When it comes to tracking just about any financial trend that exists, few do it better than the Bank for International Settlements, which highlights some striking figures on banks’ transatlantic fund flows in its latest quarterly report. The report also provides some rare insight into the workings of the key ABX index on banks’ mortgage-related losses – and, for more cheery reading, a sobering view on the broadly increasing spreads on credit-default swaps, a glance at the sad, downward trajectory of equity prices and a look at the continued funding pressures in interbank money markets.
From 2000 through to mid-2007, global banks channelled over $1,000bn more into the US across their balance sheets than they took out. But since the onset of the credit crunch in mid-2007, these net flows have reversed course and since then, banks have sent out about $321bn more from the US than they sent in – “much of this the result of interbank activity”. The report suggests that foreign banks - largely European - have cut US lending and could be sending funds from US branches to their offices abroad, while global lending to US nonfinancial firms has begun flattening after years of growth.
Admittedly, says the report, in the first quarter of 2008, claims (in all currencies) on all sectors in the US booked by banks abroad expanded (by $134bn). However, an even larger increase in these banks’ international liabilities to the US banking sector resulted in a $259bn net outflow from the country in the quarter, mainly due following a net outflow of $238bn in the second half of 2007.
The BIS said banks in the quarter stepped up their holdings in public sector debt, while their outstanding debt securities claims in the non-bank sector fell for the first time since 2001.
This trend, it said, “seemed to coincide with a broader shift in bank balance sheets away from the US non-bank private sector, at least for some banking systems.”.
Meanwhile, banks’ cross-border equity and other liabilities surged in the first quarter of 2008, as banks tapped international sources of funds. Total equity and other liabilities rose by $122bn overall, the largest quarterly increase on record by a considerable margin.
Some $41bn of this increase was booked by banks in the euro area, and an additional $54bn by bank offices in offshore financial centres. Banks’ debt securities liabilities also grew, by $201bn, roughly half of which was denominated in US dollars.
Turning to the US subprime mortgage market, BIS researchers Ingo Fender and Martin Scheicher highlight the collapse in prices in the ABX index since the height of the crisis in summer last year - and take a close look at the workings of the ABX family of indices.
The ABX index – based on credit derivatives written on MBS backed by subprime mortgage loans - is not the ideal barometer of subprime mortgage market conditions, they acknowledge. But since it started trading in January 2006, it has, as Fender and Hordahl note, been widely used by banks and investors, adding “a degree of transparency and liquidity to market segments as diverse as leveraged loans or mortgage-backed securities”.
Despite some shortcomings, ABX price information also seems to have been widely used by banks and other investors as a tool for hedging and trading as well as for gauging valuation effects on subprime mortgage portfolios more generally.
Understanding the specific factors driving the variation of ABX prices is important for market participants and policymakers because changes in the weight of credit- and non-credit-related elements may have different implications.
For instance, indications of changes in risk appetite with regard to subprime mortgage risk may help explain any discrepancies between observed ABX prices and projections of default-related losses on the underlying pool of subprime MBS. These discrepancies, in turn, can have consequences for investors, for example when ABX quotes are used to value existing holdings of subprime MBS.
Yet, the authors note, despite the importance of these issues, empirical work on the ABX indices has so far been scarce.
By carrying out what they describe as a simple regression analysis, the authors suggest that declining risk appetite and heightened concerns about market illiquidity have provided a sizeable contribution to the observed collapse in ABX prices since the summer of 2007.
Of course, they warn, such credit-default swap indexes only track a fraction of MBS instruments. Observed ABX prices are “unlikely to be good predictors of future default-related cashflow shortfalls on outstanding subprime MBS, especially for tranches at the higher end of the capital structure”. So don’t stake the whole bank on the index, but DO read the BIS report if you’re relying on the ABX.
And if you’re still hungry for more ABX geekery, here in all its glory is a special section all about ABX pricing mechanics.
