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Banks Start New ABX to Bet on Subprime Mortgage Debt


By Jody Shenn and Sarah Mulholland

May 14 (Bloomberg) -- Securities firms are creating new ABX derivative contracts that will help expand the types of AAA rated subprime-mortgage debt that investors can bet on.

The ABX contracts trading for the first time today are tied to subprime bonds that are a class one step higher than those in existing indexes, according to administrator Markit Group Ltd.

The index contracts from banks including Goldman Sachs Group Inc. and Deutsche Bank AG may provide benchmarks for a wider range of debt that has contributed to more than $335 billion in writedowns at financial firms. The contracts also may boost trading in similar bonds by making it easier for investors and traders to hedge what they own, according to Barclays Capital.

``It makes sense for the Street to create a vehicle to hedge these securities,'' said Dan Nigro, who helps oversee $5 billion as a portfolio manager at New York-based Dynamic Credit Partners.

The new contracts allow holders of the debt to bet the securities will fall in value as increased losses are being forecast for AAA subprime securities, according to a research report on May 9 from Lehman Brothers Holdings Inc.

Four versions of the ABX.HE.PENAAA contracts, each tied to different six-month periods, have been created. These contracts are tied to subprime bonds that are the second-to-last of those with initial AAA ratings to receive principal payments. They join indexes tied to bonds initially granted AAA rankings that are last in line to be repaid.

The ABX.HE.PENAAA tied to bonds from the first half of 2007, which requires the same 0.18 percentage point of annual protection payments as the existing ABX.HE.AAA, opened at a mid- price of 65.5, according to a note to clients today from Lehman. That translates to an upfront payment of $355,000 per $10 million of bonds and $18,000 in annual costs.

Misleading Information

Some holders of subprime-loan bonds such as Freddie Mac, the second-largest U.S. mortgage-finance company, have said the existing AAA ABX contracts provide investors with misleading information about the value of their assets. Those contracts are tied to the smallest portion of originally top-rated debt created by slicing pools of subprime loans into bonds.

The new contracts may be unlikelier to be used by so-called macro hedge funds to bet against the U.S. housing market because they're tied to less risky debt, New York-based Barclays analysts Glenn Boyd and Joseph Astorina wrote in a May 6 report.

That means they may not face the ``selling pressure'' that has helped drive down other ABX contracts further than may be justified by a surge in U.S. foreclosures, they said.

Plunging Issuance

New series of ABX indexes were created every six months by securities firms and London-based Markit until the end of last year, when plunging issuance prevented a new round. They indicate prices for credit-default swaps linked to 20 bonds. Credit- default swaps, contracts to protect against or speculate on default, pay the buyer face value if a company fails to adhere to its debt agreements.

The latest ABX contracts linked to initially AAA subprime bonds that are the last to be repaid closed yesterday at 55.99, up 10.5 percent from their low, according to Markit. Similar contracts linked to BBB- bonds closed at 8.09, off 2 percent from a low. The indexes tumbled last year from at or near 100 as investors bet rising defaults on home loans would continue. Contracts linked to the last AAA securities from the second half of 2005, closed at 93.78, up 11.4 percent from a low.
here's a detailed analysis of PenABX from CS.


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