Indian asset-based securities (ABS) structures appear to be evolving to better addresses counterparty risk, according to Fitch Ratings, with investors starting to focus beyond pool risk to also consider servicer continuity and account bank risk.

Magma Fincorp Limited issued an auto-loan ABS in October, with liquidity coverage of more than one year and a structure comprising timely payment of interest and ultimate payment of principal (TIUP), against the Indian industry standard of timely payment of interest and principal (TITP). This change allows the trustee more than one year to replace the servicer in case of a servicer replacement event.

Below are key differences between prominent structural features that are currently being discussed in the Indian market.

TIUP Versus TITP, with Cash Credit Enhancement (CE)

TIUP structures typically allow for longer servicer replacement timelines than TITP structures, assuming the same amount of cash support. TIUP structures usually result in slightly higher expected total losses upon default than TITP structures due to interest on the carry-forward principal portion. The difference would increase along with the note yield, default rate and duration, among other factors. The TITP structure, on the other hand, is likely to have a higher total liquidity amount to allow for sufficient mitigation of the same servicer continuity risk. The probable size of breakeven CE for hybrid structures, which allow for partial utilisation of external CE/liquidity facilities for credit losses, would be between that of the TITP and TIUP structures.

Subordination Versus Cash CE

Account bank ratings have acted as the rating caps for all Fitch-rated Indian ABS transactions to date, because CE and liquidity is typically provided by cash at account banks. We consider this as excessive counterparty dependency. CE in the form of subordination would reduce dependency on account banks and may make it possible for Fitch to rate the notes above the account bank's rating. Furthermore, subordination provides the added benefit of higher excess interest spread compared with all-cash CE. However, breakeven CE in the form of subordination would increase more than cash CE if there was an increase in default rate assumptions or a reduction in recovery rate assumptions.

Back-Up Servicer Versus Larger Liquidity Facility

Fitch-rated Indian ABS transactions, to date, have not had back-up servicer arrangements, with replacement servicers expected to be identified upon the occurrence of a servicer replacement event. A transaction with a hot backup servicer is likely to have a detailed action plan in case of a servicer replacement event, with responsibilities assigned for each counterparty. On the other hand, a larger liquidity facility would allow for a longer time period for the trustee or other counterparties to ensure a smooth and seamless transition to a replacement servicer, even in a stressed market environment.

Static Versus Revolving Transactions

India's securitisation market is limited to static transactions, which we consider to be less risky than revolving transactions. Revolving transactions may be exposed to adverse selection risk and a potential deterioration of underwriting quality during the revolving period. The risk may increase, depending on the length of the revolving period and the tightness of eligibility criteria. Fitch would expect a higher CE buffer for originators or pools where underlying asset performance shows high volatility across vintages.