Moody’s highlights swap risks within European securitisations
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In fixed amortisation swaps, the notional on which the interest is paid decreases over the lifetime of the contract. Such swaps are commonly used in commercial mortgage-backed securities (MBS) transactions. These hedges can increase market risk because the fixed schedule can lead to a mismatch between the assets and liability side of the structure.Swaps that follow the real amortisation schedule of the assets within the securitisation – prepayment of mortgages, for example - are also available. However, inclusion of prepayment optionality increases the cost of this type of hedge.
Flexi-swaps - where the notional can vary within an upper and lower band – can provide hedging at a reasonable cost, Moody’s said. But if the assumptions about prepayments used to fix the bands are wrong, then hedging can go awry.
“By explaining the risks and mitigants associated with these structures, Moody's hopes to assist in the standardisation of such external support instruments,” said Benedicte Pfister, London-based senior credit officer at Moody’s Investors Services.