ABX widening stokes credit fears

This morning, the five-year iTraxx Europe Crossover index spreads had widened to 238 basis points, up 37bp from its closing level on February 27, according to Deutsche Bank. Within the first hour of London trading, one dealer estimated there had been around €10-15 billion of trades across the iTraxx Europe, Crossover and HiVol indexes. Meanwhile, on February 27 closing, the Dow Jones CDX Crossover Index had widened to 146bp, a rise of 32bp from February 26.

Most traders in London remain confident the widening spreads represent a temporary correction. Spreads on the five-year iTraxx Europe Crossover Index had tightened back in to about 207bp by 11am during London trading on February 28, according to Deutsche Bank.

The volatility in the iTraxx and CDX indexes follow a sharp drop in the ABX.HE indexes over the past month. Since mid-January, the ABX.HE.07-1 BBB index – which tracks credit default swaps referencing 20 US subprime home equity securities rated BBB – has fallen by more than 30 points to 67.12 as of February 27.

The ABX.HE 07-1 BBB- tranche index has fallen even further – by almost 35 points to 62.25 by February 27. As the indexes have fallen, rough aggregated spreads on the BBB- rated underlying reference obligations ballooned to 1,478bp by the end of February, according to figures from Lehman Brothers.

The dramatic moves reflect growing delinquencies in US subprime loans. The Federal Reserve reported at the end of February that the share of loans for which payments were at least 30 days overdue rose to 2.11% in the fourth quarter of 2006, up from 1.72% in the previous quarter. Faced with burgeoning losses, at least 20 subprime mortgage lenders have either been sold or closed their doors to new business over the past six months, according to Bear Stearns.

However, concerns that subprime losses herald the beginning of a contagion effect that could cause widespread selling across credit markets is overdone, say dealers. “It’s too small of a market to have an impact overall,” said Robert Lepone, London-based executive director of fixed income at Morgan Stanley.

But the growing perceived risks associated with home equity loans in the US will lead to lower prices for corresponding subprime residential mortgage-backed securities (RMBS) tranches. It will also hit some US collateralised debt obligations of asset-backed securities, which normally include a substantial volume of subprime RMBS tranches in their underlying loan pools.

Analysts say increasing spreads within BBB/BBB- US home equity loans has also led to greater segmentation in the market for individual RMBS tranches, with a greater focus on factors such as issuers and collateral in their pricing.

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