The fate of Aries Vermogensverwaltungs appeared to be more or less sealed when the Russian Federation recently announced that it would buy back all of its $22 billion in face value of Paris Club debt. The securitization with the astrological namesake is linked to debt that Germany, as a Paris Club creditor, had extended to Russia. As such, the evaporation of the debt would seem to automatically redeem the deal.

But this ram's a lot woollier than it seems.

The collateral for the transaction is actually linked to a credit event of Russia's Paris Club debt to Germany, and that casts some doubt as to what will happen to Aries after the buyback is complete. Closed July 2004, the deal is split into three tranches. Due October 2007, the A notes amounted to 2 billion at issuance and mature October 2007; B notes, maturing October 2009, total 1 billion; and finally, C notes, for $2.4 billion, are due October 2014. Deutsche Bank and Goldman Sachs International were joint leads.

To qualify as a credit event under the structure one of two things has to happen: Russia misses a payment on two bilateral agreements for no less than 50 million and remains delinquent past a grace period of 60 days or Russia's missed payments in total hit or surpass 250 million. If either of these conditions is met, Germany's Federal Minister of Finance can issue a certificate to the issuer and the trustee, Deutsche Bank, stating that a credit event has occurred. Such an event would unwind the deal, with noteholders receiving a fixed recovery rate of 20%.

Without the Paris Club debt to Germany the chance of a default naturally drops to zero, but a few sources involved with the deal said that a redemption of the Aries notes isn't a foregone conclusion. "I don't think [Russia and Germany] have dotted the i's' and crossed the t's'," said one source close to the deal, adding that, until the prepayment agreement is finalized, Germany's course of action with Aries wasn't certain. Redeeming the notes "isn't automatic as far as I know," he said.

A spokeswoman from the German Finance Ministry said that the contract for Russia's prepayment of the debt hadn't been signed yet, and that an announcement of Germany's intentions would be unlikely before the Russian buyback in finalized.

If Germany decided to retire the paper, it would be obligated to launch a repurchase offer since the bonds aren't callable. Apart from those costs, the government might have accounting reasons for keeping the transaction alive, though it's unclear those reasons would remain viable without the linked collateral. What's more, the coupon payments might be too high to justify the transaction solely on those grounds. The A notes priced at 325 basis points over Euribor, the B notes at 7.75%, and C notes at 9.6%.

One source said that the notes could remain in circulation since the structure isn't a pass-through. "Russia doesn't have to send the money, the transaction is backed by payments from Germany to the noteholders," she said. While acknowledging that the chance of a credit event, as defined in the transaction, is nil if there isn't any debt on which to default, the source pointed out that Russia could enter into another Paris Club agreement with Germany before Aries matures.

Indeed, following Russia's announcement, Standard and Poor's assigned CreditWatch Positive to its BBB' rating on the three tranches of the transaction. In a report, the agency said it could boost the ratings as high as AAA', considering the low probability of a new Paris Club agreement and the creditworthiness of the German government, which, in the absence of the Paris Club debt, would determine the deal's level of risk.

Moody's Investors Service rates Aries Baa3'. An analyst with Moody's said the agency was in the process of reviewing the transaction in light of Russia's plans.

Pricing on Bloomberg was only available for the B notes, which have fallen to a midmarket price of 103.88 at last quote from 105.20 in early January. The overall gloomy environment, especially for emerging markets, has no doubt played a role in the drop.

Established in 1956, the Paris Club is an informal group of creditor governments from the world's wealthier countries. Russia finalized an initial prepayment agreement with the Paris Club in the summer of 2005, when it paid down the $15 billion of debt it owed to the United States. When the Aries transaction closed in July 2004, participants didn't foresee prepayments by Russia, sources said. But skyrocketing energy prices have filled the Russian government's coffers, giving it ample room to reconfigure, and even wipe out, its liabilities.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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