The ABX.HE plummeted last week to all-time lows amid unrelenting news of issuers pulling out of the subprime mortgage market and the sour performance of loans originated in 2006. The activity - most dramatic in the triple-B tranches of the index's second series - comes on the heels of this week's emergence of the third ABX.HE series.
Contributing to the decline, CDOs were rumored to be slacking from their usual position at the other end of hedge fund sentiment. "It would appear as though SF CDO managers are finally starting to come to terms with the gravity of the collateral credit situation and that their market-forced focus on top-tier assets, many of which trade at non-arbitrage levels, is limiting their ability to respond to overall spread widening," JPMorgan Securities analysts wrote last week. They predicted that the second ABX index will continue to underperform, maintaining last week a spread target for ABX.HE 06-2 triple-B-minus at 585 basis points.
Last week Popular Inc., parent company to Internet financial services company E-LOAN and subprime lender Equity One, announced plans to exit the wholesale subprime lending business this quarter. Popular will shutter the wholesale broker, retail and call center business divisions of its U.S. consumer finance and mortgage business subsidiary Popular Financial Holdings. It appears as though Lehman Brothers will emerge as the white knight for troubled subprime lender Mortgage Lenders Network USA, which recently announced plans to exit the wholesale subprime lending business. Lehman has agreed to fund the lender's forward commitments, and is rumored to be buying its wholesale lending operation.
Although the third series is expected to bring with it a wealth of correlation trades, the second series appears as though it will remain the favorite among those with a short interest. A number of mortgage lenders had already cleaned up underwriting guidelines for the second half of 2006 deals that will back the third series, said one source. Securities buyers had also begun to step up their own standards for what they would and would not buy. Of course, sources said, the particular deals underlying the index will ultimately dictate its performance.
A testament to the difference in deal performance between the first two indices, ABX.HE 06-2 triple-B-minus spreads were nearing 450 basis points at the end of the year, some 100 basis points wider than triple-B-minus spreads on the ABX.HE 06-1, which stood at roughly 325 basis points. The gap was the widest divergence between the two indices leading up to 2007, according to Morgan Stanley data. The second-largest disparity occurred in June, when the triple-B-minus tranches of the two indices were separated by only 50 basis points.
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