Page 104 - IFR Opportunities in Russian capital markets

CHAPTER04
ifrintelligence reports/Opportunities in: Russian Capital Markets
There are three primary types of operator in the emerging lending market: Universal Commercial Banks, the Federal Housing Lending Agency and regional agencies. Banks have been increasing their portfolio but until the final approval of an ABS law in 2006 lending was constrained by the banks’ limited capital. Since the end of 2006, it is possible to package and sell mortgages (on the domestic market) in a security that allows banks to refinance their borrowing and so offer new deals.
Obstacles to expansion
What is still missing is the establishment and operational reliability of a central credit bureau and a risk insurance system. Another major drawback of the current system is the relatively low level of income within large parts of the population.
Russia does not have a specific securitisation law for cross-border transactions. Federal Law No.152-FZ, On Asset-Backed Securities, expressly provides for the true sale of assets and the issue of ABS, but only to a domestic special purpose vehicle (SPV). An offshore SPV does not benefit from the provisions of the legislation. Any securitisation under Russian law must therefore rely on the general provisions of Russian Federal law to carry out a true sale.
The transaction can only proceed once legal opinions are able to confirm that the essential components of a true sale have been achieved under the transaction documents. There is, however, some degree of uncertainty as to the grounds on which such an assignment may be challenged. For example, it is not clear at this stage of the development of the legal framework, whether any potential challenge on grounds of an ‘undervalue’ could be launched (primarily due to a lack of analogous transactions). In addition, there is some debate regarding the precise character and application of the relevant rules and principles, as none of these rules have been tested.
Russia Railways' Red Arrow SPV
Under the Red Arrow deal, SPV Red Arrow bought rolling stock and leasing agreements from three companies that provided leases to Russian Railways, and funded the purchase by issuing Red Arrow bonds.
The papers were securitised by the underlying rolling stock and lease payments. However, the recourse to the underlying rolling stock was given little importance by the rating agencies in assessing the bonds' credit quality, as there could be legal difficulties in enforcing the claims if Russian Railways were to default, partly because there is no legislative precedent for the securitisation of leases in Russia.
So the credit quality was determined primarily by Russian Railways' ability to service the payments on the lease contracts and Red Arrow's paper is rated at the same level as Russian Railways' bonds.
Like most ABS, Red Arrow bonds are divided into three tranches, with one senior tranche (class A) and two junior tranches (class B, which is subordinate to class A, and class C, which is subordinate to both). The outstanding amounts are RUB12.57bn for tranche A, RUB1.11bn for tranche B and RUB122m for tranche C. Coupon payments on each tranche are made on a quarterly basis. In addition to coupon payments, there are scheduled amortisation payments on tranches A and B.
There is a possibility of the early redemption of tranches B and C. Cash flows on Red Arrow are paid from Russian Railways’ lease payments. Each cash flow from the lease agreements consists of payment of part of the principal and interest, plus the VAT on both sums.
The VAT rate was 18% as of the start of 2007 and cash flows from the lease agreements exceed scheduled payments on the paper's tranches. These excess funds are used for early redemption of tranches B and C. Tranche B is the first that can be redeemed. When tranche B is repaid in full, the remaining funds can be used for early redemption of tranche C. Tranche A is not eligible for early redemption, unless the lease agreement is terminated ahead of schedule. If there are funds left over on the maturity date after all the tranches have been paid in full, they will go to holders of the class C paper.
The Red Arrow paper does carry the risk of a change in VAT rate, as payments on lease agreements are dependent on this rate at the moment of payment. And this is a real risk as the government is debating reducing the VAT rate to 15% in the first half of 2007.
If VAT drops significantly, there may not be enough funds for the scheduled payments on the bonds. Assuming a constant VAT rate over 2007–12, lease payments would fall short of scheduled payments on all three tranches, though only if VAT were below 5.7%.
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