Recent events in Russia are putting its RMBS under tighter scrutiny.

While Russian mortgage originators had been basically shut out of the market since mid last year, they had nonetheless remained aloof from the worst of the West's financial volatility. This is no longer true.

As the international liquidity situation deteriorates with alarming speed, Russian consumers are facing sharply higher mortgage rates, a fraying ruble, declining property values and stock plunges that have sharply exceeded the Dow's.

Still, RMBS deals are holding up well, although origination is likely to drop sharply from the fast pace of the last few years.

LTVs: Leaner Than Ever

Buoyed by high energy prices, Russia's economy has been growing at breakneck speed, with GDP rising 8.2% in 2007. This, along with factors crimping supply, has fed into upward spiraling property prices, especially in the urban centers of Moscow and St. Petersburg. As of mid this year, Moscow home prices had increased nine-fold since 2000, according to a report by Moody's Investors Service. In the second quarter, growth tamped down a bit, to 29% year-on-year in the Moscow region and 33% in Moscow itself.

But the macro picture has altered dramatically since early August, with a significantly weaker currency, lower oil prices and plunging share values compromising the price boom. Matters haven't been helped by brisk capital outflows following recent conflict in South Ossetia and its damage to relations with the West.

While more formal statistics are not available yet for drops since late summer, anecdotal evidence points to an indisputable turnaround. Several newswire reports show that prices on newly built apartments in Moscow started to edge down beginning in September. One realtor ascribed the retreat to developers' push to make quick sales as short-term credit had dried up. That would augur particularly ill for the months ahead.

Meanwhile, on Sept. 29, Bloomberg cited Russia's Vedomosti--a business daily owned in part by Dow Jones and the Financial Times­ - reporting apartment prices had declined by as much as 24% in the regions since the spring.

As price declines are likely to beat amortization speeds, LTV ratios are heading up. But their current levels are exceptionally low, providing plenty of room for increases before distress sets in.

For the nine deals collateralizing Russian mortgages rated by Moody's, the WALTV at closing ranged between 51.3% and 71.2%. And this doesn't even tell the whole story.

"Between the time the loans were granted, and the deals were rated, prices had gone up considerably," said Jaime Sanz, senior director at Fitch Ratings, which rates three dollar RMBS from Russia.

What is more, prices have risen dramatically since issuance, which for all but one deal - a geographically dispersed ruble-denominated transaction from government-linked Agency for Housing Mortgage Lending (AHML) - took place before mid 2007. As a result, LTVs prior to the recent price declines were even lower than at closing.

For the three RMBS deals rated by Fitch, for instance, LTVs were at least several percentage points lower in August than at issuance, and this takes into account that Fitch only credited 50% of the reported price increase (see table below).

Another strength shared by these transactions is the characteristically high prepayment rates of Russian borrowers. For the deals rated by Moody's, constant prepayment rates have typically hovered in the range of 10% to 30%, averaging 20% in the first half of 2008. In Russia, mortgage holders try to pay down their debt as fast as possible.

Wobbly Ruble

Even with all the troubles facing the U.S., the dollar remains the currency of choice when investors scramble to safety. That is what has been happening lately. Add that to a weakened oil market and tension with the West, and it's clear why the ruble has been shedding value. As of ASR's closing, the ruble had lost about 10% of its value against the dollar since early August.

This obviously sends the cost of mortgages up for Russian borrowers with a dollar loan, as their income tends to be at least partly denominated in rubles. There are several outstanding RMBS denominated in dollars that have underlying collateral in the greenback. For now, at least, sources said that modest LTVs, combined with strong credit enhancement, would offset some devaluation in the ruble. Also, the economy is still growing.

"Given the strong macro-economic environment in Russia for the first nine months of 2008, we have not seen an increase in delinquencies," said Serge Ozerov, chief financial officer for DeltaCredit, which originated a dollar-denominated RMBS in Russia.

At any rate, the ratio of ruble-denominated mortgages to dollar loans is on the rise (see table above), and it's likely that ruble RMBS will become more prevalent in the future.

Origination and the Return of RMBS

While the performance of outstanding Russian RMBS will certainly shape the prospects of future issuance, there are other drivers as well that are more determinant. One is the appetite from cross-border and Russian investors. It goes without saying that right now that appetite is nil. When it will come back and where it will be focused is anybody's guess at this point.

One London-based banker said that market anxiety has heightened investors' preference for assets in their home country, with German buysiders, for instance, purchasing deals backed by German assets.

"That's happening throughout Europe," he added, saying that when Russian RMBS does return, it will likely be with a strong bias towards ruble deals marketed to Russian investors.

Another salient factor of the outlook in Russian RMBS is origination. While it's still growing by most accounts, the rate of lending has undoubtedly come down. By mid-year, growth had slipped (see table above), and recent reports of impossibly priced mortgages at a number of institutions point to a further slow down.

In addition, difficulties obtaining funding had forced a number of smaller players out of the market earlier this year. There may be another round of drop-outs taking place right now.

What all this adds up to is that the imperative to shift loans off balance sheet is nowhere as strong as had been projected a year or so ago.

All the same, it's important to recall that the room for mortgage growth in Russia remains enormous. The RUR824 billion ($31.5 billion) in total mortgages at the end of June equaled about 2% of GDP. That ratio averages 49% in the 27 countries of the European Union.

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

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