ABX Hitting Too Many New Lows to Count; Index Calculation Changes Ahead?

Most HW readers are familiar with the ABX Indices – the indices reference asset-backed bonds, and are commonly used by bond investors to speculate on or hedge against the risk of the underlying security (in this case, subprime mortgages and home equity loans).

An email I received from one bond trader characterized certain parts of the ABX as being “in a race to zero” roughly two months ago — and recent trending may actually prove that sentiment astoundingly correct. For one, nearly every index in the 2007-2 series settled at new all-time lows today (only AAA hasn’t broken its floor yet). Here’s the graph for ABX-HE-AA 07-2:

The others look even worse. For those of you who’ve been reading this blog since August at the very least, none of this should be a surprise. Not that it makes what is taking place now any less ominous for the credit markets, however — the drops being observed now across nearly every index in the ABX are far more severe than what was observed earlier this year.

But perhaps most telling of all is the troubles now facing the actual indexes themselves, which have been so decimated by the subprime mess that there aren’t enough issuances to actually back forward calculations.

From Financial News Online:

The four ABX derivative indices, which track the cost or spread of credit derivatives on 20 bonds secured by sub-prime mortgages and home-equity loans, are struggling to replace maturing bonds with newly qualified issues because supply has been severely hit by the sub-prime mortgage crisis in the US.

New versions of the indices are created every six months as some of the securities mature and fall out of the index, leaving room for newly issued asset-backed securities to qualify. However, the dearth of new supply in the past three months and poor outlook to the end of the year may lead the indexes being changed.

Ben Logan, managing director for product development at New York-based Markit Group, an independent source for credit derivative pricing, said: “The ABX indexes may need to change their criteria because securitizations have fallen so low, so there may not be enough bonds to fill the series.”

If you weren’t sure whether or not the subprime lending market had gone away or not yet, it’s now time to become dead certain.