Russian Mortgage Backed Securitisations

1
Russian Mortgage Backed Securitisations Analysis
of Legal Structures and Risks
by Joseph Tanega BA Princeton University M.Phil
Oxford University Juris Doctor University of San
Diego School of Law Course Director LLM Corporate
Finance Law University of Westminster School of
Law, London Email J.Tanega_at_westminster.ac.uk 44(
0)207 911 5000 ext 3477 Russian Structured
Finance Investment Forum New York State Bar
Association September 10-11, 2006
2
Acknowledgement

• I would like to thank Florin Coseraru,
  Fellow in Investment Banking, University of
  Westminster, School of Law, and Director in
  charge of Transactions at Bank of New York,
  London, for his kind assistance in providing me
  with publicly available materials and simple
  explanations without which this lecture note
  would not be possible. Of course, all errors
  and speculations are my own.

3
Contents

• News Flash
• Introduction
• Basic problem and new problems
• What is securitisation?
• Typical Asset-backed Structure
• Russian Securitisation Structures Risks
• Russian Mortgage Backed Securities 2006-1 S.A. -
  18 July 2006
• Deal Structure
• Main Parties
• Risk Factors Top Legal Risks
• CityMortgage MBS Finance B.V. - 10 August 2006
• Deal Structure
• Main Parties
• Risk Factors Top Legal Risks
• Conclusion

4
News Flash

• According to the Strategy of the development of
  the financial market of the Russian Federation in
  2006-2008, the development of the instruments of
  the securitisation of financial assets and of the
  market of mortgage securities is one of the main
  directions of the state policy on the development
  of the financial market in 2006-2008.
• The Strategy was approved by Order of the
  Government No 793-r from 1 June 2006. Source
  page http//www.fcsm.ru/strateg.asp?ob_no36646p
  g2 Russian SECs website.
• According to the same order, they are going to
  achieve this by
•           broadening the number of kinds of
  assets that can be used in securitisation
•           broadening the circle of rights that
  can be used in securitisation
•           introducing legislative limitations on
  the possibility to declare assignment void
•           setting the requirements for issuers of
  securities, issued in securitisation
•           creating mechanisms of increasing the
  credit quality of securities
•           clarification (or specification) of the
  legislation of securities in respect of specifics
  of
• securities, secured (guaranteed) with
  assets.
• Source http//www.fcsm.ru/eng/catalog.asp?ob_no9
  149

5
Introduction

• Russian Mortgage-backed Securitisation New
  Market
• Brief definition of securitisation
• Focus of talk is on two Mortgage-back
  Securitisation issues
• Legal Structures
• Risk Factors

Assumptions
Factual
Legal
Agreements
1
2
3
4
5
6
Implications
n
6
Basic Problem New Problems

• Will there be a US or a European type
  securitisation structure for Russian mortgage
  backed securities? True sale versus
  security-pledge.
• Current theoretical answer neither and both.
  No true sale possible under current law.
  Mortgage bond structure is untested. First
  issues are backed by mortgage certificates in
  mortgage portfolio.
• Actual market solution set out all the risks
  and satisfy requirements of credit rating
  agencies for suitable investment grade rating.
  This means more liquidity facilities, guarantees,
  contingent contracts et al.
• New Problems (1) Watch out for consolidation
  of SPEs with Originator under International
  Accounting Standards and (2) Impact of capital
  adequacy rules under Basel II could change the
  risk profile and thus, value of the deal.

7
What is securitisation?

• Securitisation Definition
• Securitisation is the packaging of income
  producing assets underwritten and sold in the
  form of asset-backed securities normally secured
  over those assets. The assets collateralising
  the issue of securities (Underlying Collateral)
  may take many forms including existing corporate
  or sovereign bonds, loans, derivative contracts,
  equities and repo arrangements. For Russian
  Securitisations, mortgage certificates.
• FSA Listing Rules Definition asset-backed
  securities mean specialist debt securities
  backed by assets which, at the time of the
  relevant issue, are evidenced by agreements and
  intended to produce funds to be applied towards
  interest payments due on the securities and
  repayment of principal on maturity except those
  debt securities which are directly secured, in
  whole or in part, on real property or other
  physical assets
• Commercial rationale The commercial rationale for
  a securitisation include
• Originators (or Obligors) need for funding
• Capital and balance sheet management
• Arbitrage
• Credit risk management.

8
Typical Asset-Backed Structure
Debtors/Obligors
Original Contracts
Originator
Purchase price
True sale
SPV
Credit Enhancement
Custodian
Proceeds of issue
Grant of Security
Security Trustee
Swap Provider
Benefit of Security
Capital Markets
9
Typical Asset-Backed Structure
Sale of assets
Issue of Securities
Investors
SPV
Originator
Cash
Cash
SPV Incorporated A special purpose vehicle
(SPV), a limited liability company, is
incorporated in a tax treaty jurisdiction (e.g.
the Netherlands or Luxembourg) or a tax haven
jurisdiction (Jersey or the Cayman
Islands). SPV Purchases Underlying Collateral
and issues Notes The SPV purchases the
underlying collateral from the Originator and
issues Notes. The purchase is normally effected
through the true sale method and this is
usually done by an assignment, novation or
sub-participation. It could also be by the
secured loan method or by the declaration of a
trust in favour of the SPV by the Originator.
10
Typical Asset-Backed Structure
Custodian and/or Administrator appointed The
Underlying Collateral purchased by the SPV is
normally be held by a custodian (the Custodian)
on behalf of the SPV which would collect the
interest and principal payments in respect of the
Underlying Collateral and make payments directly
to the Swap Counterparty on behalf of the SPV. A
professional administrator could also be
appointed to undertake all the administrative
duties in respect of the SPV and or assets.
Where necessary an asset manager is also
appointed to manage the Underlying
Collateral. Corresponding Swap transaction The
SPV enters into a swap transaction (Swap
Counterparty) under which the payments received
by the SPV in respect of the Underlying
Collateral would be swapped into payments in
currency and in the interest basis in which the
relevant Notes are denominated. The Swap could
also be structured in the form of a credit
enhancement so as to be dependent on the
performance of the Underlying Collateral on a
total return basis or as credit default
swap. Notes Issued to Capital Markets The SPV
would issue Notes which would be constituted
under and pursuant to the terms of a Trust Deed
with a Trustee appointed to hold the security
granted by the issuer over its assets.
11
Russian Securitisation Structures
Russian Mortgage Backed Securities 2006-1 S.A.
(RMBS) Deal Structure
Originator / Servicer Note Proceeds Account
Bank/ Subordinated Loan Facility Provider /
International Payment Facility Provider
International Payment Facility Guarantor
Standby Servicer / International Collections
Accounts Bank
Guarantee Payments
Receivables Related Rights
Swap Counterparty
Note Proceeds
Swap Agreements (USD Fixed / USD Floating)
Liquidity Facility Provider
Liquidity Facility
Issuer
Security under Trust Deed
Note Proceeds
Notes issued
Trustee
Cash Manager / Issuer Account Bank / Cash Reserve
Account Bank / Principal paying Agent / Agent
Bank / Listing Agent
Noteholders
Security held by Trustee for Noteholders and
other Secured Creditors
Source adapted from Russian Mortgage Backed
Securities 2006-1 S.A. Prospectus 18 July 2006,
p. 25.
12
Russian Securitisation Structures
RMBS Main Parties
Issuer
Russian Mortgage Back Securities 2006-1 S.A.,
incorporated in Luxembourg, under Luxembourg.
Securitisation Law of March 22, 2004. Entire
share capital held by Russian Mortgage Backed
Securities 2005 I and Stichting Russian Mortgage
Backed Securities 2005 II. Purpose (1) to
acquire from Originator Receivables and related
rights to residential mortgage loan portfolio
(2) to issue notes (3) enter into Transaction
Documents and (4) other related activities.
Originator
JSC Vneshtorgbank, incorporated in Russian and
registered in St. Petersburg. As Originator, its
purpose Is to sell to the Issuer receivables and
related rights as per Mortgage Sale Agreement.
Source adapted from Russian Mortgage Backed
Securities 2006-1 S.A. Prospectus 18 July 2006,
pp. 5 - 8.
13
Russian Securitisation Structures
RMBS Notes
Notes
74,200,000 Class A Residential Mortgage Backed
Floating Rate Notes due 2034 (Class A
Notes) 10,600,000 Class B Residential Mortgage
Backed Floating Rate Notes due 2034 (Class B
Notes) 3,500,000 Class C Residential Mortgage
Backed Floating Rate notes due 2034 (Class C
Notes)
Class A notes Moodys A1 and Fitch BBB Class B
notes Moodys Baa2 and Fitch BBB Class C notes
Moodys B2 and Fitch BB-
Ratings
Class A notes 1-month LIBOR 1 Class B notes
1-month LIBOR 2 Class C notes 1-month LIBOR
5
Interest Rate
Redemption Date
15 May 2034
Withholding Tax
None
Status
All payments of interest due on Class A Notes
rank in priority to payments to interest due
on Class B Notes, and all payments of interest
due on Class B Notes rank in priority to payments
of Interest due on the Class C Notes.
Use of Proceeds
To finance purchase of Receivables and Related
Rights under Mortgage Sale Agreement and
Note Proceeds Account.
Limited Recourse
Recourse against Issuer in respect of its
liabilities to Noteholders is limited to the
assets of Issuer.
Listing
Irish Financial Services Regulatory Authority
Source adapted from Russian Mortgage Backed
Securities 2006-1 S.A. Prospectus 18 July 2006,
pp. 9 15.
14
Russian Securitisation Structures
RMBS Notes contd

• The obligations of the Issuer under the Trust
  Deed are secured in favour of the Trustee for
• The benefit of itself and as trustee for the
  Noteholders and the other Secured Creditors,
  pursuant
• To the Deed of Charge (as defined below) by
• A fixed charge (the Fixed Charge) over
• (i) all of the Issuers rights,
  interests and benefits in and to principal,
  interest and other amounts
• payable by the Borrowers to the
  Issuer in connection with the Purchased
  Receivables and
• Related Rights and
• (ii) all of the Issuers rights, interests
  and benefits in and to receipt of all sums which
  may be or
• become payable by the Borrowers to
  the issuer under any claim, award or judgment
  relating
• to the Purchased Receivables and
  Related Rights ((a) and (b) together, the Fixed
  Charged
• Property) this should say (i) and
  (ii) and
• Fixed security by way of an assignment to the
  Trustee of all the Issuers rights, interests and
• benefits, both present and future under,
  arising out of, evidenced by or pursuant to
  certain
• Transaction Documents and related
  documents, agreements, deeds or instruments
  entered
• into by the Issuer in connection with
  such Transaction Documents, but excluding the
  Fixed
• Charge Property and the Russian law
  governed by Deeds of Assignment

Security for Notes
Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
15
Russian Securitisation Risk Factors
RMBS ? Top Legal Risks
Risk relating to Mortgage Loans

• Representations and Warranties
• Russian Regulation of Assignment and
  Securitisation is Developing
• Collectability of Mortgage Loans
• Difficulty for VTB (or another Servicer) to
  enforce security under Russian law
• Prepayments on the mortgage loans
• Direct debit rights
• Consumer protection laws in Russia
• Bank Secrecy and Personal Information
• Geographic Concentration of Mortgaged Properties
• Reliance on Third Parties
• Potential information technology disruptions
• Underwriting standards
• Collectability of proceeds under insurance
  contracts
• Servicer substitution

Insolvency Risks

• Insolvency of the Issuer
• Insolvency of the Originator
• Effect on Sale
• Effect on Collections

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
16
Russian Securitisation Risk Factors
RMBS ? Top Legal Risks
Risk relating to Russia

• Social instability in Russia
• Economic instability in Russia
• Currency control restrictions
• Crime and corruption could disrupt VTBs ability
  to conduct its business and could
• materially adversely affect its financial
  condition and results of operations
• Legislative framework governing bankruptcy in the
  Russian Federation differs substantially
• from that of Western European countries,
  potentially adversely affecting the value of the
• Notes in the event of VTBs insolvency
• Lack of independence of the Judicial System, the
  difficulty of enforcing court decisions and
• unpredictability of the legal system
• Political intervention
• Unlawful, selective or arbitrary state action may
  have an adverse effect on business and
• the transaction

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
17
Russian Securitisation Risk Factors
RMBS ? Top Legal Risks
Risk relating to Russian Taxation

• Russian tax law is still developing and is
  subject to frequent changes, which could have an
• adverse effect on the Mortgage Portfolio
• Payments under the Mortgage Loans may be subject
  to withholding tax
• Tax may be withheld on disposal of the Notes in
  Russia, reducing the proceeds from disposal
• VAT may be due on the sale of the Receivables by
  the Originator
• Other risks relating to taxation

Credit Structure

• Liabilities under the Notes
• Limited resources of the Issuer
• Limited secondary market for mortgage loans
• Limited secondary market for the Notes
• Ratings of the Notes
• Yield and prepayment considerations
• Conflict between classes of Noteholders
• Conflicts of interest
• Interest rate risks
• Termination payments on the swap agreements

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
18
Russian Securitisation Risk Factors
RMBS ? Top Legal Risks
Certain Legal Considerations

• Title of the Issuer
• Change of law

Regulatory Matters

• EU Savings Tax Directive
• Withholding Tax under the Notes
• State Aid

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
19
Russian Securitisation Structures
CityMortgage MBS Finance B.V. - Deal Structure
Note Trustee/ Security Trustee
Stichting
100
Cash Manager
5
9
9
Back-up Servicer
6
3
4
2
8
Security Trustee
CMB
1
8
Obligors
Source Adapted from CityMortgage MBS Finance
B.V. Prospectus 10 August 2006, p. 10
20
CityMortgage MBS Finance B.V. Deal Structure
contd.
Russian Securitisation Structures

• Mortgage Portfolio
• Purchase Agreement
• Servicing Agreement
• Enforcement Services Agreement
• Cash Management Agreement/Distribution Account
  Agreement
• Backup Servicing Agreement
• Trust Deed
• Deed of Charge/Pledge Agreement
• Senior Notes, Class B Notes and Class Z Notes

21
Russian Securitisation Structures
CityMortgage MBS Main Parties
Issuer
CityMortgage MBS Finance B.V. is a private
company with limited liability incorporated in
The Netherlands on 15 September 2005. Issuer is
a special purpose vehicle with no employees or
premises and is only Permitted to carry out
limited activities. Purposes (1) to enter into
Transaction Documents (2) to acquire Mortgage
Certificates which will comprise Mortgage
Portfolio (3) to issue Notes backed principally
by cash-flow generated under Mortgage Portfolio,
or, to enforce the Security, collateral of which
constituted by Mortgage Portfolio. Stichting
CityMortgage MBS Finance, a foundation under The
Netherlands law owns all share capital of the
Issuer.
Originators
CityMortgage Bank, limited liability company
commercial bank incorporated under laws of
Russian Federation, and Russian Interregional
Bank for Development, a joint-stock commercial
bank, registered in Moscow, Russia.
Managers
MNB Capital Markets, division of Moscow Narodny
Bank Limited, London, UK, and Greenwich
Financial Services , L.L.C., Greenwich,
Connecticut, Joint Lead Managers Raiffeisen
Zentralbank Osterreich AG, Vienna, Austria,
Senior Co-Lead Manager Banco Finantia S.A.,
Lisbon, Portugal, Co-Lead Manager.
Source Adapted from CityMortgage MBS Finance
B.V. Prospectus 10 August 2006, p. 10
22
Russian Securitisation Structures
CityMortgage MBS Notes
Notes
63,127,964 Class A-FL Senior Mortgage-Backed
Sequential Capped Floating Rate Pass-through
Notes Due 2033 (Class A-FL Notes)
Issue Price 100 63,127,964 (Notional) Class
A-IIO Senior Mortgage-Backed Inverse
Interest-only Notes Due 2033
(Class A-IIO Notes) 6,288,610 9.25 per cent.
Class B Mezzanine Mortgage-Backed Fixed Rate
Pass-through Notes Due 2033
(Class B Notes) 3,144,305 9.25 per cent. Class
Z subordinated Accrual and Profit Participation
Notes Due 2033 (Class Z
Notes) Issue Price 100 per cent. Plus a Premium
Senior Notes Baa2 Class B Notes B1 Class Z
Notes no rating
Ratings
Rankings
Notes are pari pasu amongst themselves Principal
and interest payments--Class A-FL Notes senior to
Class B notes Class Z Notes and Class B notes
senior to Class Z Notes.
Inverse Interest-only Notes
Interest only payment based on notional outstand
amount
Class Z Notes
Scheduled Interest transferred to Class Z
Capitalised Interest Amount shall bear fixed rate
interest Profit participation element equal to
funds that remain available from Revenue Ledger
after Satisfaction of more Senior obligations.
Class A-FL Notes lesser of (a) cap and (b) LIBOR
plus Applicable Margin per annum Class A-IIO
Notes greater of (a) zero and (b)(i) Class A-FL
Cap, (ii) minus Applicable Margin
minus LIBOR, per annum Class A-FL
Cap 9.25 per cent. per annum Applicable Margin
1.60 per cent. per annum Fixed Rate of Interest
for Fixed Rate Notes (including Class Z Notes)
9.25 per cent. per annum
Interest Rate
23
Russian Securitisation Risk Factors
CMBS ? Top Legal Risks
Risk relating to the Notes and the Mortgage
Portfolio

• Limited liability under the Notes means
  Noteholders are relying solely on the Issuer to
  fund
• payments due under the Notes
• Limited resources of Issuer may impact its
  ability to make payments due under the Notes
• Limited secondary market for the Mortgage
  Certificates may limit the ability of the Issuer
  to
• redeem the Notes in full
• Absence of a secondary market for the Notes may
  impact their value
• Ratings of the Rated Notes may decline and
  unsolicited ratings that are detrimental to the
• value of the Notes may emerge
• Substitution of the Servicer may be delayed,
  leading to losses in collections under Mortgage
• Portfolio
• Effective enforcement of Security may be
  difficult and the subordination under the Post-
• Enforcement Payment Priorities may reduce
  the recovery on enforcement of the Class B
• Noteholders or the Class Z Noteholders
• Responsibilities of the Security Trustee to
  protect the value of the Security are limited
• Application of Dutch insolvency law on an
  insolvency of the Issuer may restrict ability of
• Secured Parties to recover amounts due to
  them from the Issuer
• True Sale of the Mortgage Portfolio to the
  Issuer may be challenged by Russian courts on
• insolvency of CMB

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
24
Russian Securitisation Risk Factors
CMBS ? Top Legal Risks
Risk relating to the Notes and the Mortgage
Portfolio (continued)

• Issuers rights as mortgagee evidenced by certain
  Mortgage Certificates may remain
• unregistered with the State Registry which
  may be detrimental to the value of the Mortgage
• Portfolio
• On an insolvency of the Servicer, funds of the
  Issuer held by the Servicer would be susceptible
• to commingling risk
• The Servicers right to collect payment through
  the direct debit process may be questioned
• which may delay receipt of payments under
  the Mortgage Loans
• Premature declaration of a Principal Loss by the
  Servicer could adversely affect the value of
• the Class B Notes or the Senior Notes
• Note Trustee may be required to act to the
  detriment of a Class of Noteholders where the
• interests of the different Classes conflict
• Class A-IIO Notes confer no voting rights on
  their Holder, meaning decisions of Holders of
• Reference Notes impacting value of Class
  A-IIO Notes may be taken without involvement
• Of the Holders of Class A-IIO Notes
• Senior Noteholders interests prevail in relation
  to any directions given to Note Trustee or any
• Extraordinary Resolution
• Restrictions on transfer of Notes may affect
  their value
• Lack of information relating to Mortgage
  Portfolio renders future performance of Mortgage
• Portfolio more difficult to predict

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
25
Russian Securitisation Risk Factors
CMBS ? Top Legal Risks
Risk relating to the Notes and the Mortgage
Portfolio (continued)

• Customers are not notified of the sale of the
  Mortgage Certificates to the Issuer which may
• lead to Customers obligations and rights
  in relation to the Mortgage Certificates being
• performed or exercised in a manner which
  conflicts with the interest of the Issuer
• The Issuers rights as mortgagee evidenced by
  certain Mortgage Certificates may remain
• unregistered with the State Registry which
  may be detrimental to the value of the Mortgage
• Portfolio
• Under Russian law, the benefit of Insurance
  Policies is transferable by a Customer at any
• time which could limit the ability of the
  Issuer to recover any proceeds under such
• Insurance Policies
• Compliance of the Mortgage Portfolio with the
  Lending Criteria or Eligibility Criteria has not
• been and will not be verified by the Issuer
  or the Security Trustee and CMB may not be able
• or willing to perform the Put Option or
  Call Option in relation to such non-compliance
• Put Option and Call Option likely to be
  undermined following a Servicer Event relating to
  CMB
• prepayments on the Mortgage Portfolio may
  undermine the value of the Notes
• Weaknesses in underwriting standards may have led
  to inappropriate lending decisions
• relating to the Mortgage Portfoliio
• Currency control laws may be introduced which
  negatively impact the ability of the Issuer to
• recover amounts due under the Mortgage
  Portfolio
• Geographic concentration of the Mortgage
  Portfolio may increase the risk of multiple
  defaults

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
26
Russian Securitisation Risk Factors
CMBS ? Top Legal Risks
Risk relating to the Notes and the Mortgage
Portfolio (continued)

• Under the Mortgage Portfolio or a significant
  devaluation of a proportion of the Mortgaged
• Properties
• Enforcement Procedures for Defaulted Mortgage
  Loans may be weakened by the legal
• process relating to foreclosure or practical
  constraints arising during foreclosure on the
• Mortgaged Property
• Russian bank secrecy and personal data protection
  rules may adversely impact the structure
• of the Transactions and thus affect the ability
  to collect payments under the Mortgage Loans
• Enforceability of the pledge over the Mortgage
  Certificates under Russian law is unclear due
• to the lack of proper regulation and relevant
  court practice
• Information technology disruptions may adversely
  affect the ability of the Servicer to service
• Mortgage Portfolio
• Russian consumer protection laws may be
  introduced which adversely impact the ability to
• recover unpaid amounts under the Mortgage
  Portfolio, and high interest rates and heavy
• penalties under Mortgage Loans could be
  challenged

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
27
Russian Securitisation Risk Factors
CMBS ? Top Legal Risks
Risk Related to the Russian Federation

• Social instability in the Russian Federation
• Economic instability in the Russian Federation
• Currency instability in Russia
• Unlawful, selective or arbitrary state action
• Systemic banking crisis in the Russian Federation
  and the Russian banking systems
• Undercapitalisation
• Lack of independence of the judicial system and
  the difficulty of enforcing court decisions
• Placement of Foreign Securities in the Russian
  Federation

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
28
Russian Securitisation Risk Factors
CMBS ? Top Legal Risks
Risk Related to the Russian Taxation

• Underdevelopment of the Russian Taxation System
• Payments on the Mortgage Loans may be subject to
  Russian withholding tax
• Tax might be withheld on dispositions of the
  Notes in the Russian Federation, reducing
• their value
• VAT may be due on the sale of the Receivables by
  the Originator

Source Russian Mortgage Backed Securities 2006-1
S.A. Prospectus 18 July 2006, pp. 11-12.
29
Conclusion

• Transaction structures and legal risks
• Likely to be tested under Russian laws before
  2033
• Transparency is no guarantee (e.g. Yukos)
• Current mortgage-backed securities issues
• Very well documentedshows where the holes are
• Competitive rates
• Forecast