Acuité shall initially assign a Provisional Rating based on the pool data and inputs furnished by the client based on the above steps. The Conversion of Provisional to Final rating will be subject to fulfilment of certain documentation formalities as stipulated by Acuité.

Step 5

The outstanding ratings are subject to periodic surveillance on the pool performance based on feedback and inputs received from the trustee and client.

1. Delinquency Risk/ Credit Risk

The understanding of credit/counterparty risk is critical to the securitization transactions. Since the PTCs are issued on the strength of the underlying receivables, any weakness in performance of the underlying receivables will affect the cash flow profiles and returns of the PTC investors. Hence arriving at an estimate, the estimate of potential delinquencies in the pool is a critical point of the exercise.

Acuité examines the trends in historical delinquency rates across various periods to understand the overall asset class performance. The portfolio outstandings are categorised across time buckets such as 'On Time payment', '30+ DPD', '60+ DPD', till '180+DPD'. Higher the "on time’ portfolio, better is the performance. While it is common to have occasional slippages from On Time to 30/60 DPD time buckets, the near-term time buckets, a higher proportion of the portfolio in longer term time buckets of 90+ DPD could indicate a structural decline in credit quality Acuité evaluates the trend in this historical delinquency rate over a period of time. However, in cases of rapidly expanding portfolios, this delinquency ratio may understate the delinquency risk & it may be prudent to consider lagged delinquency rates as well.

It has to be understood that temporary delinquencies are to be distinguished from structural credit weaknesses. There are certain classes like Commercial Vehicle loans wherein the pool performance could indicate temporary delinquencies which eventually get rectified over a period of time. This is primarily due to uneven nature of cash inflows of the borrower and variations in fleet utilisation. The asset class and nature of security also has a bearing on the credit risk inherent in the pool. Typically, it has been observed that delinquency rates are significantly low in asset classes like housing finance vis a vis other asset classes like unsecured loans/credit card receivables. This could be attributed to factors like nature of the asset, high proportion of owner’ s equity embedded in the asset and the social implications associated with such defaults. In certain other asset classes like gold loans too, the lender can immediately recover his dues by disposing of the liquid collateral. Hence the incidence of credit losses in such asset classes is relatively low.

2. Legal Risk

Analysis of legal risks associated with securitisation transactions is important to ensure that interest of investors is protected at times, especially when credit quality of the originator deteriorates significantly and if the originator’s lenders stake their claim on the pool receivables. Essentially, the analysis revolves around the de-linking of the underlying asset pool and credit enhancement to the pool from the credit quality of the issuer. Thus, in case the originator files for bankruptcy, the performance of the asset pool and its respective credit enhancement will remain unaffected with investors receiving their payments in a timely manner.

For this de-linking to uphold in the court of law, it is essential that the sale of assets from originator to SPV is free of any recourse and that all risks and rewards associated with the asset is transferred from the originator to the SPV i.e. the transaction satisfies the requirements of a " true sale ". It is pertinent to note that in the event of a situation wherein the conditions of a true sale are not met and the originator faces actions from his creditors , such transactions could be derecognised and the investor’s interests in such cases could compromised. Acuité may analyses the specific terms and conditions of the asset transfer agreement, but also other documents including the rights and obligations of all involved. Acuité may also seek third-party independent legal opinion to learn about the legal risks involved in a securitisation transaction, if deemed necessary.

While assessing the legal risk of a given securitisation transaction, Acuité also takes into account the competence and experience of the designated trustee in performing its duties and responsibilities.

3. Servicer Risk

Since cash flow generation from the pool of underlying assets is primarily dependent on the performance of the servicer itself, analysing the profile of the servicer becomes important. Usually in most of the cases, the originator is the servicer in most of the securitization transactions. Since the collections are directly linked to the servicer’s ability to monitor and follow-up with the borrowers, the servicer's ability to adopt and adhere to high standards of servicing i.e., follow-up, collection, timely depositing in pay-out accounts etc. become critical. For medium to long tenure PTCs, the servicer’s credit profile becomes critical since any sharp deterioration in the servicer’s credit quality could impact its ability to discharge its obligations under the servicing agreement. Hence in all the securitization transactions, Acuité also analyses the financial risk profile of the servicer, quality of its management and its track record.

Since Servicer risk is also linked to the credit profile of the originator, any deterioration in the credit quality of the originator i.e., rating downgrade, may trigger the rating of the PTCs associated with the said originator. This essentially is to assess the extent of impact of the originator’s downgrade on the credit quality of the PTCs.

4. Commingling Risk

It has to be understood that in any securitization transaction there is a time lag between the periodic collections from the pool borrowers and the depositing of these collections in the escrow account of the PTC investors. The risk that the pool collections may get commingled with the originator’s funds in the interim period is always present. In times of distress faced by the originator (who is the usually the servicer), it will be necessary to isolate the pool collections from the regular collections of the originator.

5. Macro-Economic Risk

The ability of the underlying asset pool to generate adequate, stable and timely cash flows is also influenced to a large extent by the overall economic environment prevailing in the country or the geography in which the asset class is largely concentrated. Any significant but unforeseen volatility in the macro-economic scenario can influence the value of collaterals of the underlying assets, thus influencing the credit risk associated with the pool. Income levels of the underlying borrowers and interest rates to be paid are certain key variables that impact the ability of the underlying asset pool to generate stable cash flows. Acuité factors in the expected economic conditions over the tenure of the asset pool to incorporate the likely impact of the same on the credit profile of the underlying assets.

6. Regulatory Risk

Any changes in regulatory framework will have a bearing on the performance of the existing pools. For instance, a moratorium allowed by the regulator on certain categories of loans due to instances like pandemics will affect the pool payouts affecting their overall returns.

7. Interest rate Risks and Pre-Payment risks

Interest rate risks primarily arise due to mismatch in the interest rate benchmarks for the underlying pool of assets and investors. For instance, in structures wherein loans in the pool are linked to floating rates and payouts to investors are on fixed interest rates, cash flows from the pool may be inadequate in a falling interest rate regime. While analysing the credit risk in a structure, Acuité takes into consideration the expected movement in interest rates, the cushion between cash flows being generated by the pool and pay-out to investors. In cases where in the pool is linked to floating interest rates, movement in benchmark interest rates also impact the expected prepayments in the pool. Prepayment risk arises when investors receive funds earlier than expected, thus exposing them to risk of re-investing these funds at lower yields. Typically, decreasing interest rates and increasing income levels lead to higher prepayments in pools based on retail loans. While analysing prepayment risk for a given transaction, Acuité analyses the expected movements in interest rates and income levels with historical prepayment patterns for a given asset class.