Fitch Releases Case Study on Interest Shortfall Risk in ABS CDS & Synthetic CDOs.

NEW YORK & LONDON -- The potential for interest shortfalls arising from available funds caps (AFC caps) found in home equity ABS is a topic that receives much attention in the marketplace. In a report released today, Fitch Ratings studied the ABX.HE CDS index, which is comprised of twenty benchmark bonds comprising the largest, most liquid issues from active RMBS issuers (see www.markit.com) to understand the potential for AFC induced interest shortfalls in general, and implications for single name ABS CDS and synthetic ABS CDOs in particular.

'Positively, to date AFC shortfalls do not appear to have been a material issue for synthetic ABS CDOs,' said Roger Merritt, Managing Director, Fitch Ratings. In Europe, synthetic CDOs that reference ABS have typically not included any concept of premium impairment from an AFC shortfall, and in the US synthetic ABS CDOs to date have included structural features that serve to mitigate AFC risk arising from the ISDA's 'pay-as-you-go' template.

In the US, the impact of any AFC shortfalls within a synthetic CDO would most likely felt by equity holders or junior classes in the form of reduced returns while credit enhancement in the form of over-collateralization typically would be unaffected.

'AFC risk has been an important consideration for investors that own home equity securitizations outright or indirectly through CDOs,' said Grant Bailey, Director, Fitch Ratings. Fitch's analysis of the ABX.HE CDS index indicates that AFC risk is very much dependent on the interest rate stress in combination with other factors such as collateral performance. To date, most Fitch-rated BBB HEL bonds have incurred minimal AFC shortfalls

For synthetic investors, ISDA's new 'pay-as-you-go' ABS CDS template allows one to select the degree of AFC risk assumed in synthetic form. According to Tania Cunningham, Senior Director, Fitch Ratings, 'although the option to limit AFC risk to the CDS premium received is standard for the single name market, based on our analysis it primarily acts as a 'stop loss' and, depending on how it is priced, may offer minimal advantage except under fairly stressful scenarios.'

'ABX.HE CDS Index: Study of Available Funds Cap Risk in ABS CDS' is available on both the Fitch Ratings web site at www.fitchratings.com, as well as fitchcdx.com, Fitch's web site entirely devoted to analysis of the Credit Derivatives market.

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