Feature story

EBRD fast-tracks asset-backed securities

The European Bank for Reconstruction and Development is helping to develop securitization structures in central and eastern Europe. Sudip Roy reports.

Cutting edge is a phrase not often applied to development banks. But the European Bank for Reconstruction and Development’s strategy in helping to develop securitization structures for financial institutions in central and eastern Europe fits the bill. Asset-backed securities are rare in the region, but the multilateral is at the forefront of the product’s development and expects to participate in a handful of deals over the forthcoming months.

In December, the EBRD’s shareholders approved the first securitization that the bank will be involved in: a transaction from Russian Standard Bank (Bank Russky Standart) backed by consumer loans that could amount to as much as €70 million.

The EBRD is involved in two ways. First, the multilateral will invest in subordinated bonds denominated in euros and securitized by a portfolio of consumer loans originated by Russian Standard Bank. Specifically, the transaction envisages the issuance of up to €70 million in subordinated bonds, with the EBRD subscribing to about 50% and international investors and commercial banks taking the rest. Second, the EBRD will advance Russian Standard Bank a rouble-denominated loan that would be equivalent to $30 million.

The deal will be one of the first securitizations in countries in which the EBRD operates and will accelerate the development of Russia’s capital markets. It will also make consumer financing more readily available, particularly in the regions, where Russian Standard Bank originates over 80% of its new loans.

The transaction is one of four asset-backed transactions for financial institutions the bank is working on and there could be another eight in the pipeline. “We are very excited by [the potential for growth in] securitization transactions,” says Kurt Geiger, director of financial institutions at the EBRD. “It’s new, cutting edge and stimulates capital markets development. It’s exactly what we should be doing.”

Initial steps

The bank laid the groundwork for ABS two years ago when it commissioned consultants, financial agencies and associations to draw up a best-practice model for mortgage lending in the region.

Although demand for mortgages was quite small, it was clear that it was poised to grow quickly. The first step was to ensure that all of the EBRD’s borrowers were working to uniform lending standards. Then the bank set about encouraging the refinancing of loans in the capital markets. This consultative process is still very much in evidence. The bank, for example, plans to engage a consultant to assist the ministry of economy in Moldova to put in place a sound institutional and legal framework to encourage the development of the mortgage market in the former Soviet country. The EBRD hopes that the rudimentary requirements for a mortgage secondary market will also be established soon.

The multilateral is not just focusing on the mortgage market. It is actively supporting securitization structures for other assets too, such as leasing receivables, consumer credit and auto loans.

“Consumer finance institutions across the region are growing at such a pace that they are not seeking capital relief but funding opportunities,” says Jonathan Woollett, director of non-bank financial institutions at the EBRD.

Deals backed by consumer assets are proving popular in Russia in particular. In August, Bank Soyuz raised about $50 million in the first Russian ABS transaction backed by domestic receivables. The assets securitized were US-dollar auto loan contracts on foreign cars. The transaction was typical of an ABS in that it had a three-tier senior subordinated structure, supported by smaller mezzanine and junior tranches that were pre-placed.

These are the tranches that the EBRD will buy in the transactions it will participate in. That way the bank can take out the riskiest parts of the transaction, leaving the senior notes open to institutional investors. The biggest difficulty for the EBRD lies in tracking the quality of borrowers’ underlying portfolios. But because many of them are EBRD clients, the bank should have a good insight into this. “Our job is to encourage as many investors as possible to participate in the transaction,” says Woollett.

“The idea is to allow financial intermediaries access to the international capital markets with these new products that their developed world counterparts already have,” adds Geiger.

Since the EBRD is a triple-A borrower, its involvement enhances these transactions’ credibility. In Russia, for example, the legal framework for recovering loans is relatively undeveloped. The EBRD provides a credit guarantee so that deals function smoothly.

Although almost all of the securitization transactions the bank is working on will be executed in the international capital markets, the next step will be to help create an onshore market. “It would be wonderful to develop securitizations for local investors with onshore SPVs,” says Woollett. “Ideally it would provide an impetus for legislators to improve local regulations.”

A long way

The bank’s effort in developing securitization structures is a natural evolution in its financing strategy. “Every year I do a financial report for the board of directors on the financial sector,” says Geiger. “What is interesting to see are the developments that have taken place and the diversity that we’ve built in terms of products and in terms of what we’ve been doing in the markets.”

“We’ve come a long way from the standard credit lines that we traditionally did,” he adds

Although loans to banks in the countries in which the EBRD operates remain the largest single component in the financial institutions portfolio, an increasingly targeted approach has increased the importance of other products. Apart from ABS, the bank is heavily involved in investing in small and medium-size enterprises, municipal finance, loans syndications and equity investment.

EBRD president Jean Lemierre is keen to encourage equity investments, which make up about 20% of the bank’s overall financial institutions’ portfolio but should rise steadily over the coming years. In May, Lemierre outlined a new business model for the bank for the second half of the decade that will involve greater emphasis being placed on equity investments and smaller projects. The changes will help the bank as it shifts its business away from the EU accession countries and more towards southeastern Europe, Russia and the CIS. “We want to do more equity investments, as we think that we can have a big impact in creating value in an economy by becoming a shareholder,” says Geiger.

He cites the bank’s investment in Hansabank as an example. The EBRD first became an investor in the Estonian bank in 1998 following its merger with Eesti Hoiupank, where the multilateral was already a shareholder. At the time Hansabank was suffering from the aftermath of Russia’s financial crisis. The EBRD further increased its shareholding in the bank later that year to strengthen Hansabank’s capital base. As Hansabank regained its financial health, so the EBRD gradually began to reduce its stake. In 2002, the EBRD sold about half its shares. Then in February the multilateral accepted Swedbank’s offer for the remainder. Today Hansabank is one of the strongest financial institutions in the Baltic states.

Some observers have criticised the EBRD for its equity investment approach, claiming that the bank is too profit-oriented. But Geiger says that although making a return is one consideration, it’s not the only one and certainly not the most important.

“When we make our equity investments, our primary objective is to create value and to help management and other shareholders build a good business,” says Geiger. “If we were to invest in an institution and an investor came to us 12 months later [wanting to buy our stake], we wouldn’t sell unless we had finished the job that we had originally set out to do. That’s very important to us.”

“It’s very much in our culture,” he adds, “to create value. If we do a good job and succeed in this then, hopefully, we will get a return.”

Hurdles to overcome

Despite these efforts, many of the region’s financial institutions, especially in eastern Europe, remain under-developed. As an EBRD report says: “Capital market products are still largely missing, while some regulatory and legal impediments remain. Banks’ efficiency and risk management still require improvement, and most banks are not adequately prepared for the Basle II regulatory framework.

The non-bank financial sector – including specialized institutions, leasing and pension funds – is still largely under-developed.”

Geiger, though, is optimistic. The outlook for the underlying economies is favourable and corporate governance standards are improving. Investors still have a great appetite for some financial institutions in the region, such as Romania’s Banca Comerciala Romana. The next step is to grow these institutions and the markets that they serve. That’s why the EBRD’s emphasis on developing securitization products is so important. If the Russian Standard Bank deal is well received it can act as a benchmark for the use of innovative structures to help banks access funding from international capital markets.

Reproduced with kind permission of Euromoney magazine.

23 January 2006