The risk of non-calls in European RMBS was reignited last month when Portuguese bank Caixa Economica Montepio Geral said it would not exercise the scheduled call for its Pelican 2 RMBS.
This was the first scheduled call for Montepio since the crisis, but market analysts said that given the current market conditions they had actually anticipated the non-call.
The latest non-call via the Pelican 2 deal had been trading on a non-call basis for quite a while, since the requirements under the offering circular required a notice be sent 30 to 60 days prior to the Sept. 15 call date.
"Given the current economic backdrop in Portugal and the tough environment in which the banks find themselves, this is no surprise," said Dipesh Mehta, an RMBS analyst at Barclays Capital. "There have also been numerous other RMBS transactions in Portugal that have extended beyond their call dates, along with upcoming calls for other transactions."
Among the deals that Mehta referenced were Magellan 1, which was originated by BCP in December 2008. The Navigator Mortgage Finance 1 (BNC) deal followed in May 2009 and Lusitano 1 (BES) in December 2009. The most recent was Atlantes 1 (BANIF - Banco Internacional do Funchal) in January this year.
Montepio's failure to formally announce the exercise of its call of the Pelican 2 Portuguese RMBS last week reignited concerns over the inherent risks in some European RMBS structures.
Call features are structured into securitizations as a means to shorten the duration of liabilities and therefore offer a more appealing investment to the investors.
According to a research note published by the Royal Bank of Scotland (RBS), in securitizations from Germany, the Benelux and selected U.K. prime RMBS, hard calls are more common. In these cases, the seller is obliged - and in some cases, incentivized via step-up coupons - to refinance or otherwise fund using its own balance sheet, which means an outright call of fully levered ABS tranches.
Southern European and Irish deals are structured with "late calls," designed such that cash flow pays down a substantial portion of senior notes before sellers use their balance sheet to fund what is effectively an early clean-up of outstanding - mostly junior - bonds.
Although most bank ABS/RMBS are called as expected, in recent years, many of the deals extended beyond the first exercise date called or tendered, but in many cases are called as soon as the next payment date.
In the RBS research note, Ganesh Rajendra, head of ABS strategy at the firm, pointed out that the extent of non-calls is likely to remain "noticeable" in a market with liquidity and funding pressures.
Who's Calling, and Who Isn't?
Banks with plans to continue using ABS are more likely to readily exercise calls.
"The willingness to call can be argued to be driven by economics (step-up coupon costs versus the then-current market clearing spreads) and also by the importance of securitization going forward for the respective bank sellers, the premise here being the need to avoid alienating ABS investors," Rajendra said.
He added that at one extreme, strong or highly rated financial institutions with plans to still utilize ABS as a funding source - and where existing step-ups are not punitive - are expected to readily exercise calls.
At the other extreme, Rajendra said that it might be reasonable to judge weaker banks with no foreseeable plans to re-enter the securitization market - and where there are no step-ups - as unlikely candidates to honor bond calls.
Pressure on entities that have received government aid has led to some higher-performing banks to not call their bonds. This first became apparent in the U.K. with RBS' announcement that it would not call four of its bank capital securities following regulators' objection to the calls.
The U.K.'s Financial Services Authority (FSA) had instructed the part state-owned bank not to call the notes after the European Commission (EC) had made it clear that state aid to banks should not be used to repay equity or subordinated debt.
Fortis Bank followed with its announcement that it would not call Delphinus 2003-I or the Beluga 2006-1 A1 notes in October 2009. Meanwhile, ABN AMRO also stated that it wouldn't call on its EMS III transaction.
The vast majority of these support schemes were put in place in 2008 and 2009 and were slated to expire at the end of June 2010. They have been periodically extended, generally for six months, when requested by the member states concerned and if they were justified.
The EC, for instance, recently extended its authorization under European Union (EU) state aid rules until Dec. 31 of the Dutch and Slovenian bank guarantee schemes and the Greek and Polish bank support measures.
The EC has authorized the extension of the Dutch guarantee scheme until Dec. 31. The scheme was initially approved on October 30, 2008; on July 7, 2009; and on Dec. 17.
The Commission has already approved, also for six months, the prolongation of schemes in Sweden, Germany, Hungary, Austria, Latvia, Ireland, Spain and Denmark.
"Certain bailed-out banks have looked disinclined to call their securitizations because of the broader terms of state-aid, though such non-call restrictions seldom explicitly refer to ABS," Rajendra said.
In the case of Fortis, for example, he said that the bank chose not to exercise its RMBS calls in DELPH 2003-I, DELPH 2004-II and EMS III on the call date, but called the bonds instead on the subsequent payment date.
Montepio, the Portuguese bank, has also stated that the call on its Pelican 2 RMBS bond is exercisable on a quarterly basis, and it might opt to exercise calls in the future. Moreover, the Pelican notes have a 10% clean-up call.
Rajendra believes that figuring out who will call and who will not is less formulaic. Strong, creditworthy banks, for instance, may have no plans to return to securitization, although not calling on the RMBS transaction would disappoint ABS buyers and could alienate the same investors in their other liability programs.
Furthermore, Deutsche analysts said, that it's likely that the sheer scale of financing requirements coming up in the RMBS sector paired with the expiration of the EU state bank guarantees in December could lead some banks to swallow the elevated economic cost and probe structural mechanisms to allay investor concerns around timely redemption.
The non-call of Portuguese transaction Pelican 2, according to Deutsche analysts, "is a continued reminder of how investor-placed securitization markets remain shut to banks from peripheral jurisdictions," Deutsche Bank analysts wrote.
In theory, they said that secured RMBS lending - as opposed to senior unsecured - should prove a first port of call for peripheral banks.
However, what actually happens with spreads is unlikely to be too far removed from still elevated sovereign pricing. They added that economics will likely remain challenging and low prepayment rates would suggest that the reliance on sponsor call is still important, analysts said.
