An investor in an SDI (securitised debt instrument) recently shared with us his experience following a default on interest payments.
Before we get to the story, a quick (simplified) primer on SDIs (it will remind you of The Big Short if you have seen it; if you have not, you should!). Suppose A, B and C have borrowed Rs. 10 Lakhs from a Bank. The Bank no longer wants to recover its funds slowly, one EMI at a time. An SDI allows it to recover lent capital immediately, enabling it to lend again and so on.
An SPV (special purpose vehicle) is created, and it converts these loans into a bundled security – an SDI – that is sold to investors. That is, all loans are combined, and slices of the mix are sold.
Investors’ funds are paid to the bank (the originator), and the loans are removed from its books. The EMIs from A, B, and C paid to the bank are routed to the SPV and remitted to the SDI investors.
There can be multiple SDI tranches with different default rules. There can be a senior tranche under which, even if A does not pay, the SDI investor receives the full amount back. There may be junior tranches in which, if A does not pay, the principal (haircut) and interest will be lost.
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In other words, the senior tranche investors have an umbrella. As long as the rain is not heavy (i.e., there are not too many defaults), they will not get wet. Usually, institutional investors choose this for a lower interest rate.
The junior tranche investors do not have an umbrella. They will get wet if there is a drizzle (a single default), and therefore are paid a higher interest rate as a risk premium.
There can be a buffer or a cash reserve to handle small defaults. A trustee is usually appointed to urge the borrowers to pay on time.
The reader who contacted us is an active investor in both alternative and traditional assets. He had invested in a securitised debt instrument through Grip, an online bond platform. He says, “I made the bet on the pool of loans serviced by UPMONEY (NBFC) as I was going good on P2P lending and was looking to diversify into structured debt instruments”.
According to the reader, the product comprises asset-leasing-backed Pass Through Certificates (PTCs) held in demat form (SEBI-regulated), distributed by Grip Invest (OBPP), originated by UPMONEY (RBI-regulated NBFC), and overseen by Catalyst Trusteeship Ltd (SEBI-regulated).
My understanding is that in such an SDI, instead of a bank, a leasing company lends assets. Instead of EMIs, a monthly lease rent is collected. There could be incidents that result in a loss of both rent and assets. Some or all of the loans bundled in the SDI can then become non-performing assets (NPAs).
According to the reader, the originator (UPMONEY) has defaulted on its payment obligations to the SDI investors in the above product. The reader has received a communication from the trustee requesting a vote on a settlement that would require them to accept a significant loss (haircut) on their principal and interest payments.
This incident once again highlights the risks of chasing returns in the fixed-income space, whether through bonds or debt funds. Although the SDI listing is SEBI-regulated and the originator is RBI-governed in the case of a default, there are no safeguards or bailouts for investors.
In particular, retail investors must be extremely wary of the risks involved and read the scheme documents carefully. They must appreciate the nature of the underlying assets and the possible reasons for default, and recognise that this will result in a sudden and irretrievable loss of both principal and returns.
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