The securitization market ignores headwinds
Securitization volume in the first quarter of this fiscal year seems to suggest that the frenetic pace of deal execution seen in January-March of this year is not holding up. But that might not be an accurate predictor of what lies ahead with volumes growing strongly in the first quarter of last fiscal year.
And even though the current macro-economic environment is putting some pressure on the quality of the underlying loans, there is a visible reversal in sentiment and an increase in the proportion of the unsecured loan segment compared to previous quarters.
Macroeconomic risks stem from three “I’s” — income, inflation and interest rates.
Any sequential slowdown in business activity tends to reduce revenue realizations or borrower income.
A spike in inflation raises the costs of running businesses and depletes crucial excess cash that would typically fund monthly liability repayments.
A rising interest rate environment increases the cost of borrowed capital, either in the form of longer terms or in the form of increased installments, putting pressure on already depleted cash reserves.
These headwinds, present since March-April 2022, could potentially weaken the credit quality of some of the underlying loans in the securitization pools, particularly those unsecured.
Certainly, the first quarter volume of Rs 35,000 crore looks good against Rs 6,200 crore and Rs 20,000 crore, respectively, in the corresponding quarters of fiscal 2021 and 2022 (the peak of the first and second waves of the pandemic).
But in fiscal 2020, Q1 volumes were higher, in excess of ~Rs 45,000 crore, as non-bank entities flooded the securitization market to access additional liquidity, following the default. of a major infrastructure financier in September 2018.
At the beginning of the year, the unfavorable macroeconomic climate had translated into caution, as investors expected higher returns.
Many deals remained inconclusive as the originating non-banks were unable to meet or firmly anchor performance expectations.
To be fair, the first few weeks and a few months at the start of any fiscal year are also less turbulent times for the market than the rest of the year.
But in June, the surge in deals amply confirmed the latent demand for quality retail lending assets among investors.
Non-originating banks were dismissed as “negligible”, the impact of the three “I’s” on cash flow and repayment, implying high borrower agility and ability to absorb the shock.
Recovery ratios remained high, not only among secured asset classes such as mortgages and commercial vehicles, but also in the unsecured and microfinance segment. They were also higher than the levels seen during the second wave of the pandemic.
At the right time, investors’ aversion to new trades eased and the overly cautious environment lifted. Traditional investors renewed their confidence in acquiring new assets and inconclusive negotiations resumed on closing deals as the end of the quarter approached. Even investor groups have remained inactive since the pandemic returned.
Among them, foreign institutions acquired about 17% of all securitized assets this year, with banks and non-banks acquiring the bulk of securitized exposures. Mortgage pools remained the favored asset class, while commercial vehicle loans and gold remained favorites among the non-mortgage space.
Notably, the proportion of unsecured loans, including personal and microfinance loans, jumped from previous quarters. Interest in these had declined during and immediately after the pandemic.
Many of these new transactions were structured with all cash flow from the pool used to meet investors’ obligations, with little or virtually no cash flowing back to the originating non-bank; a modification — technically called “acceleration” — of the usual deal structure to prioritize investor claims.
However, some investors continued to miss out on the action in June 2022. Many of these deals spilled over and went through in July 2022 – another unusual occurrence in this space.
That said, reports of stable pool performance and uninterrupted pool collections continued to ease already diminished fears of an emerging stress.
In the near term, continued macroeconomic stress could test the stamina of retail borrowers to keep their repayments on schedule. In the event of a significant slippage, many market participants who had faith in the strength of the credit quality of retail loans may be forced to retreat to the drawing board.
But the long experience of securitization as a process, the transformation of the borrower-lender interaction since the pandemic, the availability of regular data on portfolios and pools, the refined criteria for loan selection, the legal support of securitized transactions and the continued flow of savings to financial markets are tangible factors that give good reason to believe that the growth of the securitization market will continue.
The opinions expressed above are those of the author.
END OF ARTICLE