U.S. ABS upgrades outpaced downgrades in the third quarter for the first time since 3Q01, according to a report by Moody's Investors Service. accounting for 114 of the 175 ratings actions throughout the quarter, with downgrades dropping off 38% from the previous quarter to finish with 61.
Moody's credits the auto sector - which had the most upgrades of any asset class with 46, representing 40% of total upgrade activity - for the overall increase in upgrades. The upgrades "were due to a build up of credit enhancement relative to expected future losses in the underlying receivables pools," according to Moody's.
The home-equity sector dropped to second place with 25 upgrades, less than half the sector experienced in 2Q05. Most of the upgraded tranches, backed by Option One Mortgage originated collateral, were the result of stronger-than-anticipated loan performance as well as home price appreciation. The student-loan sector saw 22 upgrades, all to Sallie Mae deals and all because of better than expected collateral performance.
The home equity sector, meanwhile, led downgrade activity for the first time ever with 31 downgrades, making up half of all downgrade activity in the third quarter. Most of the downgrades were attributed to deteriorating portfolio credit quality. Weaker than expected performance also led to 18 downgrades in the franchise loan sector, the only sector that experienced an increase in downgrade activity in the third quarter, with 16 of the downgrades related to securitizations sponsored by AMRESCO Commercial Finance.
The CDO sector saw 18 upgrades and eight downgrades, an 80% decrease from the previous quarter and the smallest number of downgrades in the CDO sector since 4Q99. Moody's notes it expects CDO upgrades to set a record this year, at the same time as the sector is seeing a significant overall drop in downgrade activity.
Moody's predicts 2005 will be a record-setting year for upgrades, with a total of 312 upgrades through September, 50% more than last year's total. At the same time, though, downgrade activity has decreased, Moody's says the trend could be easily reversed due to the large number of municipal tobacco-related deals remaining under review with ratings directions uncertain. Therefore, Moody's says it is not clear where the level of future downgrade activity is headed at this point.
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