Press Releases / 14.07.2015

Press Release as of 14.07.2015

Empire Trust JSC

AK&M Rating Agency has assigned a 'B+' national scale credit rating to mortgage participation certificates 'Income Mortgage 2', with a stable outlook.

The rating assignment was based on the Credit Rating Methodology for Mortgage Participation Securities Secured by Commercial Real Estate. The 'B+' rating indicates satisfactory creditworthiness of the mortgage securities.

The rating assigned reflects the acceptable level of risks related to the performance by management company JSC Empire Trust of its obligations to the owners of 'Income Mortgage 2' (IM-2) mortgage participation certificates (MPC). The Company operates as the trust manager of the IM-2 mortgage collateral according to the management rules registered by the Central Bank of Russia's Financial Markets Service on April 18, 2014 and Federal Law 1520-FZ "On Mortgage-Backed Securities."

The backbone of the IM-2 mortgage collateral is formed by five loan agreements secured on commercial real estate mortgage terms by land plots for farming (ca. 90% of the total area) and industrial purposes located in Tver and Tula regions. 

The total principal debt under the loan agreements is RUB 1,270,000, the interest rate is equal to the Bank of Russia's key rate plus 1 ppa. The indicative value of one MPC as of the date of issue (March 4, 2015) was 1,277 rubles 53 kopecks. To date, 1,000,000 mortgage participation certificates have been issued. Total revenues on the mortgage collateral (including interest payments) are projected at approximately RUB 2 billion. The loans under all the contracts shall mature on March 31, 2020, the trust management contract shall expire on April 30, 2019.

The IM-2 MPC rating is essentially supported by the satisfactory creditworthiness of mortgage borrowers and the proper use of loan resources.

Most of the borrowers generate a steady cash flow in the form of revenues from small wholesale activities, mining operations and sales of processed minerals. As of March 31, 2015, average interest coverage ratio (ICR) was approximately 1.2x indicating the moderately high ability to meet current debt liabilities. For different borrowers, the probability of default on the long-term horizon, according to AK&M RA's estimation method, ranges from 8% to 35%., the probability of a collective default being a mere 0.2%.

We are pleased to note that the borrowers mainly used the borrowed capital (the loans were provided in early February 2015) to replenish the operating assets required for their respective core activities. As a result, the borrowers' combined revenue in Q1 2015 increased by more than 50% year-on-year, sales profit amounted to RUB 45.8 million against a negative result for the same period in 2014. Further improvements in the borrowing companies' financial performance in the long term could come as a growth driver for the IM-2 MPC credit rating.

The rating of mortgage participation certificates is additionally supported by the high institutional status of the special depository and the registrar responsible for the maintenance and support of the IM-2 mortgage participation certificates. In particular, JSC United specialized depositary is one of Russia's 5 leading special depositories in terms of value of controlled assets provided as collateral for the mortgage securities, CJSC Computershare Registrar has pioneered creating a register of mortgage certificate holders in Russia and is currently taking the lead in the number of MPC served. Besides, we appreciate the high level of insurance coverage for the transaction, with all real estate assets insured by MAKS, one of the leading Russian insurance groups (rated by RAEX at the highest level possible) with a consolidated equity capital of more than RUB 5 billion (according to the insurance company's 12-month IFRS statements for 2014).

AK&M Rating Agency regards the low business profitability of mortgage borrowers, the poor quality of mortgage security for the loans, the trust manager's limited mortgage collateral management experience
including the skills of responding to stresses as the key rating constraints.

Despite improvements in the borrowers' financial performance in the first quarter of 2015, their business profitability remains moderately low. As of April 1, 2015, the ratio of total LTM sales profit to the mortgage portfolio (both principal debt and interest payments) was approximately 9%, which questions borrowers' ability to fully repay the mortgage debt without external financing sources on the five-year horizon. Besides, we are aware of other debt liabilities exceeding RUB 500 million the borrowers were saddled with at the moment they took out the mortgage loans related to the rated securities.

The fair current value of mortgaged property, according to AK&M Rating Agency's estimates, reaches ca. 12% of the total principal debt under the loan agreements. The meager collateral pool indicates heavy potential losses on the mortgage collateral should the mortgage borrowers default on their obligations. The level of such potential losses is 27.3% (the estimation confidence factor being ca. 0.9) of the total amount of scheduled mortgage payments, which is equivalent to the yield to maturity of approximately 3.3% p.a. This percentage is below the average inflation guidance in Russia for the 2016-2020 period (according to the Ministry of Economic Development's forecast), which AK&M Rating Agency regards as a key rating constraint for the 'Income Mortgage 2' (IM-2) mortgage participation certificates. Besides, we believe that most of the mortgaged property does not generate a sufficient cash flow for repaying the mortgage debt, which contradicts the fundamental concept of real estate mortgage in corporate mortgage loan securitization transactions.

Despite the accumulated experience in managing the mortgage collateral of four MPC issues, JSC Empire Trust has so far not had a broad contingency management experience of recovering long-term overdue debt on receivables for the mortgage collateral of securities and disposing of the defaulted borrowers' mortgaged property (in particular, land plots). This puts certain pressure on the MPC rating, especially on the long-term horizon.

Other destabilization factors, in AK&M Rating Agency's view, are the unusual structure of the transaction to issue mortgage-backed securities (most of the mortgage collateral was provided by a third party pursuing no financial interests in the transaction), the mismatched validity periods of the IM-2 mortgage collateral trust management agreement and the loan contracts, and the management company's lower scope of business this year (the early termination of mortgage collateral trust management contracts in respect of the Commercial Mortgage and Prime Mortgage MPCs, the assignment of trust manager rights and obligations in respect of the High Standard MPCs to another management company).

JSC Empire Trust (Moscow) is a small-scale management company in terms of the value of assets controlled. The company is licensed for the management of investment funds, mutual funds and non-state pension funds (license no. 21-000-1-00962 as of August 13, 2013 provided by Russia's Federal Financial Markets Service). As of April 30, 2015, the company's equity capital was ca. RUB 84 million Apart from IM-2, JSC Empire Trust Manages the mortgage collateral of the Interregional Mortgage MPCs. The total amount of mortgage collateral managed by the Company is approximately RUB 47 billion.

This press release is based on the Statement of assignment of a credit rating to 'Income Mortgage 2' mortgage participation certificates. The rating assignment is based on the Credit Rating Methodology for Mortgage Participation Securities Secured by Commercial Real Estate (AK&M Rating Agency, 2015).

The rating, along with any information and conclusions provided in this press release, only conveys our creditworthiness opinion and shall not be construed as a recommendation to purchase or sell securities managed by JSC Empire Trust.

AK&M Rating Agency shall not be held liable for any interpretations, inferences and consequences related to the application of results of the rating estimation procedure by any third parties.

CJSC AK&M Rating Agency is accredited by the Ministry of Finance of the Russian Federation (order no. 452 as of September 17, 2010) and is on the Central Bank of Russia's Register of Accredited Rating Agencies.


AK&M Rating Agency

Ul. Gubkina 3, Moscow, Russia

Phone no. (495) 916-70-30, fax no.: (499) 132-69-18.