Are a series of new Markit derivative contracts foreshadowing trouble in prime MBS?

A series of ABX indexes tied to subprime HE loans has been used by investors to hedge exposure to the MBS market. This is being blamed for driving down the value of illiquid securities closely tied to these derivative contracts. The shorting has gone so far that some holders of subprime bonds are saying that the existing AAA ABX contracts provide investors with misleading information about the value of their assets.

The latest ABX contracts linked to initially AAA subprime bonds that are the last to be repaid closed today at 56.92, up 12 percent from their low, according to Markit. Similar contracts linked to BBB- bonds closed at 7.72, a new low. The indexes tumbled last year from at or near 100 as investors bet rising defaults on home loans would continue.
Contracts linked to the last-cash-flow AAA securities from the second half of 2005, closed at 93.91, up 12 percent from a low.

In an attempt to expand the AAA tranches of HE derivative indexes, security firms have introduced a new ABX derivative contract today. Four versions of the ABX.HE.PENAAA contracts, each tied to different six-month periods, have been created. These contracts are tied to subprime bonds that are the second-to-last of those with initial AAA ratings to receive principal payments. They join indexes tied to bonds initially granted AAA rankings that are last in line to be repaid.

Lately we have seen mounting pressure on MBS contracts closely tied to ABX AAA HE indexes. Delinquencies on prime HELOC, second lien mortgages and some jumbo mortgages are on the rise. The new contracts could give investors a better opportunity to hedge their exposure to this loans without inflicting too much damage on general AAA rated mortgage bonds.



source: Banks Start New ABX to Bet on Subprime Mortgage Debt
By Jody Shenn and Sarah Mulholland, Bloomberg
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ar.VSE8VXvR4

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