The Russian bear still has an unmistakable limp. A fragile economy, spooked consumers and the absence of foreign investors are undermining the return of RMBS, but, given the brutal conditions, the performance of deals has held up relatively well.
Facing its most severe recession since the catastrophic financial crisis of 1998, the country saw its economy shrivel annually by 10.9% in 2Q09, the steepest drop on record.
A plunge in energy prices from their peak sent the ruble sliding, which neutralized Russian corporates' affair with overseas money. In addition, it added to the burden of consumers holding dollar debt but earning in local currency.
Only compounding matters, private-sector external debt repayments for 2009 are projected to total $137 billion, with 48% of that figure owed by the banking sector.
The Bank of Russia has attempted to alleviate financing pressure by injecting roughly RUR821 billion ($26 billion) into 17 banks starting in 3Q08. In addition, the Bank has been on a monetary-easing tear over the last few months, cutting the benchmark interest rate five times since April. But the scars from the violent economic about-face are not healing so easily - banks are loath to resume lending, while consumers are afraid to borrow.
"The liquidity squeeze has prompted many of the Russian banks to reduce or even stop lending to both consumers and corporates since 3Q08," Fitch Ratings said in a report.
According to the Bank of Russia, lending to consumers dropped 1.1% in June for the fifth consecutive month, while banks' loan books edged down by 1.2%.
All of this naturally augurs ill for the resuscitation of a once-thriving RMBS market, not to mention the future other asset classes that had not left as large a footprint.
Origination growth continues to falter while the outstanding volume of mortgages keeps shrinking. Moody's Investors Service reported that the value of outstanding mortgages has fallen in every month since February 2009. "For now, that trend might continue," said Nitesh Shah, an economist at Moody's.
With less raw material, the Russian RMBS machine will find it difficult to restart in earnest. But the demand side of the equation is an even bigger problem, with foreign investors out of the picture and domestic liquidity or willingness to buy seriously lacking.
Demand right now rests on the Bank of Russia and its Lombard List of repo-able securities.
"The domestic market itself is not completely dead, but it's clearly not driven by international demand. In principle, the Central Bank is accepting a broad range of collateral, including notes issued by RMBS transactions," said Fitch Director Michael Hoelter. What the Bank is doing in principle, however, has not reverberated very far in the RMBS market.
Indeed, by some accounts only a single RMBS has closed in any market of the Commonwealth of Independent States (CIS) this year. This outlier was a ruble-denominated deal with a 30-year legal final originated by VTB24. Sized at RUR14.5 trillion ($453 million), the three-tranche deal was issued from a domestic SPV, making it eligible for the Lombard List. Russian RMBS issued from a foreign SPV - which are the lion's share of outstanding deals - are not eligible to be repo'd.
"It seems that recently, investor interest in Russian RMBS has been limited, as has also been the case in other RMBS. To the best of our knowledge, transactions that have closed recently have been done for repo purposes," said Olga Gekht, a senior analyst at Moody's. "However, it would be difficult for the Russian RMBS market to grow from just repo activity."
Performance: Slipping but Holding Up
Outstanding deals, for their part, are proving to be fairly resilient, given the sharp contraction in property prices, the plunging ruble and other assaults on their performance. Among the 14 deals rated by Moody's in CIS countries - 12 of which are backed by Russian mortgages - nine still feature delinquency levels below 2%.
Increased redenomination risk in deals backed by dollar mortgages has been one cause of deteriorating credit quality and, by extension, downgrades. Obligors who earn in local currency are finding it increasingly difficult to make payments that have risen in ruble terms. Add falling house prices and a higher risk of unemployment, and borrowers appear to be significantly more apt to default.
But Russian deals have a few advantages on their side as well.
For one, these RMBS, while not especially seasoned, have tended to amortize quickly. Part of the reason is that local borrowers belong to a debt culture that encourages prepayments. As the economy deteriorated, prepayments did indeed erode, but they have not disappeared.
According to Moody's, the constant prepayment rates (CPR) for RMBS transactions in the CIS have mostly remained between 10% and 30%, averaging 12% in 1H09.
"In general, the CPR has not been going down as dramatically as we have seen in a lot of more developed mortgage markets, such as the U.K.," Gekht said.
For the three deals in Russia tracked by Fitch, the average CPR fell a bit more, to 8.9% in June, which is still on the high side by U.S. RMBS standards. In addition, the rapid amortization fueled by higher CPR early on had already plumped up enhancement levels on all the deals covered by Fitch.
Certain Russian banks, such as VTB24, have let borrowers in foreign currency loans swap their loans over to rubles, which might have been a factor preventing prepayments from vanishing altogether in the adverse economic climate. "The state-owned banks especially have been required to provide such programs," said Stanislav Nastassine, an analyst at Moody's. "I wouldn't say it was widespread, but it accounts for some portion of the CPR."
Another indicator that has deteriorated but is likewise a long way from critical levels is the average loan-to-value ratio. While the crisis has pushed up delinquencies and defaults, current LTVs still average below 70%, Fitch said. As a result, recoveries from property sales remain well above the outstanding loan amounts. Using a loose measure of local property values, the agency found that all the deals it covers would have current LTVs below 50%. Indeed, Russian Mortgage-Backed Securities, originated by VTB Bank, would have a current LTV that falls below 30%, thanks to the deal having closed in July 2006, before a boom in property prices in Moscow and much of the rest of the country had played itself out and then reversed.
Servicing Transfers in the Mix
Where deals have seen their servicers go through downgrades, the issue of transferring duties to backup servicers has arisen. This might prove to be a good test of the ability of RMBS in the CIS to make a smooth transition.
Moskommertsbank - the originator/servicer for Moscow Stars - notified debtors in early August that it had to make payments with backup servicer Raiffeisenbank. This came after Fitch cut the rating on Moskommertsbank to 'CCC' following a downgrade of its parent Kazkommertsbank.
In the transfer, the documentation stays with Moskommertsbank, but the servicing moves to Raiffeisen. The senior tranche of the deal, initially $159 million, had about 59% outstanding at last count and after downgrades was rated 'BB+' by Fitch and 'Ba1' by Moody's. The ratings at launch were investment grade.
In a report, Fitch expressed its concern about Raiffeisen's readiness to take over the servicing function in the event of MKB's insolvency.
In case of servicing transfers in Kazakhstan's only outstanding RMBS, Kazakh MBS 2007-1, there are issues surrounding the backup servicer's ability to handle a different kind of collateral sub-type.
While the debt default of the primary servicer's parent BTA Bank and the ongoing development of a restructuring plan have not directly affected the RMBS, these events have opened the door for trustee ATC Trust to transfer servicing from BTA Ipoteka (BTAI) to backup servicer Halyk Bank.
But up to August 2009 the trustee had chosen to keep BTAI as primary servicer. Hoelter said ATC is expected to set up a meeting where bondholders will be able to decide whether they would like a switchover.
At any rate, so far there hasn't been any indication that BTAI, as a unit of the distressed BTA, would go against the true sale of the assets or that the primary servicer has stopped providing the day-to-day servicing at adequate standards, according to Hoelter. "The true sale is governed under English law, but it would be subject to whether a decision of a foreign court, including internationally recognized arbitration institutions, would be enforced by Kazakh authorities," he added. "So far there is no case where this has been tested."
The main challenge in a potential servicing transfer stems from the fact that Halyk does not provide the kind of dollar-linked mortgages that are funded through Kazakh MBS. "Halyk will need to change their systems to take over the IT-supported administration of such a loan type," Hoelter said.
Nonetheless, he added, Halyk has previously taken over portfolios it has not originated itself.
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