The available funds cap was the topic of discussion by analysts at Citigroup Global Markets and Morgan Stanley last week, as it has come into focus recently as short-term rates have risen steadily and excess spread on new deals has diminished.
Citigroup evaluated the cost of the cap for both senior and subordinated home-equity ABS under several interest rate, volatility and prepayment scenarios and found that the cost is greater for seasoned deals than for recently issued securities. "Using a 12-month average of implied volatilities, the cost of the [cap] on recently issued securities is low, ranging from zero basis points on short and intermediate triple-As to four basis points on the double-Bs. In a 100 basis point parallel shift of the forward curve, the cost of the AFC increases to a range of zero to 11 basis points," according to Citigroup.
Citigroup's analysts explain that the cost is higher for seasoned deals because they have less effective corridors and higher proportions of fixed-rate loans in their pools. For a typical early 2004 deal, the cost of the AFC is in the seven to 13 basis point range. A 200 basis point interest rate increase can ratchet the cost to over 70 basis points on double-Bs.
Morgan Stanley has also taken a look at the available funds cap over the past two weeks. After a similar examination, Morgan Stanley analysts found that discount margins for senior, mezzanine and subordinate classes of home-equity ABS were not impaired for a 200 basis point upward shift in Libor. "The present results are particularly satisfying for the mezzanine and subordinate bonds because of the higher cumulative loss assumptions that we employ as forward Libor gets shifted upward," according to Morgan Stanley.
In the second part of Morgan Stanley's analysis, it found the estimated cap costs for triple-As to be from zero to eight basis points, for the double-As the costs ranged from two to eight basis points, the range for the As was from two to 14 basis points and for the triple-Bs the range was from eight to 171 basis points, as higher rated classes within a ratings range have lower cap costs than lower rated classes in the same ratings range.
The analysts note that whether the "true" cap cost is towards the upper or lower end of the range depends on whether subprime mortgage prepayments and cumulative losses will behave.
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