European RMBS is increasingly being offered with a Basel II call option, researchers at Morgan Stanley report in a report last week, and if Basel II drives a more efficient RMBS structure - as market talk indicates - it might motivate issuers to call.
"Bonds are currently priced to expected maturity, but we suggest that as Basel II gets closer, investors will pay more attention to the call," the report says. "Depending on the spread environment, we believe that such bonds will trade at lower premiums to those without the call language."
Although the wording varies, Basel II call options appear in at least a handful of recent transactions, including deals from Holmes, Lothian and Granite deals. Bradford and Bingley's Aire Valley transaction and Permanent 5 also contain such clauses.
"Issuers talk of a new structure under Basel II where they fund a triple-A tranche and retain the subordinate pieces," added Morgan Stanley researchers. "We calculate that the new structure is more efficient, and the savings may motivate issuers to exercise the call option."
To estimate the impact of a call on U.K. RMBS, the researchers examined a one-year-old transaction with a four-year average life. At the double-A level, the bonds trade at 28 basis points over three-month Euribor, although the spread, should the bonds be called, would equate to 11 basis points over, according to their analysis.
"The impact is more pronounced on junior-rated debt, given the significant tightening at the triple-B level over the past year," the researchers wrote. "The triple-Bs are currently trading at 102.09, although we calculate that if the bonds are priced to the Basel II call, they should trade at 101.03." Premiums on more recent transactions are less pronounced, researchers also said.
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