Rating Changes in the U.S. Asset-Backed Securities Market: 2001 Transition Matrix Update

Transcription

1 STRUCTURED FINANCE Special Report Rating Changes in the U.S. Asset-Backed Securities Market: 2001 Transition Matrix Update AUTHOR: Julia Tung Analyst (212) CONTACTS: Yaowaluck Tantiwattanapaibul Associate Analyst (212) Sombat Jiwariyavej Analyst (212) Joseph P. Snailer Senior Credit Officer (212) Andrew A. Silver, Ph.D. Group Managing Director (212) Investor Liaison Vernessa Poole All Asset Backed and Residential Mortgage Backed Securities (212) WEBSITE: CONTENTS Summary Calculating the U.S. Asset-Backed Security Transition Matrix Results: Rating Stability Over Time Implications: The Past Isn t The Future Related Research SUMMARY This report is an update to the historical study of rating transitions in the U.S. assetbacked securities market and contains transitions based on data through year-end It is the latest in a series of reports that addresses the history of Moody s rating changes on asset-backed securities since the market s inception. 1 Rating transitions refer to the frequency with which securities of a particular rating change over the course of time and are important tools for analyzing the historical rating volatilities of securities of different ratings. They can be used to answer questions such as How frequently in the past have Baa2-rated securities been downgraded to below investment grade over a typical year? or Have lower-rated securities been more likely to be upgraded than higher-rated securities? Our analysis focuses on rating transitions over one-year periods and shows the following: There is no significant difference between the current transition matrices and those published last year, which were based on data through year-end However, due to the severe downgrades of several Heilig-Myers asset-backed transactions in 2001, there are now several small entries in the upper-right-hand corner of the matrices. On average, asset-backed security ratings overall have been quite stable since the market s inception in 1986 with, for most rating categories, over 90% of ratings staying the same over one-year periods. For those categories with ratings above B that have shown somewhat higher rating transitions, most of the changes were caused by rating changes to entities related to the transactions. However, weak performance was the major reason for the higher transition percentages for securities rated B or below. Asset-backed security ratings have experienced lower transition rates than corporate ratings since However, over the long run, we expect assetbacked transitions to lead to credit losses roughly equal to those of corporate securities. Asset-backed rating transitions could increase in the future if the economic environment differs from the generally favorable conditions that have prevailed for most of the asset-backed market s existence, or if issuers become unwilling or unable to support troubled transactions, as some issuers have in the past. 1 See Related Research section. January 25, 2002

2 Calculating the U.S. Asset-Backed Security Transition Matrix Figure 1 shows the weighted average one-year rating transition matrix for asset-backed securities for the years 1986 through This matrix was calculated in the following fashion. For each year starting in 1986, a transition matrix was calculated for all asset-backed securities outstanding at the beginning of that year. That is, for each rating outstanding at the beginning of a particular year, we determined its status (i.e., its rating or whether it had been withdrawn) at the end of the year. In the cells of each annual matrix, we record the frequency with which securities that had the row rating at the beginning of the year had the column rating at the end of the year. As only beginning-of-year and end-of-year ratings are considered, any intermediate rating changes that occurred during a year are ignored. Weighted averages 3 of each year s annual transition percentages were calculated, resulting in the average one-year transition matrix presented in Figure 1. The rating transitions can be used to analyze the historical average annual rating volatility of asset-backed securities of different ratings. For example, Figure 1 shows that on average since 1986, of the securities rated Aa1 at the beginning of a year: 2.7% were rated Aaa at the end of that year 79.8% were rated Aa1 at the end of that year 2.9% were rated Aa2 4.5% were rated Aa3 10.1% had their rating withdrawn (WR) 4 An alternative way to present the transition matrix is to remove from consideration those securities that have had their ratings withdrawn (i.e., have matured) and consider only those securities with ratings outstanding at both the beginning and end of the year. (See Figure 2.) In such a presentation, the entries in the matrix represent rating-change percentages of securities that have not matured and, therefore, remain exposed to credit risk at the end of the year. Yet another way to view the transitions is to use the broad rating categories (i.e., Aaa, Aa, A, etc.) rather than the refined rating categories (i.e., Aaa, Aa1, Aa2, Aa3, etc.). (See Figures 3 and 4.) Each row in these matrices considers the broad rating only and ignores the numeric suffix, so that all securities that were, for example, rated Aa1, Aa2, or Aa3 at the beginning of the year are grouped into the Aa category. The columns count as transitions only those rating changes that would bring the rating of the security outside of its broad category. For example, a rating change from Aa3 to A1 would be counted as a transition from Aa to A, but a change from Aa2 to Aa3 would be treated as the rating having remained Aa. Results: Rating Stability Over Time The main results that can be gleaned from the average rating transitions summarized in Figure 2 are as follows. Current Matrix Similar to Last Year s Matrix: The current transition matrix, calculated over the period , has not changed significantly from last year s matrix, which was calculated using data through year-end However a few differences are worth noting. The rating changes that occurred in 2001 have added some small positive entries to the upper-right-hand corner of Figure 2, representing multi-rating-notch changes. Those entries are associated with the downgrades of all classes of Series and issued by the Heilig-Myers Master Trust. The A classes of the two series were downgraded from Aaa to Caa2 within the year, while the B classes, which started the year rated Aa3 and A1, were 2 Asset-backed securities for the purposes of this study are defined as US-dollar-denominated securities, excluding asset-backed commercial paper, backed by all assets except commercial mortgages and most first-lien residential mortgages. Collateralized debt obligations were included, as were deals backed by home equity loans (and starting in 1997, "B&C"-quality mortgages, regardless of lien status). Deals backed by student loans issued by municipalities were included starting in December Public, private and 144A issues have been included. 3 The weights used in calculating the average transitions for asset-backed securities are the number of outstanding ratings at the beginning of each year. Thus, the average transition percentages will reflect more heavily the experience from the most recent years, when there were many assetbacked ratings outstanding, than the experience of the asset-backed market's earlier years, when there were fewer ratings outstanding. 4 The primary reason asset-backed security ratings are withdrawn is because issues mature. As can be seen in Figure 1, the average percentage of asset-backed securities that have their ratings withdrawn in a year ranges from 0% to 13% and tends to decline as rating quality declines, especially to the Baa rating level and below. This could be explained by the fact that lower-rated asset-backed securities are more likely to be subordinated tranches, which are more likely to have longer maturities. 2 Moody s Investors Service Rating Changes in the U.S. Asset-Backed Securities Market

3 downgraded to Ca. Although the magnitudes of the rating changes are large, these downgrades contribute very little to the overall historical volatility of ratings and do not significantly change the general make-up of the matrix. There is greater volatility in the A1 category than there was in last year s matrix because of a large number of upgrades of student-loan-backed securities in There is also less stability in the B-rating categories due to the downgrades of several subordinate tranches of asset-backed transactions in However, the transition frequencies of B-rated securities are quite sensitive to even a small number of rating changes due to the small number of asset-backed securities with ratings in these categories. Rating Stability: On average, asset-backed security ratings overall have been quite stable since Generally, over 90% of ratings remain the same over one-year periods (as shown by the diagonal elements in the matrix). Note that there are very few outstanding ratings in the categories from Caa-C, so the numbers tend to be more variable. Rating Changes in Underlying Entities Often the Major Cause of Higher Transitions: For those categories with ratings above B that have shown somewhat higher rating transitions, most of the changes were caused by rating changes to entities related to the transactions. Consider the following: On average, only 45.4% of securities rated Ba1 at the beginning of a year were rated Ba1 at the end of that year, while 37.6% were upgraded to Baa3. Closer inspection reveals that the transitions to Baa3 were caused entirely by the upgrading in 1999 of 53 subordinated tranches backed by home equity and manufactured housing loans that were guaranteed by the originator, Green Tree, which was upgraded following its acquisition by Conseco. Of the Baa3 ratings at the beginning of a year, 87% were Baa3 at the end of the year, while 3.2% had been downgraded to Ba2 and 4.1% to Ba3 by year-end. The majority of these downgrades can be attributed to the two downgrades of Conseco in On average, 8.9% of asset-backed securities rated A1 at the beginning of a year had been upgraded to Aa3 at the end of the year. Almost all of those transitions can be ascribed to the upgrades in 2001 of the student-loan-backed securities issued by the Connecticut Higher Education Supplement Loan Authority due to the upgrade of the state of Connecticut. However, weak performance leading to downgrades was the major factor for the higher transition percentages for securities rated B or below. For example: In the B1 category, on average 72.4% of the securities had the same rating at the beginning and end of a year, while 27.6% had been downgraded to B3 or below by year-end. All but one of these downgrades were due to weak performance. Of securities rated B3 at the beginning of a year, 79.7% were rated B3 at the end of that year and 20.3% had been downgraded to Caa1 or below. The majority of these downgrades were also caused by weak performance. To Date, More Stability Than Comparable Corporates: Additional perspective on the assetbacked transition experience can be obtained from comparing it to the rating transitions of corporate bond issuers rated by Moody s. Figures 5 and 6 contain average one-year transition matrices for Moody s-rated corporate bond issuers from 1986 to 2001 for the refined and broad rating categories, respectively. 5 Comparing Figures 1 and 5, it can be seen that, on average, asset-backed security ratings have been more stable than corporate ratings since Due to the limited number of asset-backed issues with ratings below investment grade, comparisons in those rating categories are less reliable. Broad Rating Category Transitions Show Similar Results: In general the conclusions for ratings transitions in the refined rating categories presented in Figures 1 and 2 also hold for transitions 5 The focus of Moody's corporate rating transitions is the issuer while the asset-backed transition matrix is based on rated tranches. Thus, a corporation with many debt issues outstanding will count as one observation in the corporate transition analysis, while each rated tranche of an assetbacked transaction will count as a separate observation. For transactions with multiple Aaa-rated tranches, each tranche is counted as a separate rating observation, as it is not clear that the ratings on such tranches will always move together, especially since it is common for them to have different maturities. Rating Changes in the U.S. Asset-Backed Securities Market Moody s Investors Service 3

4 in the broad rating categories. Figures 3 and 4 reinforce the perception of stability in assetbacked security ratings, and comparing Figures 3 and 6 gives further evidence that assetbacked issues have so far been more stable than their corporate counterparts. Implications: The Past Isn t The Future Moody s ratings address expected loss, encompassing both the likelihood of default as well as the severity of loss should a default occur. Historical rating changes, summarized in the transition matrices in Figures 1 and 2, indicate those instances to date where Moody s view about the expected loss of an asset-backed transaction has changed. Although Moody s does not use rating transition figures as targets or guidelines when monitoring transactions and reviewing them for possible rating changes, over the long run, we expect that transition rates will be roughly consistent with default rates -- and hence loss rates -- that are in line with those experienced for corporate bonds with similar ratings. However, those long run transition rates are likely to be different from those experienced to date. First, the historical transition rates for some rating categories -- particularly those below investment grade -- should be viewed with caution because of the limited number of outstanding ratings on which they are based. Second, the future economic environment is very likely to be different than the unusually favorable conditions that have prevailed for most of the asset-backed market s existence. And finally, there have been numerous occasions in the past where issuers have supported transactions with assets that had not performed as expected, thereby avoiding a potential downgrade. 6 Had these issuers not supported their troubled deals, historical rating volatility in the asset-backed market could have been higher. Should issuers become either unwilling or unable to support their troubled transactions in the future, the level of future downgrade activity in the asset-backed market could increase above historical experience. Related Research A Historical Review of Rating Changes in the Public Asset-Backed Securities Market, , Moody s Structured Finance, October 20, 1995 The Costs and Benefits of Supporting Troubled Asset-Backed Securities: Has the Balance Shifted? Moody s Structured Finance, January 17, 1997 Rating Changes in the Asset-Backed Securities Market: An Update, Moody s Structured Finance, August 7, 1998 Rating Changes in the U.S. Asset-Backed Securities Market: August 1999 Update, Moody s Structured Finance, August 6, 1999 Rating Changes in the U.S. Asset-Backed Securities Market: 1999 Second Half Update, Moody s Structured Finance, July 14, 2000 Rating Changes in the U.S. Asset-Backed Securities Market: 2000 First Half Update, Moody s Structured Finance, October 6, 2000 Rating Changes in the Asset-Backed Securities Market: First-Ever Transition Matrix Indicates Rating Stability To Date, Moody s Structured Finance, January 19, 2001 Credit Rating Migration of CDO Notes, , Moody s Structured Finance, April 27, 2001 Rating Changes in the Asset-Backed Securities Market: 2000 Second Half Update, Moody s Structured Finance, August 15, 2001 CDO Rating Transitions; Year-To-Date Review - August 2001, Moody s Structured Finance, October 19, 2001 Rating Changes in the Asset-Backed Securities Market: 2001 First Half Update, Moody s Structured Finance, October 26, 2001 Rating Changes in the Asset-Backed Securities Market: 2001 Second Half Update, Moody s Structured Finance, January 25, For information about asset-backed securities that have been supported by their issuers, see "The Costs and Benefits of Supporting "Troubled" Asset-Backed Securities: Has the Balance Shifted?" Moody's Structured Finance, January 17, Moody s Investors Service Rating Changes in the U.S. Asset-Backed Securities Market

5 Rating Changes in the U.S. Asset-Backed Securities Market Moody s Investors Service 5 Beginning-of-Year Rating: Figure 1 U.S. Asset-Backed Security Average One-Year Rating Transition Matrix: 1986 to 2001 Percent Moving From Beginning-of-Year Rating to End-of-Year Rating (%) End-of-Year Rating: Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C WR Aaa Aa Aa Aa A A A Baa Baa Baa Ba Ba Ba B B B Caa Caa Caa Ca C

6 Figure 2 U.S. Asset-Backed Security Average One-Year Rating Transition Matrix: 1986 to 2001 Securities With Withdrawn Ratings Excluded Percent Moving From Beginning-of-Year Rating to End-of-Year Rating (%) End-of-Year Rating: Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C Aaa Aa Aa Aa A A A Baa Baa Baa Ba Ba Ba B B B Caa Caa Caa Ca C Beginning-of-Year Rating: 6 Moody s Investors Service Rating Changes in the U.S. Asset-Backed Securities Market

7 Figure 3 U.S. Asset-Backed Security Average One-Year Rating Transition Matrix: 1986 to 2001 Broad Rating Categories Percent Moving From Beginning-of-Year Rating to End-of-Year Rating (%) Beginning-of-Year Rating: End-of-Year Rating: Aaa Aa A Baa Ba B Caa Ca C WR Aaa Aa A Baa Ba B Caa Ca C Figure 4 U.S. Asset-Backed Security Average One-Year Rating Transition Matrix: 1986 to 2001 Broad Rating Categories; Securities With Withdrawn Ratings Excluded Percent Moving From Beginning-of-Year Rating to End-of-Year Rating (%) Beginning-of-Year Rating: End-of-Year Rating: Aaa Aa A Baa Ba B Caa Ca C Aaa Aa A Baa Ba B Caa Ca C Rating Changes in the U.S. Asset-Backed Securities Market Moody s Investors Service 7

8 Figure 5 All-Corporate Average One-Year Rating Transition Matrix: 1986 to 2001 Percent Moving From Beginning-of-Year Rating to End-of-Year Rating (%) End-of-Year Rating: Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa-C Default WR Aaa Aa Aa Aa A A A Baa Baa Baa Ba Ba Ba B B B Caa-C Beginning-of-Year Rating: 8 Moody s Investors Service Rating Changes in the U.S. Asset-Backed Securities Market

9 Figure 6 All-Corporate Average One-Year Rating Transition Matrix: 1986 to 2001 Broad Rating Categories Percent Moving From Beginning-of-Year Rating to End-of-Year Rating (%) Beginning-of-Year Rating: End-of-Year Rating: Aaa Aa A Baa Ba B Caa-C Default WR Aaa Aa A Baa Ba B Caa-C Rating Changes in the U.S. Asset-Backed Securities Market Moody s Investors Service 9

10 10 Moody s Investors Service Rating Changes in the U.S. Asset-Backed Securities Market

11 Rating Changes in the U.S. Asset-Backed Securities Market Moody s Investors Service 11

12 Doc ID# SFxxxx Copyright 2002 by Moody s Investors Service, Inc., 99 Church Street, New York, New York All rights reserved. ALL INFORMATION CONTAINED HEREIN IS COPYRIGHTED IN THE NAME OF MOODY S INVESTORS SERVICE, INC. ( MOODY S ), AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided as is without warranty of any kind and MOODY S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. Pursuant to Section 17(b) of the Securities Act of 1933, MOODY S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY S have, prior to assignment of any rating, agreed to pay to MOODY S for appraisal and rating services rendered by it fees ranging from $1,000 to $1,500, Moody s Investors Service Rating Changes in the U.S. Asset-Backed Securities Market