U.S. cashflow and synthetic CDOs experienced an uptick in downgrades and fewer upgrades during the first quarter compared to 4Q04, according to a recent report by Standard & Poor's. Driving downgrades were ABS CDOs, which experienced the highest downgrades to upgrades ratio the sector has ever seen -accounting for 23 of the 34 CDO downgrades initiated by S&P in the first quarter. Upgrades were fueled by U.S. cashflow arbitrage corporate high-yield transactions, with a total of 14 out of 27 upgrades. S&P downgraded 18 CDOs in 4Q04, and upgraded 24.
All but one of the ABS CDO downgrades during the quarter occurred on 2001 and 2002 vintages and more than half of the downgrades were initiated on tranches that had already been downgraded - mostly the result of further credit quality deterioration on the underlying collateral.
The 23 ABS CDO downgrades stemmed from 10 transactions, eight of which had at least a 10% exposure to manufactured housing. Adding additional stress to the downgraded transactions were poorly performing ETCs and EETCs, according to S&P.
Stephen Anderberg, analyst at S&P, said he expected continued downgrades concentrated in the 2000, 2001, and 2002 CDO ABS vintages, due to the significant manufactured housing and EETC exposure. Anderberg said the focus on newer deals would hinge on RMBS collateral performance, which has become the ingredient of choice in ABS CDOs.
"The later vintage deals have not seen the downgrades that the earlier vintages have, although some are experiencing stress because of tightness in weighted average credit spreads," Anderberg said. The outlook on RMBS will remain stable through the next two quarters, he added.
Synthetic CDOs were relatively stable during the quarter, according to S&P, with five upgrades, compared with 16 in the fourth quarter, and one downgrade, the same as the previous quarter.
CBO upgrades primarily resulted from amortization in the senior and mezzanine notes - of the 11 that received upgrades, nine had significantly increased the amount of overcollateralization ratios and credit enhancement available to support the senior notes.
CDOs returned to top the list of downgrades after a two-year absence from the spot in Moody's Investor Service first quarter upgrades and downgrades report, released April last week. The sector accounted for 54% of all asset-backed downgrades in the 1Q05, according to Moody's. The total number of downgrades decreased to 73 from 82 in 4Q04. CDO downgrades were mainly caused by poor collateral credit performance, and in-line with S&P, focused on 2000 and 2001 vintages.
"Regarding the trend, I think the vintage effect is primarily responsible," said Richard Michalek, senior credit officer at Moody's. Many of the downgraded CDOs continue to struggle with hedging arrangements, he added.
The rating agency initiated six CDO upgrades in the quarter, compared to seven in the fourth quarter. Five out of the six upgrades were due to increased credit enhancement from deals de-leveraging.
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