Credit Crunch: Part II
Posted by admin under: Main Oct 31A: Last Tuesday, I started discussing how something was brewing underneath the surface of creditville which led me to state that, “…the street is yet to adapt fully to a world of credit restrictions…”. On Thursday, I came right out and said, “Just a lot going on under the surface here folks that could lead to another round of credit woes when it reaches the top…” and “…I do know that the core of the credit markets are undergoing serious distress right now and it’s got to trigger some type of adjustment in equity markets in the near future”. On Friday the stock markets got killed! Let me explain to you why I had this bad feeling, so you can see that there are clear indications that round two of the credit crunch is near; ABX plunge, Mortgage Insurers Selloff, Foreclosure Index Trend ticks up.
ABX Indexes Plunge – Investors Shun Subprime Mortgage Markets
ABX Index Explained – The ABX Index is a series of credit-default swaps based on 20 bonds that consist of subprime mortgages. ABX contracts are commonly used by investors to speculate on or to hedge against the risk that the underling mortgage securities are not repaid as expected. The ABX swaps offer protection if the securities are not repaid as expected, in return for regular insurance-like premiums. A decline in the ABX Index signifies investor sentiment that subprime mortgage holders will suffer increased financial losses from those investments.
This index is in total FREEFALL; look at the chart on the right showing you the steep selloff in the past week or so! It all started around Oct. 11th, the same time that the mortgage insurance stocks (I’ll get to this in a moment) started their freefall as well! Coincidence? No way! It is a clear sign that something is brewing in the credit world as investors remove bids for anything associated with subprime investments. In my opinion, the overall stock market reacted at a delay to this brewing uncertain situation.
CNBC’s David Faber even started to acknowledge the plunge in the ABX markets mid-day Friday as the markets were in the process of a steep selloff. A bit too late if you ask me, as this situation could have been discussed earlier in the week, to raise concerns that a credit storm may be brewing again!
Mortgage Insurance Companies in Freefall
Holy Batman! Are you guys paying attention to what is going on with the mortgage insurance stocks; ABK, MBI, GNW, PMI, MTG, & RDN over the past week in conjunction with the selloff in the ABX Indexes? This sector is down betwen 10% – 45% in the past 5 trading days! This is important because these are the companies that are generally very highly leveraged, and may have trouble paying out claims for customers with heavy losses in the residential mortgage backed securities markets; the same market that I showed above as collapsing.
Mortgage Insurers Explained – Mortgage lenders and other institutions that buy & sell residential mortgage backed securities (RMBS) and other collateralized debt obligations (CDO’s) need to have some kind of insurance in case their bets go against them. We are talking big money here and there has to be some kind of hedge for the holders of these risky assets. There needs to be credit protection. There needs to be management of credit risk. The mortgage insurers provide a financial guaranty that insures lenders against loss in the event a borrower defaults on a mortgage. If the borrower defaults and the lender takes title to the property, the mortgage insurer (MTG, for example) reduces or eliminates the loss to the lender. In effect, the mortgage insurer shares the risk of lending the money to the borrower.
OK, so now you understand the role of the mortgage insurer for the lender or holder of subprime derivative products. Here is what happened to this sector in the past week; note the right side axis that shows the percentage loss for the week ranging from -10% to -45%!
Foreclosure Index Trend Ticks Up
CoreLogic’s Foreclosure Index Trend has also ticked up in the 3rd quarter of 2007.
The CMRM forecasts the relative risk of residential mortgage loan delinquencies due to fraud propensity and collateral risk, house price dynamics, and the health of the local market economy. An elevated Core Mortgage Risk Index signals the increased potential for financially disruptive and costly economic consequences for consumers, their local community, and mortgage financiers.
Beginning to get the picture? I started to notice the unraveling of the ABX markets on Monday, about 4 days after the fall began, and the collapse of the mortgage insurers on Wednesday. That led me to write about my ‘paranoia’ as I stated on Thursday. Now, I don’t know how all this will end, but I do know that investors are pulling bids fast from the ABX markets and the mortgage insurance companies. These are NOT normal moves people and it’s clear something is going on! Expect another round of uncertainty and media reports on the credit crunch, and the secondary mortgage markets to seize up again leaving no place for holders of these distressed assets to sell positions; which leads me to be very concerned about those entities that are forced to sell to meet debt requirements! I would also expect to hear more bad news from brokerages, hedge funds, banks, and other entities with uncertain exposure to these markets.
For consumers, this probably means that lending rates will tick higher again (or not fall as much as expected with bond yields or future fed rate cuts), lenders will demand higher quality borrowers, underwriting standards will continue to tighten, and fewer loan options will be at your disposal! These are all unavoidable side effects of a credit squeeze, and I’m trying my best to convey to you the warning signs that I am noticing in the tradable markets which may be a clue to the next credit storm.
Next week will be a very interesting week to say the least. Watch out for how the above noted markets follow through on last week’s selloff, and whether or not we see some stablization or rebound.
Source: Credit Crunch: Part II
Wednesday, October 31st, 2007 at 3:21 pm and is filed under Main. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.