Standard & Poor's rated global structured securities performed better during the second quarter of 2004 than during the first. The upgrade rate for structured finance securities was more than three times the downgrade rate. This positive trend was pronounced across many sectors but was most noticeable among U.S. RMBS ratings. A review of the performance suggests continued strength among U.S. RMBS ratings and therefore upgrades, a significant increase in European and U.S. CMBS upgrades, and a significant decline in U.S. ABS downgrades. A notable increase in European ABS downgrades is due primarily to lowered ratings in the aircraft ABS area. Globally, in addition to aircraft ABS, a few other ABS asset types and CDO sectors continued to show weaknesses in their rating performance during the second quarter of the year.
The following performance was observed during the second quarter of 2004:
* U.S. RMBS continued to perform well and accounted for the most significant percentage of upgrades during the second quarter.
*A few ABS asset types (such as aircraft ABS, franchise loans, and manufactured housing) and CDO segments (such as synthetic arbitrage corporate and other synthetic CDO transactions) accounted for most of the downgrades during this quarter.
* Overall, 3.1% of structured securities experienced rating transitions. This compares with the rating transition rate of 3.08% reported for the first quarter of 2004 and the rate of 3.20% for the last quarter of 2003.
* The upgrade rate during the second quarter of 2004 was 2.39%, versus 1.81% in the first quarter.
In other words, 2.39% of outstanding ratings were raised during this period, a notable improvement
from the first quarter.
*The downgrade rate was 0.70% for global structured finance during the second quarter of 2004, down from a rate of 1.27% during the first quarter.
* Defaults and near-defaults during the second quarter came primarily from previously downgraded securities.
* Global structured securities experienced an average upgrade of 5% of a notch per rating in their credit quality during the second quarter; the average number of notches changed per upgrade and downgrade was about 3 and negative 2.5, respectively.
In general, a rating transition is associated with the time period in which a security's rating performance is measured, such as the second quarter of this year. A security's beginning and ending ratings during this period (and in any quarterly transition period) are used to calculate transition rates.
Performance by region and sector
The positive rating volatility observed during the second quarter of this year was relatively significant. Approximately 2.39% of outstanding global securities rated by Standard & Poor's were upgraded and 0.70% of these securities were downgraded during this quarter. The upgrade rate of 2.39% was higher than the 1.81% rate observed during the first quarter of 2004; this was higher than the upgrade rate of 1.96% observed in the second quarter of 2003. The downgrade rate of 0.70% was lower than the 1.27% experienced in the previous quarter and much lower than the rate of 2.42% experienced in the second quarter of 2003.
U.S. ABS performed better this quarter than during the previous five quarters. For instance, 1.00% of U.S. ABS ratings were lowered during the period, down from 6.05% during the first quarter of 2004, and 1.25% of U.S. ABS ratings were raised, up from 0.16% during the first quarter of 2004.
European ABS performed relatively worse than the first quarter, exhibiting a downgrade rate of 4.64%, up from 0.63% in the first quarter. This weak performance was primarily due to high downgrades of aircraft ABS. U.S. and European CDOs both performed relatively better this quarter than during previous quarters; however, the CDO downgrade rates of 0.92% and 2.36% for U.S. and Europe, respectively, were still significant. In contrast, U.S. and European RMBS continued to experience a high level of upgrades during the second quarter, and their downgrade rates were minimal. Finally, single-issue synthetics experienced slightly higher downgrades during the second quarter than in the first, but performed much better than all four quarters in 2003.
Performance by rating
On the downgrade side, higher ratings are associated with lower downgrade percentages. In other words, securities with lower ratings tend to experience higher downgrade percentages. For example, the downgrade rates were 0.19% for AAA', 0.62% for AA' and A', and 0.64% for BBB' rated securities. For upgrades, this relationship was mixed during the quarter. For example, AA' securities experienced an upgrade rate of 4.3%, and A' and BBB' upgrades were about 3.2% and 3.1%, respectively. For non-investment-grade categories, except CCC' and below, the upgrade and downgrade rates were both higher. Overall, the results suggest that securities with higher ratings tend to be more stable, or less volatile, and securities with lower ratings tend to be less stable, or more volatile.
Subsector performance
The vast majority of upgrades and downgrades during the quarter were restricted to a few asset types or segments. For example, about 40% of aircraft ABS ratings, about 18% of franchise loan ABS, 4.5% of manufactured housing ABS and 4% of other new assets, and 4.6% of synthetic corporate investment-grade CDO ratings were lowered during the second quarter of this year. On a positive note, auto loan ABS transactions and RMBS subsectors, such as prime and re-performing categories, experienced significant upgrades during the second quarter.
Other subsectors either experienced modest levels of rating transitions or did not experience any rating transitions during this period. For example, auto ABS experienced upgrades of 4.96%, while student loan ABS showed a stability rate of 100%. Among the CDO segments, securities backed by corporate bonds and RMBS/ABS CDOs reported modest downgrades.
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