PrimeX Index Shows Weakness In Prime RMBS Market, Three Indexes Below Par (Charts)

PrimeX.FRM.2 via Markit
It's starting to get interesting again in MBS CDS land (the most interesting indexes in the world). Markit's synthetic CDS (credit default swap) indexes "referencing" buckets of residential mortgage-backed securities have been falling in value since February (ABX, PrimeX). Credit fund managers (or speculative hedge funds) can trade RMBS without actually buying or selling the securities (synthetically) via credit default swaps (RMBS insurance contracts). It's really trading "exposure" on RMBS. Listen to Goldman Sachs' CFO David Viniar explain to Senator Carl Levin that GS's mortgage desk had synthetic positions on to offset cash long positions. There needs to be a synthetic credit trading show on CNBC (boo-yah!²).

I remember Jeff Gundlach, founder of DoubleLine Capital, alerted CNBC viewers in May that the ABX index, which references subprime RMBS, dropped 20% in 3 months (link has chart). Remember when ABX.HE.AA.07-2 went from a high of 97 to a low of 3.75? It currently trades at 6.23. Crazy times, and we still haven't recovered from the housing and mortgage crash.

Now the action is in Markit's PrimeX CDS index, which references a basket of non-agency prime RMBS issued between 2005 and 2007, and backed by jumbo mortgages that couldn't be financed by GSE's (Fannie Mae and Freddie Mac). There are four PrimeX indexes; two that reference fixed-rate loan securitizations and two that reference hybrid-ARM securitizations (PRIMEX.FRM.1, PRIMEX.FRM.2, PRIMEX.ARM.1, PRIMEX.ARM.2). Here are closing prices on 10/14/2011 via Markit's website.

For more info, I found a guide: Pricing ABX index for Newbies

Buying the PrimeX index allows someone to "synthetically" gain short exposure to non-agency prime MBS and selling PrimeX allows someone to "synthetically" gain long exposure to non-agency prime MBS. If you're reading this and have no idea what I'm talking about, read the description at Markit or read their presentation from early 2010 on the PrimeX indices. You can see 7-month charts of CDS indexes on their website for free. I found an article from 2006 at risk.net that explains why the ABX Index (ABCDS) was introduced ("Synthetic ABS is hot property"). Interesting stuff.

Paulson & Co., run by billionaire John Paulson, started buying the ABX Index in 2006 and ended up making his firm billions of dollars when the subprime mortgage market crashed (and CDS spiked). When ABX indexes first dipped below par in 2007, some say that was the initial catalyst that fueled the financial crisis. When the PrimeX index was first announced, Bloomberg noted:
"Wells Fargo & Co. analyst Glenn Schultz suggested investors consider selling jumbo-mortgage securities because PrimeX trading could drive down their prices, as happened with subprime bonds and the ABX indexes he had called “Frankenstein’s monster.”

"Analysts such as Schultz said that in 2007 and 2008, more investors wanted to use the indexes to short subprime notes than take the opposite bets because the banks and asset managers already owned enough housing debt, allowing them to tumble."

As of Friday's close, three of the four PrimeX indexes have dipped below par. Look at the charts below. FT's Tracy Alloway talked about this risk in a video on 10/10/2011 and Zero Hedge had a post on 10/7/2011 with multiple follow-ups thereafter. FT Alphaville has been all over it as well, see the PrimeX linkfest below.

I was searching for an ETF with non-agency Prime MBS, and all I found was an Invesco PowerShares index that didn't exist yet: "The PowerShares Prime Non-Agency RMBS Opportunity Fund will seek to provide total return by investing, under normal market conditions, at least 80% of its assets in non-agency mortgage-backed securities collateralized by pools of Prime residential mortgage loan" (pdf, 1/28/2009).

On October 5, Fitch Ratings, in a press release promoting their report, said that 1 in 3 U.S. prime mortgage loan borrowers were underwater.
"Recent analysis by Fitch shows that more than a third of all prime borrowers in private-label securitizations are currently in a negative equity position, or as it is commonly referred to, 'underwater', on their mortgages.

Live Video: Occupy Wall Street Protesters Invade Times Square

Watch live video of the protests below via livestream.com/occupynyc. The protesters are in Times Square (New York City) and it looks like thousands of people are there. How does this movement evolve? Wow.



China’s Petrochemical Corp. Invests in Canada, Buys Daylight Energy for $2.1B - Guest Post

Daylight Energy (DAY.TO) - StockCharts
China’s Petrochemical Corp., also known as the Sinopec Group, has agreed to buy Canadian oil and gas explorer Daylight Energy Ltd. for $2.1 billion.

The Sinopec purchase is only the latest of recent Chinese investments in Canada’s booming energy industry. Two months ago China National Offshore Oil Corporation (CNOOC), China's dominant offshore oil producer, agreed to acquire bankrupt oil producer Calgary, Alberta-based company OPTI Canada Inc. for $2.1 billion. Last year Sinopec Group paid ConocoPhillips $4.65 billion for a 9.03 percent share stake in Canada’s Syncrude oil fields.

Daylight Energy Ltd. chief executive Anthony Lambert commented that the Sinopec Group offer "recognizes the highly attractive asset portfolio and exceptional terms we have assembled at Daylight," The Shanghai Daily reported.

In 2010 Daylight Energy Ltd.'s proven and probable reserves rose 46 percent to 174 million barrels of oil, 70 percent of which is natural gas.

The Sinopec Group-Daylight Energy Ltd. deal, which has been approved by Daylight's board, must still be approved by Daylight shareholders and the Chinese and Canadian governments.

Daylight Energy Ltd. went public on the Toronto Stock exchange in 2004. The Sinopec Group purchase will give the company the right to explore and develop 30,000 acres of Canadian oil and natural gas concessions.

By. Joao Peixe, Deputy Editor OilPrice.com

S&P Downgrades Spain; Fitch Downgrades UBS and Places Banks on Negative Watch

Coke bank
Coke Bank via Flickr
Fitch placed a bunch of U.S. and European banks on "rating watch negative" today (10/13/2011) and also downgraded UBS to A from A+. Keep an eye on bank and sovereign credit ratings to see if downgrade contagion affects the markets. There are worries about bank trading revenues, european sovereign debt exposure (S&P just downgraded Spain to AA- on economic growth and bank risks) and... will banks be affected by prime mortgage portfolios? Here are links to the press releases (they require free log-in, I forgot).

S&P: Long-Term Rating On Spain Lowered To 'AA-' On Economic Growth And Banking Sector Risks; Outlook Negative

Fitch Downgrades UBS AG to 'A' on Diminishing Government Support; Outlook Stable

Fitch Places Goldman Sachs' Ratings on Rating Watch Negative

Fitch Places Major French Banks on Rating Watch Negative (BNP Paribas, Credit Agricole, Societe Generale, Banque Federative du Credit Mutuel)

Fitch Places Deutsche Bank on Rating Watch Negative

Fitch Places Bank of America's 'a-' Viability Rating on Rating Watch Negative

Fitch Places Morgan Stanley's Ratings on Rating Watch Negative

Fitch Places Credit Suisse AG on Rating Watch Negative

Fitch Places Two Nordic Banks on Rating Watch Negative (OP-Pohjola Group and Danske Bank)

Fitch Places Rabobank's IDR and VR on Rating Watch Negative

China CDS Breakout Predicted FXI Breakdown, Sovereign CDS Info (Charts)

According to Bloomberg, China's 5Y CDS rate (credit default swap) closed at 167 basis points yesterday, which is $167,000 to insure $10 million of Chinese government bonds per year. It peaked out at 201 basis points on October 3, 2011. On August 10, I posted that China 5Y CDS broke out to early 2009 levels at 113 basis points and said it looked exactly like the inverse of FXI (iShares FTSE China 25 Equity Index), which was testing 2010 support at $35.

China 5Y CDS vs. FXI (source: Bloomberg.com)

I don't trade credit default swaps, but charting out CDS is a great way to measure market risk because speculative trading, or hedging, default risk in the CDS market is essentially controlled by large financial institutions, banks and their clients (hedge funds) in over-the-counter trades (off-exchange bilateral contracts). CDSs are also used to correlate with other assets (there are Saudi Arabia CDSs but no underlying debt!). So technically, liquid or not, China 5Y CDS looked like a decent setup for a potential breakout when it was testing ceiling resistance in that two year sideways channel. And it eventually took off, see below. Did someone ride China 5Y CDS from 100 to 200 and sell the contract for a quick double? "The net value of outstanding credit default swaps on Chinese sovereign debt" is $8.3 billion, according to FT.


China 5Y CDS (source: Bloomberg)

ECRI's Achuthan Explains New US Recession, Contagion Among Leading Indicators

If you missed it, on September 30, 2011, ECRI (Economic Cycle Research Institute) publicly announced that the U.S. economy was tipping into recession. Lakshman Achuthan, co-founder of ECRI, hit the media HARD after that. He was interviewed on WSJ NewsHub, The Daily Ticker, CNN, Bloomberg TV, CNBC Squawk Box and Bloomberg Surveillance. I embedded the Bloomberg and Daily Ticker interviews below. He thinks it will get a lot worse from here as "contagion among the forward looking indicators" spreads like a wildfire. And most importantly, he said he wouldn't be surprised if the unemployment rate hit double digits.

ECRI Weekly Leading Index going back to 2005 (Source: ECRI)


Interesting points Achuthan made during his interviews.
  • During recessions you get in a vicious cycle of "lower sales, lower production, lower employment, lower income, and back to lower sales."
  • Sees deadly combination of contagion in non-financial services, manufacturing and exports.
  • Government spending will go up as tax receipts go down.
  • Recessions kill inflation.
  • We're in an era of more frequent recessions and bear markets, which elevates the equity risk premium and lowers government bond yields (like in Japan).
  • 1799-1929 90% of expansions were 3 years or less, 1970-1981 2/3 expansions were 3 years or less.
  • If there's an exogenous shock like the Lehman bankruptcy, but in Europe, recession could overshoot.

Links: Euro, UK Bank, Sovereign Downgrades, Dexia, Proton, Paulson Advantage, ECRI

wall of banks
Wall of Banks (Dystopos on Flickr, click)
Weekend links on bank bailouts, credit downgrades and other economic concerns

Belgium to Buy Dexia’s Consumer Lending Unit for $5.4B - Bloomberg
"The Belgian federal government will pay 4 billion euros ($5.4 billion) for the division and guarantee 60 percent of a so-called bad bank to be set up for Dexia’s troubled assets, Finance Minister Didier Reynders said at a press conference today in Brussels." (continue reading)

Merkel, Sarkozy Pledge Bank Recapitalization - Bloomberg

Moody's places Belgium's Aa1 ratings on review for possible downgrade - Moody's

ECRI Recession Watch: Growth Index Declines Further (Weekly Leading Index) - Dshort.com

BNP, Socgen deny reported plan to raise $9.4 billion - Reuters

U.S. Bank Exposure to European Debt Crisis Could Be $640 Billion, Per Congressional Paper - WSJ

Greece activates rescue fund to save Proton Bank - Reuters

Paulson’s Main Fund (Paulson Advantage Plus) Said to Lose 47% in 2011 Through September - BusinessWeek

FYI: I found Paulson & Co. mutual fund quotes, via BNP Paribas Japan and Lyxor, denominated in yen focusing on european equities and debt. Links go to bloomberg.com.

Moody's downgrades 12 UK financial institutions, concluding review of systemic support - Moody's
"The rating actions include a one-notch downgrade of Lloyds TSB Bank plc (to A1 from Aa3), Santander UK plc (to A1 from Aa3), Co-Operative Bank plc (to A3 from A2), a two-notch downgrade of RBS plc (to A2 from Aa3) and Nationwide Building Society (to A2 from Aa3); and downgrades of one to five notches of 7 smaller building societies."

Weale Says Bank of England Can Increase Asset Purchases Plan - Bloomberg

Moody's takes rating actions on Portuguese banks; outlook negative - Moody's