While Russia still makes some players nervous (see related story, p.1), specialty arranger Greenwich Financial is betting on the country and its originators. The previously U.S.-centric shop snuck onto the emerging market scene in July, with the first transaction backed by Russian auto loans (see ASR 8/1/05). On the sidelines of the Securitization in Emerging Markets conference held by the New York Society of Security Analysts, ASR sat down with senior vice president Dmitri Dorofeev to discuss intriguing features of the transaction and what kind of MBS a new law in Russia would most favor, an area that the firm is pursuing.
ASR: In your auto-loan deal, there was a small inverse floater of $100,000 sold in tandem with the $43.7 million A1 piece. Could you explain how this worked and why you did it?
DD: It was to split the credit risk and the prepayment risk. If you separate it, the deal works [because there's] a split between the two investor types (those comfortable with credit risk and those seeking prepayment risk). We basically concentrated the entire negative convexity of the collateral and stuck it in the small piece. Most of the risk is on the credit side - people defaulting on the loans, but by virtue of the coupon being floating and the price being par there is very little negative convexity in it. And [as an investor], you get your money; you're largely indifferent whether people pay fast or slow. In the small piece, the defaults are not a major concern, but it sells at a major premium, so the investor pays a million dollars, because the coupon is huge, [roughly] 1,500%. But the underlying reduces fast. [Soon] you're getting the 1,500% on only half the issuance amount [and so forth] - it's a race against time. Also it's reversed to Libor, so every time Libor goes up, the coupon [drops]. A hedge fund bought the inverse floater.
ASR: While the bond and the collateral are denominated in dollars, most, if not all, of the borrowers earn their income in rubles. A severe devaluation, then, would jeopardize the borrowers' ability to pay their dollar loans. How did you tackle this problem?
DD: By using a Z bond (a tranche below the subordinated B series, amounting to $1.99 million) for the subordination. It has a nominal coupon of 8.75%, but instead of paying it to holders of C class it pays to holders of A class bonds and accrues the same amount to C's principal. That way, we end up de-leveraging the deal very rapidly. The senior bonds then pay off faster and the portion of the subordination in the deal increases quicker, mitigating the risk of an FX (foreign currency) movement adversely affecting the transaction. Normally, the risk of a currency devaluation is perceived to be higher in the future. So having the deal amortize this way, if a devaluation hits, there would be more subordination on an absolute basis and on a proportional basis, coming from the Z structure. The originator has retained that tranche.
ASR: The country's recently passed MBS law has put that asset class on the radar. Right now, what's possible with a local MBS?
DD: For one, we don't think it's possible to do a domestic deal with a domestic SPV. (Greenwich used a Dutch SPV governed by English law for the auto loan deal.) Russian law, for example, doesn't provide for tranching in terms of credit risk. What the new MBS law does do is lay down the framework for [originating] loans and enforcing them, so [a lender] can repossess the house. The law introduces two kinds of bonds that can be issued. One is a mortgage certificate, which has a pass-through structure like here in the U.S. The other is a mortgage bond, which is the German type. The mortgage certificate establishes the right to collect the loan and the right to enforce the mortgage and repossess the collateral. Those rights can be transferred to the SPV. That makes it easier [to securitize].
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