Bad news from the second and third largest sub-prime lenders in the U.S. slammed the synthetic asset-backed market last week, with the ABX index hitting new lows. Investors reported that some dealers are starting to trade BBB-minus bonds at a discount, a first for this market since the advent of synthetics.
"I tried to get pricing on the BBB single names of the 20 ABX constituents and the answer I got from a couple of dealers is that those names are now trading on a loss and not on the coupon. I've never gotten that before," a portfolio manager said. The BBB-minus stack of both the 07-01 and the 06-02 vintages traded down around three percentage points between market close on Wednesday and early afternoon on Thursday. ABX 07-01 dropped from 92% to 89% and 06-02 from 89.63% to 86%. Bid-ask spreads were tight at around one basis point.
Dealers reported that some firms that issued synthetic deals referencing the BBB and BBB-minus parts of the ABX last fall have now came back to market to try and unwind some of their long positions. "These guys were delta hedging by going long the ABX because for months they thought the index was oversold and instead went long by selling protection," noted one head of ABS trading in the U.S. He declined to comment on what firms he saw in the market last week, but said that many were forced to adjust these delta hedges by selling more protection in the single-name market. Macro hedge funds that were positioned for a massive correction in the housing market since last year have been taking profits wherever possible.
The ABX started to spiral late Wednesday after California-based New Century Financial Corp. said it expects to report a loss for the fourth quarter because of accounting errors related to loan repurchase agreements. The company also must restate results for the first three quarters of 2006 because it did not set aside enough money to buy back sub-prime loans that went bad.
On the same day, HSBC Holdings said it plans to set aside USD10.6 billion companywide for bad debts, 20% more than the USD8.8 billion it said analysts expected on average, because of struggles in its sub-prime platform. "This all paints a picture that the predictions that there would be a quick end to this housing downturn, are more and more ridiculous," said another ABS trader.
