Tallying the upgrades and downgrades for asset-backed vehicles each quarter always yields a mixed bag of emotions. In the CDO sector, however, 1Q 2003 will shine particularly bright - collateralized debt obligations racked up the only upgrades seen over the last three months. Furthermore, they were unseated as the leader in downgrades.

Moody's Investors Service released its first quarter upgrade/downgrade report this week and found that while high downgrade activity did continue in the first quarter - dominated by tobacco settlement-related securitizations - only five upgrades were recorded in the first quarter, and all were asset-backed CDOs.

In January Moody's upgraded the $110.5 million senior secured floating rate global rate notes, due 2008, from Alliance DHO Limited. The tranche of the bond-backed CDO was upgraded to A1' from A2'. In February, two tranches of notes from Synthetic Asset Linked Swap 2003-9 were upgraded; the $20 million fixed rate collateral notes were upgraded to A2' from A3' and the $10 million fixed rate collateral notes were upgraded to Baa2' from Baa3'. The CDO is backed by a static corporate reference pool, with UBS AG, via its Jersey Branch, as the deal's sponsor and credit swap counter party. The deal benefited from a structural change, the addition of a restructuring maturity limitation.

And in March, two tranches of notes from St. George Funding 2001- Limited, backed by a mix of ABS, CMBS, HELs, REITs and CDOs, were upgraded. The $48.4 million class B floating rate notes went to Aaa' from Aa3' and the $18.5 million class C floating rate notes were upgraded to Aa3' from A3'. St. George benefited from a structural change in the transaction.

As investors and issuers know all too well, CDOs have been the king of downgrade activity for nearly three years. While another record was set for the number of ABS downgrades, as Moody's recorded 792 affecting $33.5 billion in securities, just 150 CDO downgrades were issued in the first quarter, 42% less than the high of 260 downgrades reached in 2Q 2002 and slightly less than the 164 downgrades that occurred in the fourth quarter 2002. The agency found that downgrades were concentrated in high yield bond or syndicated loan collateral pool-backed transactions.

Downgrades last quarter were instead concentrated in transactions backed by tobacco- settlement receivables, which accounted for 63% of all ABS downgrades. (In March, Moody's downgraded 492 classes of 39 such deals and five classes of four deals backed by tobacco attorney fees.) However, extracting tobacco from the picture paints a different one concerning the quarter. Excluding tobacco-related deals, 295 downgrades were issued compared to 440 in 4Q 2002.

The manufactured housing sector saw 71 downgrades, a figure comprised entirely of Oakwood Homes' securitizations. There were 29 downgrades related to franchise loans transactions, with particularly poor performance in the convenience and gas area.

As for home equity and credit cards sector, GE Capital Mortgage Service Inc. and NextCard Credit Card Master Note Trusts racked up the only downgrades for their respective sectors in the second quarter. Moody's downgraded 20 classes of mezzanine and subordinate bonds of subprime mortgage securitizations issued from 1996 through 1999 by GE and eight classes of securities issued by NextCard were downgraded.

And, finally, the small-business loan sector made its debut on the downgrade list. Eleven classes of notes in four securitizations sponsored by First International Bank were downgraded in January. The pools have been adversely impacted by the recession in the manufacturing housing sector.

According to Julia Tung, Moody's assistant vice president/analyst and author of the upgrade/downgrade quarter report released this week, the figures achieved by each asset class in 1Q 2003 are similar to their historic norms - excluding tobacco-related deals. CDOs, MH and franchise loans comprised 50.8%, 24.1% and 9.8% respectively of the downgrades last quarter, compared to 46.8%, 20.9% and 6.8% prior to January 2003.

And excluding tobacco again, poor asset performance accounted for 73.9% of downgrades last quarter, similar to 71.3% for the same period last year. In all, the weak economy continues to have a negative impact on asset performance and high downgrade activity is likely to continue, said Tung. The second quarter of 2003 is expected to produce similar results to the first quarter.


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