Of the 1,363 ratings downgrades since the ABS market's inception in 1985, 37% occurred in the first half of 2002, according to a report released this week by Moody's Investors Service. Of the record 502 downgrades seen from January through the end of June - 400, or 80% - were in the CDO sector, and 102 were for standard ABS product. By contrast, there were just eight ratings upgrades in the first six months of 2002, Moody's adds.

The more disturbing factor, however, is that 490 of the downgrades, or 99%, were due not to the performance of the issuer or a credit enhancement glitch, but to deterioration of collateral performance. In fact, 100% of the upgrades were due either to strong collateral performance or a buildup of credit enhancement.

"These results differ markedly from previous experience," says Julia Tung, author of the report. "Prior to the first half of this year, 38% of downgrades were due to the downgrading of a credit enhancer, while 42% of upgrades were not related to performance."

Moody's sees this trend continuing throughout this year and for the foreseeable future, until the economy completely turns around. "Moody's expects that in the future most rating actions will be the result of asset performance," Moody's said in the report. "As transactions pass their peak loss periods, credit enhancement levels could build up to the point where upgrades may be warranted. Poor asset performance accounted for nearly all of the asset-backed downgrades during the first half of 2002, continuing a trend that began in 1997."

The sectors within the ABS market hit the hardest by poor collateral performance were CDOs, franchise loans, mutual fund fee and aircraft-related securitizations, Moody's notes. The relatively new CDO sector accounts for 48% of all downgrades since 1985, and the credit card sector even had two blowups in the first half of the year.

Traditional ABS saw 102 downgrades in the first half, breaking the previous record of 98 seen in the first half of 2000. Franchise loan ABS accounted for 39 downgrades; mutual fund fee ABS accounted for 17 downgrades, and aircraft lease ABS accounted for 16 downgrades. NextCard Inc. and Spiegel Inc.'s First Consumers CCMNT accounted for a total of 12 downgrades.

While upgrades were far more scarce in the first half of 2002, just two were in typical ABS product, with six CDO tranche upgrades. The upgrade of the Sallie Mae 1995-1 certificated class is not surprising, the only other ABS upgrade comes from the troubled manufactured housing sector - Green Tree Financial Corp. M.H. Trust 1992-1 B class.

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