The synthetic asset-backed securities (ABS) market completed another important step in its evolution in January with the launch of the first set of synthetic ABS indices, ABX.HE, by the CDS IndexCo consortium and Markit Group.
Bradford Levy, managing director of the eBusiness Group at Goldman Sachs and chairman of CDS IndexCo, says: "The CDS of ABS market has grown at a rapid pace over the past six months, and we have seen increasing appetite among clients for a way to take a synthetic view on ABS. ABX is a direct response to that demand, and gives clients an efficient standardised tool with which to quickly gain exposure to this asset class."
In line with the prevailing liquidity in the underlying single-name ABS credit default swap market, the first version of the index is focused on the sub-prime home equity sector. There are plans to launch ABX indices backed by other sectors like credit cards, student loans and auto loans in the near future.
The home equity ABX is a family of five sub-indices, each consisting of a basket of 20 CDS which are equally weighted at index launch and based on the ratings of the underlying obligations. Subsequent weightings may change based on the performance of loans in the underlying pools.
The set of ABX.HE indices is formed by choosing deals from 25 of the largest sub-prime home equity shelves, by issuance amount, from the previous six months. The minimum deal size is $500 million, and each tranche referenced must have an average life of between four and six years, except for the triple-A tranche which must have a weighted average life greater than five years.
Ben Logan, director in product development at Markit, says: "The portfolio for ABX.HE is developed through an independent rules-based algorithm that seeks to identify a universe of deals that is both liquid and representative of the market as a whole."
Unlike the corporate CDS indices, the ABX contract component trades are reference obligation specific, rather than entity specific. Also, unlike corporate bonds which are bullet maturity, ABS bonds amortise at variable rates over the life of the instrument. A pay-as-you-go template from the International Swaps and Derivatives Association, the standard for US residential mortgage-backed securities, references each bond.