Wednesday, 19 September 2018

Real Estate Finance: To boldly go

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Russia’s mortgage market is attracting the world’s biggest banks, despite being worth a mere 2% of GDP. But real estate finance bankers see the country as having tremendous potential. The country’s first securitisation only came in July 2006, but it was rapidly followed by two more, and already market insiders are predicting five or six transactions this year. Oliver Bullough reports.

Russian mortgage lending more than doubled last year. Average prices per square metre for new-built flats have tripled since the start of 2002. Housing stock in some towns increased by more than 10% last year. The government has made building new homes a key strategic goal. In a word, the country’s property sector is booming.

The State Mortgage Agency, according to media reports, is itself planning a securitisation deal with Citigroup as lead manager. It estimates stellar growth in levels of mortgage lending. From a total of Rbs291bn last year, it forecasts a total of Rbs407bn by the end of December. By the end of the decade, that will have risen to Rbs798bn.

It is hardly surprising then that the world’s biggest banks are getting involved.

"Every time I pitch to a client I am aware that other banks are also actively pitching to that same client. The Russian RMBS market will become exceptionally large,” said Michael Strange, a director at Barclays Capital.

BarCap co-arranged the first deal, for state-owned bank VTB, last summer. It was denominated in US dollars, sold abroad and secured on mortgages in Moscow. The bank has since arranged a trickier deal for Sovfintrade, the mortgage subsidiary of state gas giant Gazprom’s bank, that was denominated in roubles.

"Dollar-denominated deals are primarily Moscow focused. In Moscow the property market is primarily in dollars and people who work for large companies or multinationals frequently get paid in dollars. However, the majority of growth will come from the regions where mortgages are denominated in roubles. The deal we did with Gazprombank provides the template for future deals from this growing sector," said Strange.

Other banks getting into the action include SG, which started a roadshow for a securitisation deal from its Russian unit DeltaCredit in March; Morgan Stanley, which bought Russia’s CityMortgage in January; and Raiffeisen, which bought Impexbank last year. CityMortgage and Raiffeisen have already securitised their own deals, and more are in the pipeline.

"There are several new deals that will be announced in the next couple of months," said Nikolai Chitov, president of CityMortgage, which was bought by Morgan Stanley in December.

"We are preparing a second deal together with Morgan Stanley. The number of transactions that are in preparation has grown very significantly . . . By using our previous experience, we are going to place this second deal on European and US markets as well. We are considering now [a total of] US$150m–$200m."

And all this comes together with substantial political support. Russia’s government has set up four National Projects as a way to spend the country's vast oil earnings, and the most important is to create affordable housing for Russian, many of whom live in Soviet-era housing that has decayed since 1991.

Dmitry Medvedev, a close ally of President Vladimir Putin and one of the favourites to succeed him into the Kremlin, is in charge of the programme, which gets regular television play on state channels.

Under the plan, the Kremlin wants the number of mortgages given out to rise from 46,000 in 2004 to 1m by 2010. And with the Kremlin so keen, Russia’s compliant parliament has rushed through the laws needed to create a modern securitisation market.

However, problems remain. "The domestic mortgage securities market is heavily regulated, and this is an impediment. If a bank is considering funding then the initial advice would be to go with an international [dollar-denominated] structure because it is quicker to execute and the market is generally deeper. The transaction costs are higher, but the deal will likely get a better rate,” said Vladimir Dragunov, securitisation partner at law firm Baker and McKenzie’s Moscow office, who advised banks on most of the securitisation deals last year.

As an example, he said a US prospectus for a typical transaction would come to around 400 pages. The extra weight of Russian regulation means Sovfintrade’s prospectus for its rouble-denominated deal was 1,700 pages long. And all that extra legal advice is expensive, complex and time-consuming.

Lena Krepikova of the World Bank’s International Finance Corporation saw the flaws in Russian legislation close up last summer when she was helping to arrange the CityMortgage securitisation deal.

“There are still a lot of things to work on, and Russia is in the process of drafting a general law on securitisations . . . The president and administration are very supportive and that helps push the necessary amendments to legislation,” she said, singling out escrow accounts as something Russia needed to introduce. She also said the complex nature of the registration process made mortgages far more expensive than they need to be.

But she warned potential investors that political support from Medvedev could backfire, especially in the light of his recent comments that mortgages in Russia were too expensive. With parliamentary elections in December and presidential elections next year, the temptation to play the populist card and accuse banks of ripping their clients off will be strong.

Medvedev has already made moves in this direction. Speaking in January, he welcomed the rush to buy houses on credit, but said the rate charged should be “fairer”.

“The government thinks, and Medvedev said, that the interest rate should be below 4%, but this is not possible unless the government subsidises rates. Interest rates are decreasing but the minimum is still 9.5% for hard currency and 12% for roubles,” said Krepikova.

And for the man in the street, the mortgage experience is far from smooth. Russia is still largely a cash economy and an opinion poll last year showed almost a quarter of Russians had no idea what a mortgage even was. Credit may be expanding, but that does not mean people are prepared to trust banks, or that banks and estate agents are making things easy for customers.

Take the case of Carl Schreck, an American living in Moscow who spent more than a year trying to buy a flat with his Russian girlfriend.

“We started looking for a place in August 2005, and ended up sealing a deal in October 2006, by which time real estate prices had probably risen by more than 100%. Prices were going up so fast that it was not in the interests of the estate agents to process the paperwork because the price of the flat could have risen by US$15,000 in the meanwhile,” he said.

“We would just have not to admit we were buying with a mortgage, and if we did let it slip, then the estate agents would just hang up instantly. When we finally got a place lined up, there were all sorts of weird details. We had to carry US$35,000 worth of roubles to the banks – bricks of roubles – for the hand-over. We were terrified we might get robbed.”

With snags like that, it is unsurprising that many people do not go through banks, preferring to make informal deals with the property's seller. But statistics show that distrust is slowly fading, the market growing, and the number of participants increasing.

State bank Sberbank had more than 60% of the market in 2005, but was the source of only a quarter of mortgages issued in 2006. The nine largest private banks, including CityMortgage, had around a quarter of the market between them, while the State Mortgage Agency had 20%.

But despite the government’s hurry, it can do nothing about the largest snags – the innate conservatism of the big rating agencies.

The rating agencies are nervous about these deals, and will need considerably more time before they can start giving them top marks. Standard & Poor’s rated the Class A tranche of Sovfintrade’s rouble-denominated deal at BBB+, while Moody’s gave CityMortgage’s US dollar-denominated deal Aaa.

“There is no real experience yet because there is no information on foreclosure, conditions, prepayment (both partial and full), so the rating agencies are trying to be conservative and that is why the first transactions were rather expensive. The market hopes that when the cycle is completed, it will become cheaper,” said the IFC's Krepikova.

For similar reasons, the monoline insurance agencies will not yet wrap issues by Russian mortgage companies. For Barclays Capital’s Strange, this is one of the two main factors holding back the development of the market, along with the technical difficulties surrounding the swapping of roubles into hard currency for periods up to 40 years.

“If you have 10 Russian banks issuing US$400m–$500m deals each on a regular basis, then these are big numbers, particularly when you remember that the highest rated note class will be Single A,” he said.

“The only way forward would be for the monolines to become involved and provide insurance wraps for the senior note classes. They are looking at the market, but have not yet become actively engaged. If a monoline is brave enough to bite the bullet, then it has the potential to gain exposure to a rapidly growing market which will be exceptionally profitable."

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