Securitising future flows or mortgage portfolios is rare in central and eastern Europe, but interest in this financing tool is growing in the region. Geraldine Lambe reports.Securitisations of one flavour or another may be the financing plat du jour in western Europe, America and parts of Asia, but in many financial markets they remain a rare dish. While lots of bankers in New York and London feel that securitising future flows or mortgage portfolios is commonplace, maybe even old hat, few, if any, deals have been struck in regions such as Russia, the Commonwealth of Independent States (CIS) and eastern Europe.

“There is a growing interest in these sort of structured finance deals in eastern Europe,” says Paul Sass, head of structured finance at OTP Bank in Hungary. “But at the moment there is a lot of talk and not much else.”

Several barriers need to be overcome before this efficient financing tool takes hold, including regulatory and legal issues, unrated originators and servicers of securitised paper, the low cost and simplicity of existing lending terms and the lack of depth in local capital markets, says Mr Sass. “The market in Hungary is over-banked, and competition is very sharp. Cheap lending is available for whatever projects corporates want to undertake, and obtaining capital relief by moving assets off the balance sheet is not a hot topic for issuers here.”

Movement in Poland

Deals are beginning to be made, however. In June, Fitch Ratings assigned an expected triple B rating to the notes to be issued by DTC Real Estate Finance SP z.o.o. (a majority stake of which is owned by Dutch company Eastbridge NV) on behalf of DTC Real Estate SA, the operator of 12 commercial properties in Poland. This is the first commercial mortgage-backed securitisation in Poland.

At closing, the issuer will issue 320m zlotys ($81.96m) rated bonds, the proceeds from which will be used to purchase bonds issued by the Polish operator and the funds to refinance existing debt under a syndicated loan agreement. The issuer is an insolvency remote, special purpose vehicle (SPV) incorporated in Poland and established just for the purpose of issuing the notes.

But a fundamental problem in most emerging markets is that the regulatory and legal systems are ill-equipped to deal with some of the complexities of structured finance. For example, clarification of the structure of the SPV and the transfer of securitised assets is often needed, and there are limits on the ability of institutional investors to invest in this type of security. Equally, there are inefficiencies that must be ironed out.

Reform needed in Russia

Marcus Hopkins: for most Russian banks securitisation is not economically viable

In Russia, the banking and judicial system both need reform, says Marcus Hopkins, head of banking at Moscow Narodny Bank (MNB). “The inefficiencies of both compound the inherent difficulties and expense of structuring a securitisation deal for domestic receivables. For example, Russia’s reliance on statute law rather than precedence means that it takes much longer to introduce changes. On the other hand, very few of the 1300 banks in Russia – which necessarily have a limited market share – have portfolios of the sort of size that make securitisation economically viable.”

Alex Kotcherguine: MDM Bank is finding a way to achieve investment grade

Alex Kotcherguine, head of international business development for Russia’s MDM Bank, agrees but says things are changing, if a little slowly. “There are champions for legislative change in the State Duma,” he says Mr Kotcherguine. “But the pace is quite slow because their priorities are to drive changes, such as a new tax law, rather than to enable securitisation structures.”

That said, Mr Hopkins notes that many MNB commercial lending transactions contain elements of a securitisation. MNB’s core business is to extend money against future flow receivables for natural resources companies in Russia and, although these are not executed via a purpose built structure, the overall financing package will incorporate loans secured over receivables. “Because of the cost of securitisation and the unpreparedness of the environment, most deals go the route of commercial banking rather than the capital markets,” says Mr Hopkins.

Making the grade

Future flows are seen as a prime candidate for securitisation deals but one of the key problems for issuers and servicers is achieving an investment grade rating for the paper. They often have to contend with high country premiums, currency risk, concentration risk and in some countries, such as Russia, a short maturity profile that causes reinvestment challenges for investors. And if the paper is rated below investment grade, it can be difficult to place.

Fiona Steel, head of structured finance at Fitch Ratings, says that to get an investment grade rating from Fitch, the originator subject to a future flow securitisation must go through a “going concern assessment”. That is because Fitch must be comfortable that the stream of receivables is robust even in distress situations. If an originator goes into serious default, future flows are more likely to continue flowing if the entity is restructured than if it is pushed into bankruptcy. “It often comes down to whether or not the business or entity in question is seen as systemically important,” says Ms Steel. “In such a situation, would the sovereign step in to support the business or would creditors rather restructure their debt than place the company in receivership and thereby allow the entity to continue producing the securitised product?”

But a good banker cannot be prevented from finding a route round a problem: Mr Kotcherguine says MDM is planning to securitise payment future flows, such as credit card remittances, made into its correspondent accounts through an offshore SPV. “Our main constraint is achieving investment grade. This structure essentially securitises payments to us that originate outside Russia. Technically, this should enable us to negate Russian country risk and achieve an investment grade rating,” he says.

Fitch Ratings says that such a transaction would also require a going concern assessment on the bank. “If all the assumptions were proved positive then there is no reason for it not to be awarded an investment grade rating,” says Ms Steel.

Mr Hopkins agrees that a major challenge is obtaining a high enough rating; this is particularly difficult when the originator’s sovereign is not investment grade and the portfolio, although made up of top quality assets, is highly concentrated. Such issues aside, MNB is also working towards securitisation. “We have looked at the benefits of securitising our own loan portfolio – it would be the first such deal in Russia,” says Mr Hopkins. “We would take the first loss portion and have had discussions with potential high yield investors. With the equity and high yield tranches taken care of, it should be easy to place the investment grade tranche at a competitive rate.”

Size matters

Another issue for emerging market securitisations is the limited size of portfolios or payment flows, which often makes the cost of a complex structured finance deal prohibitive. “The size of the issue needs to be big enough to bear the additional costs associated with securitisations,” says Mr Hopkins. “Not many banks, and not that many businesses in Russia and CIS, have portfolios or flows of sufficient size to be able to justify the higher fixed cost compared with a straight bond issue.”

Many people believe that it will not stay that way for much longer, however. Mortgages, credit cards, car leasing and other consumer finance products are becoming increasingly popular outside of well developed financial markets.

Dan Bunea: Banca Comerciala Romana is building its portfolio with securitisation in mind

In Romania, the mortgage market in particular is growing at a cracking pace. Dan Bunea, director of the Capital Markets Division of Banca Comerciala Romana, which has secured a line of credit from the European Bank of Reconstruction and Development specifically to grant retail mortgages, says that the bank already has a portfolio of more than E100m. By the year end it should be closer to E200m.

“Based on figures from the housing market and our market share of the mortgage sector, by the time Romania joins the EU in 2007, our portfolio should stand at around E1.5bn, out of a Romanian mortgage market of between E3bn to E5bn,” he says.

More to the point, Mr Bunea says that the bank is building its portfolio with securitisation in mind. At the moment, it is waiting for changes to legal provisions surrounding foreclosure procedures, a new framework for SPVs and new regulations for participants in primary and secondary markets, which will take two or three years to complete, he estimates.

“But this waiting period gives us the ideal opportunity to build a standardised portfolio according to best practice that is suitable for securitisation,” he says. However, he adds, in all probability the bank will issue mortgage-backed bonds before embarking on a securitisation programme.

EU accession

There are other positive signs for many countries wanting to take advantage of structured finance. For those either waiting or hoping for EU membership, Sharif El-Hamalawi, senior manager for origination at Bank Austria Creditanstalt, says accession will drive change in domestic legal and financial environments that should enable securitisation structures to gain a foothold.

“Equally, if these countries also join the euro, this will add further momentum by cutting the costs associated with such deals. At the moment, the currency risk linked with any domestic securitisations would mean that many international investors would have to take out a currency swap. This can be very expensive,” he says.

Preparing the ground

Macro developments may be largely beyond bank control but, in addition to choosing asset classes that are of suitable quality, are likely to grow sufficiently and be attractive to investors, there is plenty of groundwork that banks can prepare in the meantime.

Jennifer O’Neil, an emerging market analyst at Fitch Ratings, says most financial institutions can benefit from having the time to put systems in place to provide the information that rating agencies need to rate transactions. “This is an opportunity for them to look at their management information systems and the way they collect and manage data on loan and other portfolios, and tailor them to the needs of rating agencies,” says Ms O’Neil. Typically, banks should ensure that they have captured between three and five years historical data and that this data will meet the specific information needs of the rating agencies.

Equally, financial institutions should look at the policies and procedures that they have in place for credit underwriting, for the management and monitoring of portfolios, and for the resolution of problem loans. “They need a standardised set of policies and procedures that meet international standards. As important, they must ensure that these are being implemented because rating agencies will go to see if these are being adhered to in practice,” Ms O’Neil says.

While securitisation may not yet be the standard fare for financiers in developing markets, it is clearly going to be introduced to the menu. Barriers are already being slowly chipped away or circumnavigated. Either way, market participants are positive. “Had it been easier we would have done it already,” says Mr Kotcherguine, “but it is only a matter of time.”

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