A number of emerging market players delighted in the rhetoric last year about their world trading places with the U.S. The longtime risky bet and the safe haven, it appeared, had flipped.

But soon the liquidity crunch metastasized into nearly every corner of the globe, infecting emerging markets as well.

Few caught it as badly as Kazakh banks. Avid borrowers of overseas money when Western banks and bond investors dripped with funds, these institutions suddenly faced a dried-up marketplace.

At the same time, the strong sentiment around Kazakh banks tapping diversified payment rights, RMBS, and other yet-to-emerge asset classes started to fray. Perhaps more than anywhere else in emerging market structured finance, the liquidity scare turned a story of bright promise into a cautionary tale.

There was still activity after July, but it was hard going. Beleaguered joint bookrunners ABN AMRO and Standard Chartered closed a $750 million DPR transaction from Bank TuranAlem in October, but market sources at the time said the deal was swallowed by the arrangers or their warehouses. Ambac Assurance Corp., FGIC and MBIA wrapped tranches in the deal.

It is true that ABN announced a $200 million mortgage warehousing facility with a TuranAlem unit BTA Ipoteka in December, but even then an official from the arranger acknowledged the deal probably wouldn't come to term until the second half of 2008.

The ebb of funding worldwide didn't push any Kazakh banks to the brink, but it did expose real and potential weaknesses that were either overlooked or negligible while the economy boomed and liquidity poured in. "The global liquidity squeeze has presented banks and regulators with their sternest test in years," said Ekaterina Trofimova, associate director at Standard & Poor's. She said that banks have successfully managed the immediate impact of the liquidity crunch, but that a more protracted crisis could have a more serious effect on their creditworthiness.

Last year, issuer downgrades hit structured deals too.

In December, S&P cut the unwrapped and underlying ratings on Kazkommertsbank's DPR notes to BBB' from BBB', following the agency's downgrade of KKB's long-term foreign and local currency credit rating to BB'. More importantly, the bank's survivability assessment, a key ingredient of a future flows rating, was cut to BBB-' from BBB'. S&P also put the foreign and local currency ratings of TuranAlem and Alliance Bank on negative outlook.

In November, Moody's Investors Service put DPR notes issued by KKB and TuranAlem on downgrade review. The originators have said they would tinker with the structure - installing triggers most likely, sources said - presumably to avert a downgrade. Prior to the move, the agency had cut TuranAlem's foreign currency unsecured debt ratings to Ba1' from Baa3', and Kazkommertsbank to Ba1' from Baa2.'

Neither Moody's nor Fitch Ratings changed their rating on Kazakh Mortgage Backed Securities, a $141 million deal issued by BTA Ipoteka off the same kind of facility that opened in December. The servicing impact of issuer downgrades was marginal and the pool performance strong, Moody's said about the deal.

But in light of last year's changes, the view of Kazakh's existing asset potential isn't as rosy as it had been going into 2007.

"We certainly expect some deterioration in the asset quality, particularly in those banks exposed to real estate and construction segments," said Armen Dallakyan, banking analyst at Moody's. TuranAlem and KKB are among the banks with large investments in those businesses.

Ultimately, the retrenchment of foreign funding sources had a drastic effect on loan growth, which, until August, had outraced an economy growing in the 9% to 10% range over the past several years.

Outstanding loans in the Kazakh banking system shrank by 1% in the last four months of the year, according to S&P, a sharp swing from the 40% expansion posted during the first eight months of the year. Loan growth had been in the 75% range over the past several years.

Dallakyan also pointed out that investment decisions were often made in terms of the pace of economic growth seen in the past few years, a scenario that's unlikely to pan out for the next year or so.

Ultimately, when financial markets settle down, the banks will have to return to foreign markets. "Local funding is stable, [but] it's quite limited and insufficient to support the previous growth rates and very short-term," S&P's Trofimova said.

For these issuers, 2007 may end up as the year that provided an opportunity to pursue more realistic financing and growth targets, sources said. While the Kazakh banks weren't hit through their future flow or MBS activity, their issuance in these markets was part of an overall strategy that was only sustainable if the good times had carried on. And they never do.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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