New ABX Mortgage Index Still Looks Ugly

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:

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?