Safe and securitised
A generation on from the collapse of the Soviet Union, and Russia is still plagued by the shortcomings of communism – with a critical shortage of housing perhaps the most pressing. It is a problem that the government is keen to tackle and it has turned to the ingenuity of structured finance to resolve it. Benjamin Seeder reports.
Mortgage securitisation had auspicious beginnings in Russia. It burst onto the scene in 2005, and issuance volumes ballooned the next year. Driven by white-hot growth in the country's mortgage and consumer finance markets, securitised assets went from nil to US$3.5bn by the end of 2006. By 2007 it was looking even better for bankers, with some US$2.5bn worth of securitised deals in the first half alone.
Then the problems started. "Everyone in 2007 was expecting a deluge of deals in the second half, with many banks choosing to accumulate larger portfolios, but all of it was subsequently delayed with the liquidity crunch," said Hal Rilling, head of CIS securitisation at Standard Bank in Moscow.
Total securitised issuance declined to US$1.86bn in the second half of 2007, according to figures from Moody's. The second half of the year saw just one RMBS transaction - a US$180 note from Russian second-tier lender Moskommerzbank - against four in the first half.
It was the reverse of the situation in 1998, when a financial crisis in Russia spread to affect the developed markets. This time, the contamination of US sub-prime mortgages spread to Russia, cutting the legs out from an ABS and RMBS market that was about to blossom.
Richard Clement, a structured products specialist with Troika Dialog in Moscow, said spreads on Russian paper have doubled or even tripled since mid last year. "In the Russian RMBS and ABS markets, even though nothing has fundamentally changed with the underlying assets, anything bearing the name securitisation is hard to sell right now," he said.
Olga Gekht, an analyst with Moody's Investor Services in London, said investors have left Russia despite there being little changes to the fundamentals of Russian mortgaged-backed paper. “Russian RMBS ratings are essentially limited by sovereign ratings, so you have what are basically prime mortgages packaged as lower investment grade," she said.
Russia's fundamentals are still extremely strong. Consumer spending is growing at around 17% per annum, underpinned by record-high prices for oil and gas - the country's main exports by value. Despite the seemingly good value, analysts predicted the market will probably remain closed for the time being.
Troika's Clement said there are two types of investors in Russian securitised assets: the global institutional investors that are familiar with securitised assets but are diversifying geographically to Russia; and the Russia-specialists who are diversifying their product mix to securitised assets.
"As far as I can tell, the first lot of (global institutional) investors have completely left this market. The smaller Russian specialists are still here but they are demanding much higher prices," he said. He believes the mortgage securitisation market won't return before the end of this year, and only shorter duration deals, such as factoring and consumer credit securitisations, will get off the ground. "Leasing deals could be interesting as well," he added.
The only cross-border mortgage transaction on the cards right now is being arranged by Morgan Stanley for local investment bank, Kit Finance. Known as the RUMBA deal, Kit Finance is securitising some RUB7bn of mortgages. It acquired the loan portfolio from smaller Russian originators who decided to abandon securitisation programmes after financing costs soared. Rilling said almost all of the Russian securitisation deals that were set to close in the second half of 2007 were warehoused, delayed or abandoned. "I estimate some US$11-$12bn in issuance from the second half of 2007 and first half of 2008 has now been warehoused or delayed," said Rilling.
Eugene Gorelik, a banker with Credit Suisse in London, said the problem now is many of these warehoused deals signed last year are reaching expiration. Most have both 6-month and 12-month punitive step-up coupons attached. "I think most of them were signed on Libor plus 100 bps, with 365-day durations, but they all had punitive step-up coupons after that - it is effectively considered a default after that point," he said.
As a consequence, he believes many of the Russian RMBS deals that were warehoused have now - or shortly will - see rates rise to between 450 and 600 bps, from around 100 bps, as the warehouse arrangers exercise the punitive step-up coupons on the deals. "As the spreads on the warehouse deals rise, I think alot of these banks will be losing money, but their hope is this will turn around by the end of this year," Gorelik said. The result is many originators unable to refinance at the stepped-up rates have sold their loan portfolios.
Gorelik estimated US$1bn of the assets warehoused since last year for securitisation at a later date have now been sold off. Buyers include Russian hedge funds, such as Yamal, investment banks like Kit Finance, and the bigger Russian originators like Gazprombank and VTB, who are keen to expand their lending. "I know that VTB had a standing buy offer for any mortgages afew months back, although they are probably more selective now," said Rilling.
Most experts agreed there would be a long wait for the mortgage bonds market to bounce back, and that could pose problems for cash-starved originators. "The mortgage market in Russia is now over US$30b, and it has been doubling every year in the past few years. Many originators are writing US$30-$50m per month in new mortgages," said Standard Bank's Rilling.
The problem with such break-neck growth is that it needs to be financed from somewhere, and the source of the majority of the funding - foreign investors - has now dried up. The problem is especially acute for smaller, regional originators, many of which are unrated by ratings agencies, and are unable to tap alternative sources of funding. For these banks, securitisation was a boon – perhaps their only path to global capital markets. Now that path has closed.
"Securitisation has proven to be a good way for lowly rated or non-rated Russian banks to access international capital markets," said Gekht. This is forcing Russian originators such as state mortgage agency AHML to push for changes that would boost local investment into the mortgage-backed securities market.
"There are two measures they are talking about - allowing the Russian state pension fund to invest in more domestic asset classes, including mortgage-backed securities. And including mortgage-backed securities on the Central Bank of Russia's Lombard list," said Mikhail Galkin, an analyst with MDM Bank in Moscow.
The state pension fund has around US$12bn in assets, most of which is held as cash or very low-yielding government bonds. In fact, the returns on the fund's assets for the past five years have averaged 6-8% - considerably below the inflation rate.
Experts are already calling for the policy to be changed. "We need to support the market of mortgage-backed securities (by) creating demand from institutional investors, including pension funds, insurance companies and possibly the National Wealth Fund," said Mikhail Zadornov, head of retail banking at VTB, one of the country's largest originators.
Indeed, on April 8th, Finance Minister Alexei Kudrin suggested change was on the cards when he told reporters that the issue of the Pension Fund's investment strategy would be resolved in 2008.
The inclusion of mortgage-backed securities on the CBR's Lombard List would potentially have a much bigger impact, experts agreed. "The effect would be substantial and immediate in increasing new liquidity into the mortgage sector, I think it's going to be a big thing this year if it happens," said Rilling.
Credit Suisse's Gorelik estimated that up to US$23bn in new liquidity could be brought in if the CBR allows both local and cross-border mortgage bonds onto the list. "We have been monitoring what the CBR is doing very closely. I understand things are developing there, but it isn't final yet," he said.
For local investors, the issue of the Lombard List and the pension fund's investment rules are critical in forming a viable market. Maxim Tishin, who manages a US$250m bond portfolio for UFG Asset Management, said he is unimpressed by the relatively low yields and liquidity of the mortgage bonds issued locally in 2007 by state mortgage agency AHML and Gazprombank.
Gazprombank closed the first mortgage securities issued under new Russian legislation last year, while AHML - the equivalent of the American Freddie Mac - followed suit in September last year. It closed another RUB9.5 billion deal in February this year. "I remembered the issues, but we only bought a small amount for our offshore fund. It wasn't really of interest for Russian investors, there is just too much more liquid, higher-yielding paper in the Russian corporate bond universe," he said.
As evidence, industry insiders point out that AHML's issues were very poorly received. Both had very low yields, and the second deal failed to attract any investors - the issue bought entirely by AHML itself. But Tishin said this situation could change if the state pension fund was allowed to buy Russian mortgage-backed securities.
With housing shortages continuing, despite a boom in construction, there is every chance the mortgage-backed securities market will remain on the government's agenda. "I was in Moscow last week, and the thing I noticed is you can't turn the TV on without hearing gripes on the housing problems there," Gorelick said.