- ALTERNATIVE INVESTMENTS
- REAL ESTATE INVESTING
What Is the ABX Index?
The ABX Index tracks the market prices of 20 subprime residential mortgage-backed securities (RMBS). Created by market intelligence firm Markit, the ABX is used as a financial benchmark measuring the overall value and performance of the subprime residential mortgage market.
KEY TAKEAWAYS
- The ABX Index tracks a basket of the 20 largest residential mortgage-backed securities.
- It is used as a barometer for the strength of the subprime residential real-estate sector.
- The index is updated twice per year.
- Although demonstrative of its collection of securities, the Index should not be relied on as the only indicator of overall market conditions.
How the ABX Index Works
The ABX Index uses credit default swaps in its construction to create an index that is representative of the subprime RMBS market. Values have ranged from 50 to approximately 100, with daily pricing available only to market subscribers.
The index is also known as the Markit ABX Home Equity Index, the ABX.HE Index, or the asset-backed securities index.
The ABX Index uses credit default swaps (CDS) on the 20 largest subprime residential mortgage-backed securities (MBS) selected for the index. The index has six sub-indexes that represent varying levels of credit quality among various RMBS tranches. It seeks to provide a representative comparison of a range of subprime credit in the market.
The index is reconstituted semi-annually on two roll dates, January 19 and July 19, or the next business day following each date. Markit is the administrator of the Index and reviews all market issuance of subprime residential mortgage-backed securities in the prior six months for inclusion in the next roll date. Markit then identifies the corresponding credit default swaps traded on fourth market exchanges for inclusion in the Index.
Special Considerations: Indicators
Values for the ABX Index are calculated daily and provided to index subscribers. Increases in the level of the ABX Index indicate a well-performing RMBS market. Significant decreases in the Index and lower Index values are a warning sign for high risk.
Since the ABX Index is one of only a few leading market indicators in the subprime RMBS market, it is used broadly by institutional investors and traders as a gauge for the levels of risk and value of subprime RMBS.
The details of the Index are not disclosed publicly, requiring trading groups to license the Index data from Markit to use it as a steady resource for determining market trades.
What Are Subprime Mortgage-Backed Securities?
Banks routinely sell the mortgages they hold to free up cash to make more loans. The mortgages are purchased by financial institutions that package them together and then sell them on to investors, who earn their profits from the payments made by the people who are paying off the mortgages.
These packages of loans are mortgage-backed securities. Subprime mortgage-backed securities have been rated as having a greater risk of default. The interest rates, and therefore the profits from the loan packages, are correspondingly high.
Do Subprime Mortgage-Backed Securities Still Exist?
Yes. There is still a market for mortgage-backed securities in general, and subprime mortgage-backed securities specifically.
The market got a bad name during the 2007-2008 financial crisis when a wave of defaults on subprime home mortgages threatened to bring down the institutions that unwisely held massive amounts of SMBS.
Do Subprime Mortgages Still Exist?
Yes. Lending standards have been tightened considerably since the 2000s heyday of the subprime mortgage. But a subprime mortgage is any secured loan that comes at a relatively high interest rate because the lender deems the applicant at greater risk than its best-qualified customers.
Most subprime mortgages today are adjustable-rate mortgages. This type of mortgage starts out with a very low rate, making it more affordable to buy a home. It then can be adjusted higher periodically if interest rates rise. Homeowners with adjustable-rate mortgages can flounder if their incomes have not risen as much as interest rates.
The Bottom Line
The ABX Index was created in 2006, shortly before the historic collapse of the subprime lending market. Some analysts note that the index declined sharply before the crisis. Some may have noted that as a warning sign of trouble ahead, but many others didn't.