Was the Panic of 2007 bogus? I have previously highlighted doubts about the ABX index validity (as has, famously, Fabulous Fab) … Richard Stanton and Nancy Wallace supply another interesting paper, The Bear’s Lair: Indexed Credit Default Swaps and the Subprime Mortgage Crisis:
ABX.HE indexed credit default swaps on baskets of mortgage-backed securities are now the main benchmark used by financial institutions to mark their subprime mortgage portfolios to market. However, we find that current prices for the ABX.HE indices are inconsistent with any finite assumption for mortgage default rates, and that ABX.HE price changes are uncorrelated with changes in the credit performance of the underlying loans. These results cast serious doubt on the suitability of the ABX.HE indices as valuation benchmarks. We also find that ABX.HE price changes are significantly related to short-sale activity in the option and equity markets of the publicly traded builders, the commercial banks, the investment banks and the government sponsored enterprises (GSEs). This suggests that capital constraints, limiting the supply of ABS insurance, may be playing a role here similar to that identified by Froot (2001) in the market for catastrophe insurance.
…
We collect detailed credit and prepayment histories from 2006{2008 for all of the roughly 360,000 individual loans underlying the ABX.HE indices, and use these data, plus current prices, to infer the market’s expectations for future defaults. Using both a simple, “back-of-the-envelope” model (in which all defaults and insurance payments occur instantaneously) and a full CDS valuation model calibrated to the historical loan-level performance data, we find that recent price levels for ABX.HE index CDS are inconsistent with any reasonable forecast for the future default performance of the underlying loans. For example, assuming a recovery rate of 21%, the AAA ABX.HE prices on June 30, 2009 imply default rates of 100% on the underlying loans. In other words, if recovery rates exceed 21% (a value well below anything ever observed in U.S. mortgage markets), there is no default rate high enough to support observed prices. We also find that changes in the credit performance of the underlying loans explain almost none of the observed price changes in the ABX.HE indices. These results cast serious doubt on the use of the ABX.HE indices for marking mortgage portfolios to market.
The Canadian preferred share market advanced modestly on good volume today, with PerpetualDiscounts gaining 2bp and FixedResets up 7bp.
MFC issues maintained their presence in the volume highlights; probably continuing portfolio rebalancing after the DBRS downgrade.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.4480 % | 2,053.3 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.4480 % | 3,110.6 |
| Floater | 2.55 % | 2.17 % | 36,998 | 21.93 | 4 | -0.4480 % | 2,217.1 |
| OpRet | 4.90 % | -2.64 % | 102,983 | 0.19 | 9 | 0.1249 % | 2,350.8 |
| SplitShare | 6.03 % | -25.10 % | 67,997 | 0.09 | 2 | 0.1459 % | 2,333.1 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.1249 % | 2,149.6 |
| Perpetual-Premium | 5.77 % | 5.49 % | 101,002 | 5.58 | 7 | -0.1405 % | 1,959.4 |
| Perpetual-Discount | 5.74 % | 5.78 % | 183,793 | 14.07 | 71 | 0.0161 % | 1,891.3 |
| FixedReset | 5.28 % | 3.28 % | 287,612 | 3.38 | 47 | 0.0676 % | 2,244.9 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| TRI.PR.B | Floater | -1.06 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-08-20 Maturity Price : 23.09 Evaluated at bid price : 23.35 Bid-YTW : 2.05 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| RY.PR.G | Perpetual-Discount | 210,890 | TD crossed 187,800 at 20.60. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-08-20 Maturity Price : 20.63 Evaluated at bid price : 20.63 Bid-YTW : 5.49 % |
| TRP.PR.B | FixedReset | 77,674 | Scotia crossed 11,000 at 24.97; Nesbitt crossed 50,000 at the same price. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-08-20 Maturity Price : 24.92 Evaluated at bid price : 24.97 Bid-YTW : 3.63 % |
| MFC.PR.B | Perpetual-Discount | 49,579 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-08-20 Maturity Price : 18.90 Evaluated at bid price : 18.90 Bid-YTW : 6.16 % |
| TD.PR.O | Perpetual-Discount | 43,971 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-08-20 Maturity Price : 22.25 Evaluated at bid price : 22.40 Bid-YTW : 5.46 % |
| SLF.PR.A | Perpetual-Discount | 42,436 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-08-20 Maturity Price : 20.03 Evaluated at bid price : 20.03 Bid-YTW : 6.03 % |
| MFC.PR.E | FixedReset | 37,773 | YTW SCENARIO Maturity Type : Call Maturity Date : 2014-10-19 Maturity Price : 25.00 Evaluated at bid price : 26.00 Bid-YTW : 4.44 % |
| There were 36 other index-included issues trading in excess of 10,000 shares. | |||