Deteriorating subprime market

Deteriorating subprime market pummels ABx, bond insurers [¹]

By Anusha Shrivastava | 27 October 2007

NEW YORK (MarketWatch)—

Fresh evidence that the subprime mortgage problems are growing worse pummeled a leading derivative index Thursday, and caused investors to grow much more cautious about the prospects of bond insurers and financial institution American International Group Inc. (AIG:62.15, +0.36, +0.6%) .

Troubling data on subprime mortgage delinquencies and defaults released Thursday punished the riskiest, BBB-portion of the closely watched ABX index based on mortgages made in the second half of 2006 to record lows.

Investors have used the ABX index as a gauge of the subprime market since its fortunes have largely led the deterioration of mortgages extended to borrowers with shaky credit. The BBB-slice of the index traded at a record low of 18 cents.

Even the less risky tranches of the index are much weaker, with the A and AA tranches hit the most. The single A slice of the index based on loans from the second half of 2006 is quoted at 28.5 cents, down from a close of 32.42 cents.

Though analysts are still digesting the reams of data on loan performance released by the trusts that hold loans that ultimately influence the ABX index, the preliminary readings of these remittance reports are bad.

"After seeing the remit reports, people are saying it's time to go back into bomb shelters because the war continues unabated," said Dan Nigro, ABS portfolio manager at Dynamic Credit Partners in New York, a hedge fund investing in ABS, CDOs and distressed structured finance, with $5.5 billion in assets under management. Nigro trades the index and has been buying protection, and therefore, benefiting from the declines in the index.

The data fed anxiety already heightened by Wednesday's staggering writedowns at Merrill Lynch & Co. due to exposure to subprime mortgages, with the bulk coming from collateralized debt obligations, complex securities that are difficult to trade.

The mortgage-related jitters, however, only provided modest and short-lived flight-to-safety buying.

Financial institutions and bond insurers were targeted by cautious investors. The cost of credit protection on insurer AIG and bond insurers such as Ambac Financial Group rose while their stock price tumbled as worries about their exposure to the subprime mortgage market mounted.

Credit default swaps on AIG gapped out 15 basis points to a bid/offer price of 55/60 basis points, according to Scott MacDonald at Aladdin Capital Holdings.

RBS analysts in London noted that AIG has acknowledged a super-senior portfolio of $465 billion at AIG Financial Products at the end of the second quarter, of which $64 billion is backed by subprime. "The scale of the exposure must surely raise eyebrows here," they wrote.

"The real issue is understanding exactly what the underlying assets are and the structure of the CDO (collateralized debt obligations)— gross exposure alone doesn't really tell us a lot although clearly anything with subprime looks more at risk in the near term," they wrote.

Other bond insurers that saw their credit default swaps widen included Ambac, which have gapped to 365/395 basis points from 345/375 basis points Wednesday, according to Sid Bakst at Robeco Weiss Peck & Greer. The insurer reported worrisome results Wednesday.

But protection on MBIA Inc., whose stock also declined after the insurer marked down the value of its structured portfolio, held steady at 200/220 basis points, compared with 210/230 basis points Wednesday.

Recently, MBIA's share price was down 20%, Ambac was down 18% and AIG's stock was 6.7% lower. Countrywide Financial Corp. was also under pressure ahead of its earnings report Friday— its shares were down 9.1%.

Normxxx    
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