Interest Rate Sensitivity Analysis on European RMBS

Transcription

1 JULY 2011 STRUCTURED THOUGHT Interest Rate Sensitivity Analysis on European RMBS Constantinos Tavlas Associate Director Andrew Jacobs Director David Kurnov Associate Director Contact Us To access all of our research, visit us at: Alternatively, you may contact our customer service team: Americas Europe Asia-Pacific Japan In light of European interest rates coming off the lowest levels seen in over a decade, we performed an analysis of movements in interest rates and the impact on European RMBS tranches. To isolate the effects of changing interest rates we generated twelve possible interest rate and prepayment forecasts 1 while keeping the defaults and severities of the Baseline credit environment constant. Using the Structured Finance Workstation (SFW) 2, we applied these scenarios to a sample of 114 deals spanning ten European countries. Within this sample, we found that: On average, interest rate shocks have minimal effect on senior tranches, a moderate effect on mezzanines, and a more severe effect on juniors Deals from different countries tend to place more of the interest rate risk on different tranche seniorities; for example, in U.K. deals from our sample, mezzanine tranches bear the brunt of the interest rate shocks while, in Spanish deals, the juniors take the most additional loss With a more severe credit environment overlaid, overall losses are obviously higher but tranches show less sensitivity to increasing interest rates Breaking down the tranches by seniority, we see that the mezzanine and junior tranches can experience, on average, noticeable increases in losses as interest rates rise. In Charts 1 and 2, the x-axes show rate shift scenarios for example, u200 represents a 200 basis point (bps) upward shift in interest rates. 1 The interest rate scenarios, created by Moody s Economy.com, included a baseline outlook, eight rate-shift curves, and three standard deviation-based shocks. Further details are available in the appendix. 2 SFW is Moody s Analytics proprietary structured finance modeling and analysis tool, which covers all structured asset classes other than CDOs.

2 Chart 1: Average Tranche Loss 0.12% % 0.06% 0.04% 0.02% % 9% 8% 48% 46% 44% 42% Senior Mezz Junior Chart 2: Average Tranche WAL Senior Mezz Junior In our sample, each 100 bps upward interest rate shift results in an additional 40 bps of loss for mezzanine tranches and 100 bps for juniors. The losses on the senior tranches, on the other hand, are affected only slightly with two basis points of additional loss per 100 bps upward interest rate shift. Their weighted average lives do increase, though, as interest rates rise and prepayments slow. That being said, in this low rate environment, prepayments are already low and increasing interest rates do not drastically reduce prepayments further in our projections. To fully understand the source of these movements, we investigate how individual tranches behave. Do all tranches tend to move similarly or do most tranches stay the same while a few outliers drive most of the average change? In Chart 3, we show how the estimated fundamental values (EFV) 3 of the tranches change in the scenario where interest rates move up by one standard deviation 4. Chart 3: One Std. Dev. Rate Shock v.s. Baseline 10 8 Senior Mezzanine Junior % of tranches 6 < -5%- 1 to -5% 0 to -1% 00 to 1% 1 to 5%> 5% EFV % Change Buckets As expected, the senior and mezzanine tranche values resist the upward shift in interest rates, with the majority falling in the no-change bucket. By including the tranches that moved up or down in value by less than 1%, we cover 99% of the senior tranches and 87% of the mezzanines. Only about of the mezzanines move up or down in value by more than 5% and these tend to be deals with weaker relative performance. 3 The estimated fundamental value of a given tranche is calculated by discounting its estimated cashflows by its issuance spread/coupon. 4 The standard deviation scenarios were derived through statistical analysis of historical factors including LIBOR rates, monetary policy rates, and country-specific corporate bond yields. One standard deviation, to put into context for this analysis, is most comparable to the u200 shift scenario, although not directly parallel. 2 JULY 2011 STRUCTURED THOUGHT: INTEREST RATE SENSITIVITY ANALYSIS ON EUROPEAN RMBS

3 The junior tranches are a different story. Only 43% of the sample did not change value in this interest rate shift scenario. Tranches that moved in value by more than 5% made up 23% of the sample. In the case where a tranche s baseline valuation is for cents on the dollar and the tranche is not expected to receive the majority of its principal, any change in available interest can make a significant difference. What may be surprising, however, is that the directionality of the value changes is split relatively evenly 3 of the juniors depreciate in value while 26% appreciate. The explanation for this is found on a deal-by-deal basis. Structural features like overcollateralization, triggers, and swap agreements can all interact with changes in interest rates differently. Given the importance of deal-specific structural features as well as overall credit quality, in Charts 4 and 5 we look at the change in tranche loss across the five countries with the most deals in our sample. Chart 4: Average Mezzanine Tranche Losses by Country 14% 12% 8% 6% Italy Netherlands Portugal Spain United Kingdom 4% Chart 5: Average Junior Tranche Losses by Country Italy Netherlands Portugal Spain United Kingdom Most of the countries follow the same pattern of increasing tranche losses as interest rates rise. On a relative basis, the mezzanine tranches in U.K. transactions respond the most severely, with a jump from just over 5% in average tranche loss under baseline to about 11% in the 500 bps shift scenario. 7 of our U.K. sample is comprised of non-conforming transactions with high delinquency buckets. Breached delinquency triggers divert cash to senior tranches, increasing losses on the mezzanines. On the other hand, the Spanish mezzanines deteriorate by only 1% in losses from baseline to the most severe scenario. Many of the Spanish transactions we analyzed feature the usage of interest to cover unpaid principal which help the mezzanines at the expense of the junior tranches the relatively high sensitivity of the Spanish junior tranches in Chart 5 illustrates this point. 3 JULY 2011 STRUCTURED THOUGHT: INTEREST RATE SENSITIVITY ANALYSIS ON EUROPEAN RMBS

4 Interestingly, the Netherlands mezzanines reverse the overall trend by actually improving along with rising interest rates. This is due to extra spread generated by a swap that converts fixed rate asset proceeds to floating rate. So far, we have only considered the baseline scenario with varying interest rate environments. How do these deals respond to rising interest rates when accompanied by a more severe default environment? We doubled the default vector for all deals in the sample and re-ran the analysis. The average loss for senior tranches in baseline rose from zero to 28 bps. Mezzanines deteriorated from about 8% to 16% and juniors went from 41%, on average, to 47%. 5 Charts 6 and 7 represent the relative change in tranche losses between baseline and each interest rate shock scenario, for both our regular and doubled CDR analysis. For example, in Chart 6 for bl vs. u300 in the doubled CDR analysis, we see a 7.5% data point this means that the losses in the u300 shift scenario were 7.5% greater than they were in the baseline interest rate environment when running double the regular CDR. Chart 6: Relative Change of Mezzanine Losses: Regular CDR vs. Doubled CDR Chart 7: Relative Change of Junior Losses: Regular CDR vs. Doubled CDR 25% Regular CDR Mezzanine Doubled BL CDR Mezzanine 25% Regular CDR Mezzanine Doubled BL CDR Mezzanine 15% 15% 5% 5% We note in Charts 6 and 7 that doubling the CDR assumptions results in less loss sensitivity to increasing interest rates. In many deals, added defaults and losses triggers principal diversion to the senior-most pieces and, in some cases, the mezzanines are the most senior tranches outstanding at the time. At the junior level, losses increase at the same rate as baseline until the 400 and 500 bps shift scenarios. At that point in the double CDR scenario many junior tranches have already experienced 10 losses, leaving no room for further deterioration. This report contains only a sample of our findings additional output is available by request. Appendix The default, severity, and prepayment projections for the underlying portfolios, as well as the alternate interest rate scenarios, were generated by Moody s Economy.com. The interest rate scenarios included the Baseline economy, as well as nine rate shift scenarios (+25 basis points through +500 basis points) and three shock scenarios (+1, 2, and 3 standard deviations). These projections were used to analyze a sample of 114 European RMBS deals spanning ten countries: Belgium, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, and the United Kingdom. The cashflow and waterfall analysis was executed using the Structured Finance Workstation (SFW), a Moody s Analytics cashflow tool. 5 The reason juniors appear to deteriorate less severely than mezzanines is because many junior tranches in the sample experience 10 loss in the regular CDR scenario already and thus could not get any worse when doubling the CDR. 4 JULY 2011 STRUCTURED THOUGHT: INTEREST RATE SENSITIVITY ANALYSIS ON EUROPEAN RMBS

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