The second quarter of 2004 saw a 30% spike in U.S. CDO volume and a smaller number of downgrades compared to years past, noted Moody's Investors Service. The rating agency issued 43 downgrades in the quarter, a sizeable improvement compared with the 80-downgrade-per-quarter average in 2003.
"CDOs were again bolstered by strong demand, with activity less tilted toward CDO resecuritizations than the previous few quarters," said Moody's Managing Director Jeremy Gluck. High yield CLOs and synthetic arbitrage deals were "plentiful," he added, and TruPS CDOs accounted for most of the residual.
A sharply improved collateral picture is the story throughout the quarter, as the North American corporate downgrade-to-upgrade ratio fell to 1.17:1 in June, a drop from a ratio of 5.85:1 in March 2003. Moody's rated 48 new-issue CDOs in 2Q04, up 30% from the 37 rated in the same period the year prior. Rated volume in 2Q 2004 was $17.9 billion, 43% greater than the $12.5 billion experienced in 2Q03.
Resecuritizations (cash or synthetic) accounted for 15 of the 48 transactions completed during the second quarter, and high yield CLOs and synthetics comprised the remaining balance. Of the 48 transactions, 45 were arbitrage.
According to Moody's, it placed 35 tranches on watch for a possible downgrade within 16 transactions and five tranches within two deals on watch for upgrade in the quarter. Based on new-issue activity in the first half of 2004, Moody's will revise its expectation for annual volume in 2004 up 20% to 25%, according to Gluck.
In part through the spike in single-tranche synthetics, which are less spread-driven, the "market has proven resilient to relatively narrow collateral spreads," Gluck noted. Market innovation will likely foster new transactions in the second half of the year, he added, pointing to Alpine III, the first U.S. muni CDO that hit the pipeline recently. The $105.07 synthetic deal was arranged by UBS.
Structured Finance upgrades exceeded downgrades
Separately, Fitch Ratings found the structured finance CDO upgrades exceeded downgrades in the first half of 2004. During the first half, the global structured finance (SF) upgrade-to-downgrade ratio was 1.7:1, up from the 0.8:1 ratio recorded during the same period last year, the study found.
A fact further bolstering opinions about improving credit quality: In the first half, U.S. consumer and commercial ABS showed improvement with 53 upgrades and 169 downgrades versus 32 upgrades and 844 downgrades during the first half of 2003.
More specifically, U.S. RMBS saw upgrades exceeding downgrades by a 2 to 1 margin; driven by outstanding deals' seasoned pools de-leveraging. Also, CMBS performance was similarly stable.
As with the Moody's study, Global CDO sectors showed a drop in downgrades as well and an increase in upgrades by Fitch's tally. However, "further deterioration of speculative-grade credits may result in additional CDO downgrades," the Fitch report cautioned.
And the global corporate downgrade-to-upgrade ratio was 1.8:1 in 2003, down from a 3.6:1 ratio in 2002 and 2.2:1 back in 2001.
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