Mortgage lending is on the increase across central and eastern Europe, and there is fierce competition in the banking sector to offer a wider variety of mortgage products to the fast growing middle class.
In response to a general recognition that the overall poor state of housing stock remains an important issue, governments across the region are committed to establishing new sources of cheap funding for the banking sector to promote mortgage lending.
Competition among banks for consumer lending is fierce. Such has been the boom in lending that the banking sectors in many countries are now looking for efficient ways to move assets off balance sheet, and recycle capital. That will involve both domestic securitisations and covered bonds, as well as cross-border deals, especially where the underlying loans are linked to the dollar or the euro.
Structured finance
Securitisation is in its early stages, however. Many banks were taken over during the 1990s by foreign institutions, and these parent banks often funnelled cheap debt to their new subsidiaries, rather than take the route of complex structured finance deals for relatively small portfolios. Costs such as rating agencies, investment banking fees, and lawyer’s fees are high, and can often be unrewarding for deals of less than $50m.
Nonetheless, international law firms and investment banks are putting significant resources into structured finance across the region and, as asset values rise and loan portfolios get bigger, they are optimistic that cross-border securitisations will follow.
A single deal out of Latvia is the only cross-border residential mortgage-backed securities (RMBS) offering so far but there are hopes that a transaction out of Russia will soon enter the market.
Last December, the Baltic-American Enterprise Fund (BalAEF) offered $63.6m worth of pass-through certificates in a deal led by Wachovia Securities. The $60m senior tranche was rated Aa2 by Moody’s and there was a $3.57m Baa1 rated piece. The bonds were sold to European and US institutional investors.
The aim of the deal was to broaden the funding base for mortgage lenders away from deposits, borrowing from parent banks, or local covered bond programmes.
The BalAEF was established in 1994 to promote private sector development in the Baltic states. It was initially funded with a $50m grant from the US government, under the Support for Eastern European Democracies Act.
“The Baltic-American Mortgage Trust deal was the first cross-border RMBS transaction out of central and eastern Europe,” explains Boudewijn Dierick, vice-president at Moody’s Investors Service. “The Latvian economy has been performing well, so households have more purchasing power, and floating rate mortgage interest rates have also been falling.
“Poland, Hungary and Russia are all countries where we may potentially see cross-border RMBS transactions in the future, in addition to more deals out of the Baltics,” Mr Dierick says.
Lending rises in Poland
In Poland, the central bank has been steadily cutting rates and the main reference rate was reduced by 25 basis points (bp) to 4.5% in August, an historic low. This is fuelling the rapid increase in mortgage lending.
Bank Pekao, which is the second largest bank in Poland and is controlled by Italian banking group UniCredit, increased its mortgage lending by 80% in 2004. Other banks have also been seeing a big increase in business. BPH, which is part of the HVB Group, is very strong in the mortgage sector – the merger between UniCredit and HVB will create a new Polish banking giant.
“We are in the early stages of Poland’s economic recovery but the labour markets are slowly improving and, with rising employment levels and declining interest rates, households have stronger finances, which allows for a higher level of mortgage borrowing,” explains Piotr Bielski, economist at Bank Zachodni WBK in Warsaw, which is part of the Allied Irish Bank Group.
“There has been rising housing demand, which started shortly before EU accession, because people believe that in the long run – maybe 10-15 years – house prices in Poland will rise to average EU levels,” says Mr Bielski. “And as time-deposit rates are very low, investing in a house has become a popular alternative to keeping savings on deposit.”
In Poland, a number of new laws were passed in 2004, including specific securitisation legislation. Some market players have been unhappy about the confusing legal framework, however, and this has held back the market’s development.
There has been one internationally offered deal out of Poland but it was a commercial mortgage-backed securities transaction. The deal was led by Morgan Stanley in November 2003 and launched under the name Polish Retail Properties Finance. In total, €74m worth of bonds were sold, secured on 12 shopping centres owned by Dutch retail company Eastbridge NV, through its Polish subsidiary DTC Real Estate.
Steady market growth
The mortgage markets have also been growing steadily in Hungary and the Czech Republic, although to date the only domestic securitisation has featured consumer credit card loans. This was denominated in Czech koruna and was launched in 2003, setting a template for Czech asset-backed securities (ABS). Disappointingly, there have been no follow-up deals – such as car leases, consumer loans and mortgages. Czech legislation does provide a basic regulatory framework for securitisation transactions.
Russia also has a fast developing mortgage market and is putting domestic securitisation legislation in place. In the meantime, arrangers have been pressing ahead with cross-border deals.
In 2004, there were two cross-border securitisations out of Russia, one for foreign currency credit card payments led by Merrill Lynch and CSFB, and the other for dollar payments for oil and gas, led by ABN AMRO, Merrill and Morgan Stanley.
Russian securitisation
In July, an auto loan securitisation for Bank Soyuz was completed. The basic legal structures underpinning the deal will provide a good template for mortgage-backed and other bond offerings. The deal was a small one, totalling only $48m, and was led by Greenwich Financial Services and Moscow Narodny Bank.
“The Russian auto loan deal for Bank Soyuz was the first Russian deal done on a true sale basis,” says Michael Cuthbert, managing partner at Clifford Chance in Moscow, which acted as legal counsel for the arrangers.
“There is a pipeline of other deals in the market, most of which are related to the consumer lending boom that we have seen in Russia,” Mr Cuthbert adds.
“The Russian banks have seen a lot of growth in consumer lending, such as home loans, consumer loans or auto loans, to the growing Russian middle class, and they need to do securitisations to move some assets off their balance sheets and free up capital to expand their lending business further.”
Various law firms, including Clifford Chance, are advising the Russian Mortgage Federation as part of a process to amend the MBS Law, which was passed in November 2003. A number of issues still need to be ironed out before the domestic MBS market can develop.
“The MBS law was passed to facilitate domestic securitisation but some of the implementing legislation has not been put in place and, although it may be possible to do transactions without that implementing legislation, banks have taken a conservative view with regard to proceeding on that basis,” says Vladimir Dragunov, partner at Baker & McKenzie in Moscow.
“But we may soon see some cross-border deals, with the assets sold to an offshore SPV [special purpose vehicle], and the notes offered on the international capital markets,” Mr Dragunov adds. “These may include deals backed by mortgages denominated in foreign currency, but rouble receivables transactions are also being worked on where – since the funding will be done in foreign currency – hedging will be required.”
Lending boom
Arrangers are confident that the first domestic Russian RMBS will take place in the next few months. Consumer lending is booming in Russia and the banks need new sources of financing.
Cross-border deals in central and eastern Europe are sure to benefit from the desire for ABS investors to diversify their portfolios. There is a tremendous hunger for assets among European and US asset-backed investors, who have pushed spreads steadily tighter over the past few years, to levels of only around 10bp over Euribor for the Triple A tranches of RMBS from countries such as the UK and the Netherlands.
Offerings from new jurisdictions tend to be priced slightly wider to make sure they are a success, but the experience of countries such as Greece is that offerings from new countries are heavily oversubscribed.
All the signs are that well-structured offerings from central and eastern Europe will be in heavy demand from ABS investors, and will provide banks in the region with a new source of cheap funding, and allow them to recycle their capital to generate new loan business.