Fitch Ratings says that the number of European structured finance deals using swaps to hedge interest-rate mismatches may decrease as hedging costs rise and the number of eligible counterparties drops. This reduces the counterparty risk but can place more emphasis on credit enhancement if the resulting interest-rate risk is not adequately mitigated, for example through natural hedges.
The credit ratings agency (CRA) commented that various techniques have emerged to compensate for the absence of swaps, which typically consist of constructing a natural hedge by matching coupon payments on the notes as closely as possible to interest rate payments on the underlying loans. For example, in Candide Financing 2012, a Dutch mortgage-backed transaction that Fitch rated earlier this month, the proportion of fixed-to-floating class A notes (83.1% to 16.9%) closely matches the proportion of fixed-to-floating mortgage loans (82.5% to 17.5%).
The CRA adds that matching note coupons to payments on underlying fixed-rate loans depends on investor demand for fixed-rate structured finance issues. This may be limited in the European market, which has been characterised by floating-rate issuance. It is, however, becoming popular in retained transactions where the notes are kept to be used as collateral.
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