Insightful analysis and commentary for the US and global equity investor
Contributors: Douglas McIntyre Jon C. Ogg

Previous Posts

Tuesday, October 24, 2006

Derivatives Market Forsees Housing Slump Worsen

By Yaser Anwar, CSC of Equity Investment Ideas

Traders of mortgage-backed securities (MBS) and the derivatives on which they are based predict that the current housing slump is about to get a lot worse, reports Bloomberg.

The ABX index, which measures the risk of mortgage-backed securities, rose 30% since August 9, says Bloomberg. That’s its highest level since January.

The ABX index tracks the cost of so-called credit-default swaps, which are instruments that are used as insurance by traders in the event of a default. An increase in the cost of a credit-default swap indicates that the risk that underlying loans in the MBS and their derivatives will default is rising.

The index, which was created by London-based Markit Group Ltd., tracks 20 asset-backed securities with ratings of BBB-, the lowest level of investment-grade debt. Based on the index, the cost of insuring against a default rose to $267,000 to protect $10 million of bonds against default for a five-year term from $205,000 in August.

There are more than $500 billion worth of these credit-default swap notes outstanding, says Bloomberg.

According to Moody’s, the percentage of home loans that are late on their payments for more than 60 days rose to 7.23% in July from 5.9% the year before. That’s the fastest rate of increase since 1998, says Moody’s.

Freddie Mac, which buys mortgages and packages them into mortgage-backed securities, expects sales of new and existing homes to drop 9.4% in 2006 after five consecutive years of increases, says Bloomberg.

Even asset-backed securities with higher ratings are suffering. Merrill Lynch’s index of debt securities derived from home-equity loans rated AA to BBB fell 0.01%, it’s worst month this year.

Subprime loans are leading the pack in defaults. The default rate on a subprime loan rose to 7.35% in July from 5.51% the year prior, says investment bank Friedman Billings Ramsey.

Powered by Blogger