This report summarizes Moody's rating changes in the asset-backed securities market during the first half of 2000. It is the latest in a series of reports that reviews the history of rating upgrades and downgrades since the market's inception. In our review of the rating changes that occurred between January 1, 2000 and June 30, 2000 we found the following:
*Downgrades of asset-backed securities far exceeded upgrades during the first half of the year.
*While the main cause of asset-backed security downgrades in the first half of 2000 was credit enhancer downgrades, poor asset performance continued to play a significant role.
*Strong asset performance was the main cause of asset-backed security upgrades in the first half of 2000.
Historical Rating Change Data
Figure 1 provides a summary of rating changes of asset-backed securities from the inception of the market in 1986 through June 30, 2000. In all, 800 rating changes have affected $64.2 billion in securities issued, with 320 upgrades ($16.8 billion) and 480 downgrades ($47.4 billion).
Downgrades dominated rating changes in the asset-backed securities market through 1993, while upgrades prevailed in the 1994-to-1996 period. In 1997, there were few rating changes. Activity increased sharply in 1998 and was dominated by downgrades. Heightened rating change activity continued in 1999 (which was evenly distributed between upgrades and downgrades) and the first half of 2000 (which was dominated by downgrades).
Rating Changes From January 1, 2000 to June 30, 2000
There were 145 rating changes between Jan. 1, 2000 and June 30, 2000, affecting $4.5 billion in securities issued, with downgrades (122 for $3.5 billion) far exceeding upgrades (23 for $1.1 billion).
Both the upgraded and downgraded securities include issues that had rating changes that were unrelated to deal performance, due to, for example, the downgrading of a credit enhancer or the provision of additional credit enhancement. Excluding rating changes due to such reasons, and focusing solely on rating changes caused by deal performance, downgrades were still three times as great as upgrades during the first half - 58 versus 19. This contrasts with the experience prior to January 2000, when there were 219 upgrades that were due to deal performance, about 50% greater than the 145 downgrades that were performance related. While deal performance has been the main cause of upgrades since the early 1990s, downgrades due to performance were rare before 1997, when credit enhancer downgrade was the dominant cause.
Downgrades Dominated by Conseco Downgrade
The downgrade of Conseco Finance Corp. (formerly known as Green Tree Financial Corp.) resulted in the downgrade of 59 subordinated tranches from Baa3 to Ba1 that were guaranteed by Conseco and backed by manufactured housing and home equity loan assets. These downgrades, which occurred in April and accounted for nearly half of the downgrades that occurred in the first half of 2000, reversed asset-backed security upgrades that occurred in December 1999 because of an upgrade of Conseco. Historically, Conseco/Green Tree-related downgrades have contributed significantly to asset-backed security downgrades, accounting for nearly 30% of such downgrades prior to January 2000.
Additionally, five subordinated tranches of five United Companies Financial Corp. (UCFC) manufactured housing transactions that were guaranteed by UCFC were downgraded in March 2000 from Caa2 to C as the result of the withdrawal of UCFC's rating by Moody's.
Although the main cause of asset-backed security downgrades in the first half was the downgrade of credit enhancers, poor asset performance continues to play an important role. Despite the Conseco/Green Tree-related downgrades, over 40% of the downgrades that occurred in the first half of 2000 were the result of poor asset performance, somewhat higher than the 34% of downgrades that were asset-related prior to January 2000. (See Figure 2.)
Most Upgrades Were Asset Related
Strong asset performance was the main cause of asset-backed security upgrades in the first half of 2000. Of the 23 upgrades that occurred in the first half, 18 were due to strong performance, including:
*ten tranches of five LAI vehicle-lease-backed transactions;
*six tranches of three Ford auto-loan-backed deals; and,
*two classes of the TCW GEM II collateralized debt obligation (CDO) transaction.
Performance was also the main reason for upgrades prior to January 2000, when approximately 75% of asset-backed upgrades were the result of strong asset performance or a build-up of credit enhancement. (See Figure 3.)
Four subordinated classes of Associates First Capital Corp.'s (AFCC) manufactured housing transactions, which were experiencing weak asset performance, were upgraded during the first half as the result of additional credit support that was provided in the form of a corporate guaranty from AFCC. Since AFCC's senior unsecured debt is rated A1, the asset-backed securities were upgraded to A1 from Baa2 and Ba2.
Recent Rating Changes by Asset Type
Mainly as a result of the Conseco-related downgrades, asset-backed security downgrades during the first half of 2000 were concentrated in the manufactured housing (58 downgrades) and home equity (31 downgrades) sectors. The manufactured housing downgrades included 13 tranches of the 1997-1 and 1997-2 BankAmerica transactions that were downgraded as the result of continued poor performance of the underlying pools, including six tranches that were downgraded to Aa2 from Aaa. The concentration of recent downgrades in the manufactured housing sector is consistent with historical experience, as 40% of downgrades of asset-backed securities prior to January 2000 were in this sector. (See Figure 4.)
In addition, there were 24 downgrades involving 13 CDO transactions as well as six sub-prime auto downgrades in the first half. Three classes of the Global Franchise Trust 1998-1 franchise-loan-backed transaction were downgraded in June as a result of the steep deterioration in the credit performance of the largest loan in the underlying portfolio and the likely low recoveries from the collateral. These were the first downgrades ever in this asset class.
As a result of the upgrades of the LAI and Ford Motor Credit transactions, asset-backed security upgrades that occurred during the first six months of 2000 were concentrated in deals backed by vehicle leases and prime autos. In contrast, the manufactured housing and credit card sectors accounted for the largest portions of upgrades that occurred prior to January 2000. (See Figure 5.)
Outlook: Asset-Related Changes Will Drive Activity
As a result of the Conseco downgrade, downgrades of credit enhancers were the largest cause of downgrades of asset-backed securities during the first half of 2000. However, poor asset performance resulted in a significant number of asset-backed downgrades, continuing a trend that began in 1997. In addition, asset-related downgrades once again affected the highest credit-quality tranches. Moody's expects these trends in asset-related downgrades to continue in the foreseeable future.
Upgrades in the asset-backed market during the first half of 2000 were mainly asset-performance-related, and Moody's expects similar upgrades in the future, especially if the strong economy persists. As transactions pass their peak loss periods, credit enhancement levels could build up to the point where upgrades may be warranted.
The economic expansion, however, will not last forever. We expect the number of asset-backed securities downgraded due to poor asset performance to increase during the next economic downturn. Some deterioration in performance is generally expected during a downturn for virtually all transactions - and would not necessarily result in a downgrade - but the extent of that deterioration will vary across transactions, and is likely to result in downgrades for some. Although we expect this to be particularly relevant to transactions backed by lower-quality assets - whose performance may be particularly volatile - transactions backed by higher-quality assets may also be affected.