TABX launches into rocky ABS market

Dealers started trading tranches of the ABX indices just as fears of subprime mortgage losses sent spreads reeling and caused wildly divergent pricing on the new product

These are rocky times for the synthetic asset-backed securitisation market. The US ABX index, which references a pool of 20 home equity loan asset-backed securities, has taken a battering in recent months as investors have reacted to a rising number of delinquencies in the underlying home loans market (see feature p. 31).

Amid this turmoil dealers released the first set of ABX tranched indices, TABX, into the market on February 14. The tranches were issued in two series referencing the BBB and BBB- sub-indices of the ABX 07-1 and ABX 06-2 index vintages, the two worst performing ABX indices. Attachment points for the indices went from the first loss 0-3% to 35-100% super-senior on the BBB tranche, giving participants six different points of exposure in the capital structure.

Considering the hammering that the underlying ABX 06-2 index has taken over the last few months - the BBB- tranche broke the symbolic 1,000 basis point barrier in mid-February and peaked at 1,983 on February 27 - it was an inauspicious start for the release of the product. Lack of consensus over the pricing structure underlying TABX - in particular the market remains stumped on how to account for the tricky issue of ABS correlation - only compounded difficulties surrounding the launch.

"Dealers and investors have not come to any agreement over the parameters of trading ABS correlation," says the head of ABS trading at a large US investment bank, who wished to remain anonymous. "ABS is not as clean an underlying as corporate credit, which makes modelling the different parameters extremely difficult; in fact, with the underlying trading so wide, people can't even agree on delta (sensitivity to the underlying) in this market."

The wide range of prices on the TABX tranches on the first day of trading were some indication of the disparity of dealer opinion. Pricing on the super-senior tranche came in at a range of 72-300bp, settling at an end of day bid/offer spread of 140/195bp. On the bottom tranche the range came in at a huge 2,600-3,600bp, eventually coming in at a bid/offer of 2,760/3,200bp.

Pump up the volume

Launch day volumes remained moderate, with around six or seven dealers making markets, though trading in the indices came from a variety of dealers, hedge funds and even real money accounts seeking to sell super-senior ABS protection at a juicy bid/offer spread.

According to one participant, the major losers on the day were a handful of dealers who had been pre-positioned for the launch, though he refused to elaborate on who may have been hit. While the wide bid/offer spreads present participants with good opportunities to make money, the lack of consensus on pricing makes this too risky a play for many.

"Front-running was limited, as it was clear that no one really knew what the price levels would settle at," says Ben Logan, managing director in Markit's structured finance division in New York, which administers the indices. "It would have been a far too dangerous game to play."

Some argue that volatility in the underlying ABX index already offers savvy investors sufficient money-making opportunities. "There is enough volatility in the ABX index in BBB/BBB- to carry out interesting trades," says a hedge fund manager who spoke anonymously. "You do not need these tranches yet for money-making purposes."

When the ABX settles down, however, participants hope the TABX will provide the market with a clearer picture of correlation values on ABS. In the short term, though, it could spell bad news for synthetic ABS investors.

"If the market sees TABX implied correlation values much higher than the current assumptions on the underlying market then we could easily see a big repricing of CDS of ABS," says Dean Smith, managing director at hedge fund Highland Financial Holdings Group in New York. "There's not a ton of liquidity in the market, and bid/ask spreads on the ABX have been very wide. This means that you not only need to be right but need to be really right on your prices."

- Sarfraz Thind.