In its fifth annual European structured finance rating transition study, Moody's Investor's Service found that the average credit quality of European structured finance securities continued to improve in 2006 compared to 2005.
The number of upgrades, 163, exceeded the number of downgrades, 68, and the frequencies of both upgrades and downgrades declined across all structured finance sectors. More specifically, the CDO sector in Europe continued to perform very well as it did in 2005.
"CDOs were again the most active in terms of rating changes across the major sectors of the European structured finance market," Moody's analysts said. The report said that 60 ratings involving 52 transactions were downgraded and 71 ratings involving 42 transactions were upgraded, resulting in an upgrade-to-downgrade ratio of 1.2. Although this ratio represents a drop from 2.2 in 2005, it is the second straight year that upgrades outnumbered downgrades for CDOs in Europe.
Static, synthetic arbitrage transactions made up almost 82% of all the CDO downgrades and 72% of all structured finance downgrades in Europe. This increase in downgrade activity of synthetic arbitrage CDOs was mostly a result of the increases in the corporate downgrade rate, which rose to 8.9% on a global basis in 2006, up from 8.3% in 2005.
Still, upgrade activity was also positive for CDOs as previously noted, making up 43% of all upgrades in European structured finance. The majority of the upgrades affected the securities issued in 2002, Moody's said, because of deal seasoning and collateral performance.
As for RMBS, the rating agency carried out no downgrades in the sector, making the one-year downgrade rate zero in 2006. Only one downgrade was carried out in the ABS side during 2006, helping the one-year downgrade rate in the European ABS sector to reach a six-year low of just 0.1%.
"In the ABS and RMBS sectors, ratings were very stable as 97% of the ratings remained unchanged in 2006," said Jian Hu, director of structured finance default research at Moody's. Hu added that in CMBS, upgrades exceeded downgrades by almost four to one, resulting in a positive 11.6% rating drift, which is considerably higher compared with all other major structured finance sectors.
Downgrades affected only eight tranches from four transactions in the ABS, CMBS and RMBS sectors combined in 2006, Hu reported, adding that since these three sectors continued to grow, the one-year downgrade rate dropped to only 0.3% in 2006 from 0.5% in 2005.
An asset class unique to Europe, structured covered bonds, saw no rating changes in 2006, remaining the same as in the previous year. In the past, there have been no downgrades and nine upgrades in this asset class, making the lifetime downgrade rate zero and the lifetime upgrade rate 3.3% of a total of 251 ratings issued as of the end of 2006.
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