or indirectly control the SPV.
- The originator should not support the losses in the securitization transaction or bear the expenses of the SPV.
- Para 3 (e) is strange - it reads: "The loans to be securitised should be accorded an investment grade credit rating by any of the credit rating agencies at the time of assignment to the SPV." It is difficult to see how the loans being securitised can be rated at all. Rating agencies do lay down selection criteria, but that cannot be said to lead to an investment grade rating for the loans.
- One of the passing statements in the last para talks about "irrevocable transfer of risks and rewards". This is out of the world. There is a transfer of risk and rewards, but never an absolute transfer of all risks and rewards in any securitization transaction.
As we have commented before, these guidelines, and such guidelines all over the world, are laid down from viewpoint of capital relief for the originator. However, from an investor viewpoint, it should be enough to ensure that the securities are backed by residential mortgages, to be treated at par with lending against a mortgage. There are so many conditions above for which an investor will have no means to satisfy himself except to rely on opinions. For example, whether there has been a transfer of risks or rewards, or whether the originator controls the SPV or not, is not of much concern to the investor, neither does the investor have any means to verify the same.