More than half of all downgrades experienced by the U.S. CDO sector in the first quarter stemmed from synthetic transactions, according to Standard and Poor's. However, only 17 synthetic CDOs were downgraded, compared to a record 43 in the fourth quarter.

Implications for the synthetic CDO sector from corporate credit events within the U.S. auto sector - such as the bankruptcies of autoparts manufacturer Dana Corp. - were relatively muted compared with the volatility seen at yearend 2005, S&P reported in its quarterly tally of sector-specific upgrades and downgrades.

The CDO sector mirrored trends within the general structured finance market, where a robust real estate market fueled growth in RMBS, CMBS and U.S. real estate companies. At the same time, the loan market continued to revel in a low cost of funds while trouble within certain U.S. corporate sectors resulted in depressed corporate credit ratings.

Upgrade to downgrade ratio

Overall within the CDO sector, the first quarter saw 10 upgrades and 28 downgrades, resulting in a 0.36 ratio of upgrades to downgrades, slightly lower than the fourth quarter's 0.38 ratio of upgrades to downgrades. The total number of upgrades during the quarter - all of which were for cash flow CDOs - was the lowest since the second quarter of 2004. Four arbitrage corporate high-yield CBOs were upgraded in the first quarter, compared with 12 in the fourth quarter and 60 total for last year. Structured finance CDOs took the final six upgrades in the first quarter, down from 10 in 4Q05.

Meanwhile, next to the 17 synthetic CDO deals downgraded during the first quarter, the second-highest number of downgrades went to structured finance CDOs. These deals were downgraded eight times compared with 22 in the previous quarter; arbitrage corporate investment grade CBOs were downgraded twice and the high yield version of the sector received a single downgrade, compared with zero and five in the last quarter, respectively.

As of last week, 54 CDO ratings were on S&P's watch list for a possible downgrade, while less than half that number - 25 - were up for possible upgrades.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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