Nancy Leinfuss was mostly
right. The much-followed ABX index of subprime mortgage bonds rolled over
yesterday, and Leinfuss wrote on Wednesday that the new series, known as 07-2,
would barely outperform the old series, known as 07-1.
At the end of the first day’s trading, here’s how the prices
look:
| 06-1 | 06-2 | 07-1 | 07-2 | |
| AAA | 99.29 | 97.79 | 96.44 | 99.33 |
| AA | 97.85 | 93.43 | 90.94 | 97.00 |
| A | 90.21 | 77.43 | 70.42 | 81.94 |
| BBB | 80.67 | 56.28 | 48.03 | 56.61 |
| BBB- | 71.75 | 50.00 | 44.86 | 50.33 |
As I understand it, these prices are calibrated so that they are comparable,
even though the coupons on the different series do vary dramatically. (The BBB
series in 06-1 had a coupon of just 154bp, for instance, which is now 500bp
in the 07-2 series.)
Behind each series, once you get past the layers of credit derivatives and
securitizations, are mortgages written in the previous six months. The 07-2
series, then, is based on subprime mortgages written in the first half of 2007,
while the 06-2 series is based on subprime mortgages written in the first half
of 2006.
By 2007, of course, everybody knew about the unexpected spike in subprime default
rates, and underwriting standards, we were told, had tightened up significantly.
So how come the prices on the 07-2 tranche are significantly lower than the
prices on the 06-1 tranche, which is based on 2005 subprime loans written before
underwriting standards tightened up? It turns out that maybe the changes in
underwriting practice weren’t quite as widespread as we had been led to believe:
The new index’s average FICO score, a gauge of borrower credit risk is 625,
the analyst said, similar to the two previous series. The weighted average
combined loan-to-value (CLTV) is slightly higher than prior indexes, as is
the percentage of loans in the pools with CLTV greater than 80. He added that,
while the new series will have fewer second-lien loans and the smallest amount
of interest-only loans, it will have the largest percentage of 40-year loans.
Which raises the obvious question: what about the subprime loans which are
being written now? Are lenders still extending cheap credit to homeowners
who can’t afford to make their mortgage payments? How will the 08-1 series look,
in six months’ time?