ABX indexes continue to crater

[eyePod]

What’s eponymous about “Dennis Gartman”?

[eyePod]

What’s eponymous about “Dennis Gartman”?

[Ozzie]

I’m confused by how anyone values these CDO’s and I have a feeling that the issuers have no idea either. A typical foreclosure that takes a year to resell will probably result in a 30% loss for that particular loan if it was 100% financing and in a weak RE market. The numbers I’ve seen say that at worst 20% of subprimes go into forclosure. Using that math and assuming the other 80% perform at high interest rates between (8-14%) I don’t see how these guys are losing money. Now some of these funds are being forced to sell the loans for pennies on the dollar. If I had a a few billion dollars I’d love to buy as many subprime loans as you’ve got at the prices I’ve seen quoted. Service the debt for 10 years and rent the houses that the deadbeats default on and collect the high interest paymens on the others. Wait until the next RE upturn and then sell the property you’ve foreclosed on. I’ll bet a guy like Sam Zell is looking into doing something like this.

On another note, credit card debt is also resold in these packages and defaults there run twice as high as mortgage default (4% to 2% I’ve read) and it’s not secured. I’m wondering how the risks and rewards of these two types of debt track each other.

[Ozzie]

I’m confused by how anyone values these CDO’s and I have a feeling that the issuers have no idea either. A typical foreclosure that takes a year to resell will probably result in a 30% loss for that particular loan if it was 100% financing and in a weak RE market. The numbers I’ve seen say that at worst 20% of subprimes go into forclosure. Using that math and assuming the other 80% perform at high interest rates between (8-14%) I don’t see how these guys are losing money. Now some of these funds are being forced to sell the loans for pennies on the dollar. If I had a a few billion dollars I’d love to buy as many subprime loans as you’ve got at the prices I’ve seen quoted. Service the debt for 10 years and rent the houses that the deadbeats default on and collect the high interest paymens on the others. Wait until the next RE upturn and then sell the property you’ve foreclosed on. I’ll bet a guy like Sam Zell is looking into doing something like this.

On another note, credit card debt is also resold in these packages and defaults there run twice as high as mortgage default (4% to 2% I’ve read) and it’s not secured. I’m wondering how the risks and rewards of these two types of debt track each other.

[barnaby33]

Bottom line being that many hedgies stand to realize massive windfall CDS profits when the defaults occur and the insurance has to pay up.

The underlying assumption being that they can pay up. I am guessing that a fair number can’t.

On an unrelated note, this article is a nice primer on how debt creation all the way from mortgages to synthetic CDO’s occurs.
Bullion vault article

Josh

[barnaby33]

Bottom line being that many hedgies stand to realize massive windfall CDS profits when the defaults occur and the insurance has to pay up.

The underlying assumption being that they can pay up. I am guessing that a fair number can’t.

On an unrelated note, this article is a nice primer on how debt creation all the way from mortgages to synthetic CDO’s occurs.
Bullion vault article

Josh

[stansd]

I’ve been confused by this same thing: Just to make sure I’ve got it: When the popular press quotes the ABX index, they are quoting the BBB- rated portion of it, correct? If so, that means that the default rates are creeping way past the equity tranche.

With that said, the AAA tranche is still selling for 95 or so, meaning that that’s still quite safe.

I will confess, though…looking at all the different traches, I’m surprised by how much risk the market is pricing in (5 ppts on an AAA rated bond seems like quite a lot).

I haven’t done the math, but it seems like at these prices, and given the ratings downgrades, this market truly is in the process of evaporating, while the spreads skyrocket.

Am I reading this all correctly?

Stan

[stansd]

I’ve been confused by this same thing: Just to make sure I’ve got it: When the popular press quotes the ABX index, they are quoting the BBB- rated portion of it, correct? If so, that means that the default rates are creeping way past the equity tranche.

With that said, the AAA tranche is still selling for 95 or so, meaning that that’s still quite safe.

I will confess, though…looking at all the different traches, I’m surprised by how much risk the market is pricing in (5 ppts on an AAA rated bond seems like quite a lot).

I haven’t done the math, but it seems like at these prices, and given the ratings downgrades, this market truly is in the process of evaporating, while the spreads skyrocket.

Am I reading this all correctly?

Stan

[stansd]

Data I’m looking at in my previous post:

Index Series Version Coupon RED ID Price High Low
ABX-HE-AAA 07-1 7 1 9 0A08AHAC6 95.23 100.09 95.23
ABX-HE-AA 07-1 7 1 15 0A08AGAC8 88.11 100.09 88.11
ABX-HE-A 07-1 7 1 64 0A08AFAC0 68.50 100.01 68.50
ABX-HE-BBB 07-1 7 1 224 0A08AIAC4 47.09 98.35 47.09
ABX-HE-BBB- 07-1 7 1 389 0A08AOAC1 45.02 97.47 45.02

Stan

[stansd]

Data I’m looking at in my previous post:

Index Series Version Coupon RED ID Price High Low
ABX-HE-AAA 07-1 7 1 9 0A08AHAC6 95.23 100.09 95.23
ABX-HE-AA 07-1 7 1 15 0A08AGAC8 88.11 100.09 88.11
ABX-HE-A 07-1 7 1 64 0A08AFAC0 68.50 100.01 68.50
ABX-HE-BBB 07-1 7 1 224 0A08AIAC4 47.09 98.35 47.09
ABX-HE-BBB- 07-1 7 1 389 0A08AOAC1 45.02 97.47 45.02

Stan

[betting on fall]

Ozzie-
I think the issue is that these loans get chopped up and some bonds are based on the riskiest parts. Those risky bonds are now essentially worthless, and the “good” parts are not looking as good.

But you are very right that many piggingtons and others may overestimate the amount of money being lost. Even if 10 % of all mortgages default, and there is a 75% recovery on those defaulted loans, only 2.5% of the total mortgage value is lost (plus lost interest payments.) Lots of money lost, but not a “crash the banking system” type of problem.

But the bigger issue is the loss of appetite for mortgage bonds. Mortgage companies need to sell their mortgages to make money, and if Wall Street stops buying- or pays less for them- the business model that drove mortgage lending the last few years is over. Lots of those radio station ad re-fi guys will be out of work. And people that need those exotic loans to stay in their houses (or to buy) will have more trouble finding someone to write the mortgage. To me, that the more important part of the story.

[betting on fall]

Ozzie-
I think the issue is that these loans get chopped up and some bonds are based on the riskiest parts. Those risky bonds are now essentially worthless, and the “good” parts are not looking as good.

But you are very right that many piggingtons and others may overestimate the amount of money being lost. Even if 10 % of all mortgages default, and there is a 75% recovery on those defaulted loans, only 2.5% of the total mortgage value is lost (plus lost interest payments.) Lots of money lost, but not a “crash the banking system” type of problem.

But the bigger issue is the loss of appetite for mortgage bonds. Mortgage companies need to sell their mortgages to make money, and if Wall Street stops buying- or pays less for them- the business model that drove mortgage lending the last few years is over. Lots of those radio station ad re-fi guys will be out of work. And people that need those exotic loans to stay in their houses (or to buy) will have more trouble finding someone to write the mortgage. To me, that the more important part of the story.

[Ozzie]

What I continue to not understand is if these packages of bonds are really tied into the underlying mortgages for the duration or if they are just bought, sold, insured, sold again, etc. for a quick buck and commission. I have experience with hard money loans to people with issues, but the underlying worth of the property always motivated me to do the deal because I felt I could come out whole if things went wrong. I have a couple in BK court right now and expect decent results. The borrowers (developers) only went BK to buy time and they know the worth of the properties are much greater than our loans. I’ll post about them once it closes in the next 6-12 monts, but I get the feeling these CDO’s are just kind of made up products by investment banks looking for a commission and a gamble by their investors.

I appreciated the post and link by the other poster which went in to detail at the Bullion site. Good stuff.

[Ozzie]

What I continue to not understand is if these packages of bonds are really tied into the underlying mortgages for the duration or if they are just bought, sold, insured, sold again, etc. for a quick buck and commission. I have experience with hard money loans to people with issues, but the underlying worth of the property always motivated me to do the deal because I felt I could come out whole if things went wrong. I have a couple in BK court right now and expect decent results. The borrowers (developers) only went BK to buy time and they know the worth of the properties are much greater than our loans. I’ll post about them once it closes in the next 6-12 monts, but I get the feeling these CDO’s are just kind of made up products by investment banks looking for a commission and a gamble by their investors.

I appreciated the post and link by the other poster which went in to detail at the Bullion site. Good stuff.

[DaCounselor]

bof – you are absolutely correct regarding loss limitations on the underlying assets (mortgages) as well as the potential credit contraction due to loss of appetite for mortgage-backed securities.

Another aspect to consider is the impact of credit derivatives. We’re potentially talking about trillions of dollars in credit derivatives at stake as the default process unfolds. So a hedge fund or investment house’s exposure on derivatives may far exceed their exposure on CDO’s. Therefore, potential losses are not limited to the underlying asset alone.

[Author]

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