Negative Interest Rates Around The World May Affect Structured Finance Products

In this CreditMatters TV segment, Darrell Wheeler, Managing Director of Structured Finance Ratings, Ramki Muthukrishnan, Senior Director and Analytical manager of Legacy RMBS, and Tom Schopflocher, Senior Director of SF Global Research, discuss our recent paper on how recent negative rates around the world might affect structured finance products.

Hi i’m daryl wheeler head of s&p global’s research for structured finance and we recently put together a paper that looked at negative rates and how they might affect structured finance products joining me today are to the co-authors tom and ramky thank you both for being here thanks thanks for having us right ok romkey how pervasive good negative interest

Rates become around the globe whereas become gentleman parts of europe and in japan the central banks have been aggressively lowering their policy rates in an effort to spur economic growth and fight off deflationary pressures the ecb first lowered its deposit facility rate in june of 2014 2-1 percent and earlier this year in march they lowered the rate to minus

Point four percent in the us the fed funds rate are at 25 to 50 basis points and although most economists agree that the rates would likely go up if based on how the economy performs one cannot rule out the possibility altogether of negative interest rates here just given the negative rates around the world most abs products really refer to libor so how are they

Related to these these policy rates that’s a good question and if you look at historically libor has tended to track the policy rates if you look at table one of our piece the u.s. libor has moved in lockstep with the fed funds rate the same is the case with the with the japanese lie board the euribor the swiss franc libor in japan the one-month libor fell into

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The negative territory in january of this year and today five of the six lois maturity libor rates are all in the negative territory and have moved in tandem with the rates that i administered by bank of japan and again in table 2 you will find that the international libor rates have all been negative and are moving in lockstep with the corresponding policy rates

Ok great in the paper tom which which abs products do we focus in on we looked at european abs european rmbs we also looked at japanese rmbs and we looked at us abs are mbs as well as cmbs and cielos so when you do that any of the the products currently paying a negative coupon no we didn’t see any instances of products paying it out of negative coupon we did see

Instances of european structured finance bonds that had negative calculated coupons but as far as we know issuers to date have not sought payments from the bond holders and the reason for this is most likely because these structures don’t have mechanisms allowing for cash to flow from the investor back into the trust and so notwithstanding a negative calculated

Cuckoo calculated coupon the effective floor is taken to be 0 ok does that mean that note holders are pretty much not going to see negative rates on their on their on their structured products no not at all because in the future we could see payments are rising through a legal right to set off against future obligations and there have already been instances in which

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Legal and market authorities have made public statements seeking to provide guidance on this issue notably in japan because the issue is murky and we could see further guidance coming from the courts in various regions given the conflicting interests among different bondholders within a transaction ok that that’s a key point about structured finance products you

Really do have different interests depending upon where in the credit stack you are so if so far to date they’ve been entitled to negative coupon going in and there’s been no disputes or credit stress against it nothing to really test but if if a bond holder on the subordinate bonds was experiencing a stress you can see where they may want the the senior bonds

To pay into the trust and there could be that dispute risk any other risks that we’re looking at the inn in the paper tom yeah there are in particular with the european abs in which swaps are employed if a structured finance vehicle employs interest rate swap for example there could be the situation where negative rates lead to payments on both the fixed and the

Floating legs of the swap and so there would be an expectation that knoll holder would be required to pay into the trust under the agreements and a related risk would exist in currency swaps which are also often employed in european abs okay let’s go back to the u.s. ramki you mentioned negative rates could happen here if they did which products that we looked at

Would actually be at risk don’t all of the transactions we looked at some of the older vintage deals did not have a specific mention of a floor and although the tranches for these we’re structured with a pretty high spread so they calculated coupon is high that libor needs to go down significantly below zero for these two experience- coupons there is still that

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Possibility given that there is no mention of such an explicit floor it’ll be a challenge at that point to interpret these documents when they do get there but that potential does exist going forward the paper make some comments on how we might expect the markets to evolve tom any just quick comments there sure we expect the risks will develop over time and they

Will almost certainly depend on the future path of the short term rates and in turn markets will continue to adjust we expect it issues will set explicit floors on new transactions going forward presumably pricing of the bonds will occurred a premium with wider initial margins and finally we expect that in the deal documents the offering documents that these

Potential risks concerning negative rates and negative coupons will be highlighted for the investor okay that provides a pretty good overview of the paper obviously we will continue to monitor these bonds as for dispute risk and as rates move around the paper itself is titled how might negative interest rates affect floating rate securitizations it’s available

On our structured finance research website and i’d like to thank my co-authors for joining me today thank you oh you

Transcribed from video
Negative Interest Rates Around The World May Affect Structured Finance Products By S\u0026P Global Ratings