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Taiwan Ratings' 2009 Corporate Default And Rating Transition Study 2010/05/11
Coverage Taiwan Ratings Corp.'s annual default and ratings transition study closely examines the track record of credit ratings assigned by Taiwan Ratings since it began operations in 1998. Our comprehensive study shows that the movement of ratings has followed a broadly similar pattern to Standard & Poor's Ratings Services' global experience; however, rating movements in Taiwan have been more volatile, particularly at lower rating levels. This study primarily measures ratings migration over time and provides a quantitative measure of ratings distribution and movement. This report covers 226 issuer credit ratings assigned by Taiwan Ratings between 1998 and 2009, inclusive. The study analyzes the movement of ratings on Taiwan-based obligors--industrials, utilities, insurance companies, financial holding companies, banks, securities firms, and other financial institutions. The study includes public and confidentially rated entities, as well as those whose ratings were withdrawn after being assigned. Key Findings
Domestic Obligors' Credit Quality Mostly Reflects The Continuing Impact Of The Recent Global Economic Recession Rated obligors' credit quality mostly trended downward in 2009 with Taiwan Ratings downgrading 18.11% of its rated issuers during the year. This was particularly true in the first half of 2009 when locally based corporate and financial institutions more deeply felt the affect of the global economic slow down and capital market dislocation. The financial sector led the downward ratings movement, followed by some cyclical or highly leveraged industrial sectors. The downward pressure on ratings gradually eased since the second half of 2009, when the global and local markets responded to the stabilizing global economy (see table 1 and chart 1).
Ratings Remain A Good Indicator Of Default Probability The findings of our study largely support the existence of a negative correlation between rating levels and default probability--broadly similar to the observations of Standard & Poor's global study (see "Global Corporate Default Study" ). Nonetheless, the overall experience of defaults in our pool of rated entities will continue to develop, given our smaller sample size and shorter review period compared with Standard & Poor's global experience. Our study covers ratings migration for 226 entities as of the end of 2009 in 1998-2009 compared with Standard & Poor's global rated pool of 13,952 entities in 1981-2009. In particular, the number of default during the earlier years of Taiwan Ratings' established pool (before the end of 2002) is limited by the small rating base (see tables 2, 3, and 4).
As a statistically smaller and less-diversified ratings pool than Standard & Poor's global ratings pool, Taiwan Ratings' issuer rating pool has several distinct anomalies (see tables two and three) including:
Our pool of rated entities experienced no defaults in 2009, despite a difficult economic environment. This is contrary to Standard & Poor's Ratings Services' global experience of a sharply rising default rate in 2009. We believe that a small and less diversified rating pool and the completion of the Taiwan government's action to remove weaker banks from the banking system have attributed to the zero default rate in 2009. In addition, at the beginning of 2009, Taiwan Ratings' ratings pool mostly consisted of entities rated 'twA-' or above and contained only four entities rated 'twBB+' or below, or 3.1% of the pool. In our view, the Taiwan government's efforts in maintaining the stability of the domestic financial system and the adequate access of non-financial corporations to liquidity also helped to minimize immediate defaults in 2009. The government took measures to ease the liquidity concern on smaller and weaker financial institutions, such as providing a full guarantee on banking deposits till the end of 2010. In addition, since late 1998, the Taiwan government has asked local banks to provide liquidity for non-financial corporations whose financial conditions drastically weakened due to the current global financial crisis, in. The aim is to allow such entities time to address their funding needs and avoid immediate defaults. The somewhat excess liquidity provided by the banking sector has supported funding needs for low-rated non-financial entities prior to the current financial dislocation. For the purpose of global consistency, financial institutions that are placed under regulatory supervision are classified as default records in this study. However, placing a financial institution under regulatory supervision, to which we assign a 'twR' rating, does not necessarily indicate a default event but emphasizes that the regulator has the power to favor one class of obligations over others or to pay some obligations and not others. Among the nine institutions rated 'twR' by Taiwan Ratings in 2000-2009, five had generally serviced their debt obligations and were not subsequently recorded as 'SD' or selective default, as they did not have debts beyond the legal scope of the government's protection as defined by the relevant regulation (i.e. non-deposit debts issued after July 2005). Taiwan's Rating Transitions Largely Mirror Global And Regional Rating Trends As mentioned above, our transition study shows a strong mirror to the observations by Standard & Poor's of rating movements on a global and regional scale. In particular, observations show that the ratings on higher-rated issuers tend to exhibit less volatility than the ratings on lower-rated entities. For instance, the probability that a Taiwan issuer rated 'twAA' at the beginning of a year will be rated 'twAA' at the end of the year is 92.8% (see table 5), whereas the probability that an issuer rated 'twBB' at the beginning of a year will be rated 'twBB' at the end of the year is only 58.1%. The probability that a global issuer rated 'AA' will retain this rating after one year is 86.6%, whereas the probability that a global issuer rated 'BB' will retain this rating after one year is only 75.5%.
The majority of Taiwan Ratings' rated categories registered a lower stability rate than those rated by Standard & Poor's, due to our smaller issuer rating pool and shorter observation period, as well as the volatility inherent in smaller or weaker financial institutions. Caution is required in interpreting the higher stability rates associated with the 'twCCC/twCC' rating category relative to the 'twB' rating category in light of the extremely small sample size. In addition, the somewhat high number of withdrawals diluted the rating stability at the 'twB' rating category (see table 5). Standard & Poor's global observations reveal that entities generally migrate toward lower-rating categories; however, most entities in our pool tended to move up rather than down for the 11-year period 1998-2009, despite a sharp downward movement in 2009 due to the global financial downturn. This is mainly due to the large-scale rating adjustment we conducted in December 2004 to reflect important developments in the financial services industry in which Taiwan Ratings' rating pool concentrates. This included the accelerating integration within financial holding company (FHC) groups, improvements in risk management across major participants, and continuing government support to maintain financial system stability. The adjustment resulted in a lower downgrade-to-upgrade ratio for Taiwan Ratings' pool that averaged 0.45 times in 1999-2009 compared with 1.56 times for Standard & Poor's regional and global pools over the same period (see table 6, 7). Our high 23.0x ratio of downgrades to upgrades in 2009 was somewhat overstated by an extremely low upgrade ratio in 2009, regardless of the fact that our downgrade ratio was about the same as the global level. This is again a reflection of our high number of financial service ratings, which have been more volatile during the current period of global financial dislocation.
The ratings in our domestic-oriented pool, however, have exhibited higher volatility than the ratings in Standard & Poor's global pool due to our smaller and less diversified sample concentrated in the financial service sector. The frequency range of annual rating changes in Taiwan was 9.4%-71.6% in 1999-2009 and averaged 33% over the same period (see table 6). This is in contrast with the range of annual rating changes in Standard & Poor's global pool of 23.9%-35.5% in 1999-2009 and an average 30.8% over the same period (see table 7). Default implications of ratings transition As the pattern of ratings migration for entities within Taiwan Ratings' rated pool continues to develop, as well as the size of the rated pool and the length of rating history, the default and rating transition is likely to closely mirror Standard & Poor's global study after its issuer pool undergoes testing through future business cycles. However, there remains a major difference in the implicit default risk between Standard & Poor's global scale and Taiwan Ratings' scale. Our scale is positioned as a national scale and excludes direct sovereign risks of a general or systemic nature (Standard & Poor's Rating Services has assigned Taiwan an 'AA-/Negative/A-1+' rating). Based on Standard & Poor's historical observations, cumulative default rates may also be calculated for multi-year periods. Note the one-year and three-year default rate columns in table 3 are approximately equivalent to the level of the respective D (default) columns in table 8. The slight difference in results between the two tables mainly stems from slight variations in the static pools used to calculate transition to default and cumulative average default rates. Cumulative average default rates are the summary of all available static pools and are calculated using marginal default rates (conditional on survival), while the number of pools used in the average transition rate is limited by the transition's time horizon.
Appendix: Default Methodology And Definitions This long-term corporate default and rating transition study uses the CreditPro® 7.72 software. An issuer credit rating reflects Taiwan Ratings' opinion of a company's overall capacity to pay its obligations (that is, its fundamental creditworthiness). This opinion focuses on the obligor's ability and willingness to meet its financial commitments on a timely basis, and it generally indicates the likelihood of default regarding all financial obligations of the firm. It is not necessary for a company to have rated debt in order to be assigned an issuer credit rating. Although a company's senior secured debt (particularly debt with strong covenants) may occasionally be rated higher than the issuer credit rating on the company, specific issues are typically rated as high as or lower than the issuer rating, depending on their relative priority within the company's debt structure. For lower rated entities, the issuer credit ratings are generally two notches higher than the subordinated debt ratings; otherwise they are generally one notch higher. Therefore, though a 'twBB+' issuer credit rating is generally paired with a 'twBB-' subordinated debt rating, a 'twAA' issuer credit rating usually corresponds to a 'twAA-' subordinated rating. Standard & Poor's ongoing enhancement of the CreditPro® database used to generate this study may lead to outcomes that differ to some degree from those reported in previous studies. However, this poses no continuity problem because each study reports statistics back to Dec. 31, 1998. Therefore, each annual default study is self-contained and effectively supersedes all previous versions. Issuers Included In This Study The study analyzed the rating histories of 226 companies that were rated by Taiwan Ratings as of Dec. 31, 1998, or that were first rated between that date and Dec. 31, 2009. These include industrials, utilities, insurance companies, FHCs, banks, securities firms, and other financial institutions in Taiwan with long-term credit ratings. The global data presented in this report refers to Standard & Poor's ratings histories of all 13,952 long-term rated issuers from Dec. 31, 1980 to Dec. 31, 2009. The study includes non-confidentially and confidentially rated entities as well as those whose ratings were withdrawn after initial assignment. The analysis excludes public information (pi) ratings and ratings based on the guarantee of another company. Structured finance vehicles, public-sector issuers, and sovereign issuers are the subject of separate default and transition studies and are excluded from this study. Subsidiaries whose debt is fully guaranteed by a parent or whose default risk is considered identical to that of their parents were excluded. The latter are companies whose obligations are not legally guaranteed by a parent but whose operating or financing activities are so inextricably entwined with those of the parent that it would be impossible to imagine the default of one and not the other. At times, however, some of these subsidiaries might not yet have been covered by a parent's guarantee, or the relationship that combines the default risk of parent and child might have come to an end, or might not have begun. Such subsidiaries were included for the period during which they carried a distinct and separate risk of default. Definition Of Default A default event is recorded on the first occurrence of a payment default on any financial obligation, rated or unrated, other than a financial obligation subject to a bona fide commercial dispute; an exception occurs when an interest payment missed on the due date is made within the grace period. Preferred stock is not considered a financial obligation; thus, a missed preferred stock dividend is not normally equated with default. However, we consider distressed exchanges as defaults whenever the debt holders are coerced into accepting substitute instruments with lower coupons, longer maturities, or any other diminished financial terms. Issue ratings are usually lowered to 'D' following a company's default on the corresponding obligation. In addition, 'SD' is used whenever Taiwan Ratings believes that an obligor that has selectively defaulted on a specific issue or class of obligations will continue to meet its payment obligations on other issues or classes of obligations in a timely matter. A 'twR' issuer rating indicates that an obligor is under regulatory supervision owing to its financial condition. This does not necessarily indicate a default event, but the regulator may have the power to favor one class of obligations over others or pay some obligations and not others. 'D', 'SD', and 'twR' issuer ratings are deemed defaults for purposes of this study. A default is assumed to take place on the earliest of: the date Taiwan Ratings revised the ratings to D', 'SD', or 'twR'; the date a debt payment was missed; the date a distressed exchange offer was announced; or the date the debtor filed for or was forced into bankruptcy. Static Pool Methodology Taiwan Ratings conducts its default studies on the basis of groupings called static pools. Static pools are formed by grouping issuers by rating category at the beginning of each year covered by the study. Each static pool is followed from that point forward. All companies included in the study are assigned to one or more static pools. When an issuer defaults, that default is assigned back to all of the static pools to which the issuer belongs. Taiwan Ratings uses the static pool methodology to avoid certain pitfalls in estimating default rates, to ensure that default rates account for rating migration, and to allow default rates to be calculated across multi-period time horizons. Some methods for calculating default and rating transition rates might charge defaults against only the initial rating on the issuer--ignoring more recent rating changes that supply more current information. Other methods may calculate default rates using only the most recent year's default and rating data--this method may yield comparatively low default rates during periods of high rating activity, as they ignore prior years' default activity. The pools are static in the sense that their membership remains constant over time. Each static pool can be interpreted as a buy and hold portfolio. Because errors, if any, are corrected by every new update, and because the criteria for inclusion or exclusion of companies in the default study are subject to minor revisions as time goes by, it is not possible to compare static pools across different studies. Therefore, every new update revises results back to the same starting date of Dec. 31, 1998, to avoid continuity problems. Entities that have had ratings withdrawn--that is, revised to N.R.--are surveyed with the aim of capturing a potential default. These companies, as well as those that have defaulted, are excluded from subsequent static pools. For instance, the 1999 static pool consists of all companies rated as of 12:01 a.m. Jan. 1, 1999. Adding those companies first rated in 1999 to the surviving members of the 1999 static pool forms the 2000 static pool. All rating changes that took place are reflected in the newly formed 2000 static pool. This same method was used to form static pools for 2001 through 2008. Consider the following example: An issuer is originally rated 'twBB' in mid-1998 and is downgraded to 'twB' in 2000. This is followed by a rating withdrawal (N.R.) in 2002 and a default ('D') in 2005. This hypothetical company would be included in the 1999 and 2000 pools with the 'twBB' rating assigned to it at the beginning of those years; likewise, it would be included in the 2001 and 2002 pools with the 'twB' rating. It would not be part of the 1998 pool because it was not rated as of the first day of that year, and it would not be included in any pool after the last day of 2002 because the rating had been withdrawn by then. Yet each of the four pools in which this company was included (1999-2002) would record its 2005 default at the appropriate time horizon. Ratings are withdrawn when an entity's entire debt is paid off or when the program or programs rated are terminated and the relevant debt extinguished. This may also occur as a result of mergers and acquisitions. Other ratings are withdrawn because of a lack of cooperation, particularly when a company is experiencing financial difficulties and refuses to provide all the information needed to continue our surveillance on the ratings. Default Rate Calculation Annual default rates were calculated for each static pool: first in units, and later as percentages with respect to the number of issuers in each rating category. Finally, these percentages were combined to obtain cumulative default rates for the ten years covered by the study. Issuer-weighted Default Rates Averages that appear in this study are calculated based on the number of issuers rather than the dollar amounts affected by defaults or rating changes. Although dollar amounts provide information about the portion of the market that is affected by defaults or rating changes, issuer-weighted averages is a more useful measure of the performance of ratings. Many people in the investment field use statistics from this default study and CreditPro® to estimate the probability of default and the probability of rating transition. It is important to note that we do not imply a specific probability of default; however, our historical default rates are frequently used to estimate these characteristics. Cumulative Average Default Rate Calculation Cumulative default rates that average the experience of all static pools are derived by calculating marginal default rates, conditional on survival (survivors being non-defaulters) for each possible time horizon and for each static pool, weight averaging the conditional marginal default rates, and accumulating the average conditional marginal default rates. Conditional default rates are calculated by dividing the number of issuers in a static pool that default at a specific time horizon by the number of issuers that survived (did not default) to that point in time. Weights are based on the number of issuers in each static pool. Cumulative default rates are one minus the product of the proportion of survivors (non-defaulters). Time Sample This update limits the reporting of default rates to the selected time horizon; however, the data has been gathered for ten years and all calculations are based on the rating experience of that period. The maturities of most obligations are much shorter than the selected time horizon. In addition, average default statistics become less reliable at longer time horizons as the sample size becomes smaller and the cyclical nature of default rates increases its effect on averages. Default patterns share broad similarities across all static pools, suggesting that Taiwan Ratings' rating standards have been consistent over time. Adverse business conditions tend to coincide with default upswings for all pools. Speculative-grade issuers have been hit the hardest by these upswings, but investment-grade default rates also increase in stressful periods. Transition Analysis Transition rates compare issuer ratings at the beginning of a time period with ratings at the end of the period. To compute one-year rating transition rates by rating category, the rating on each entity at the end of a particular year is compared with the rating at the beginning of the same year. An issuer that remained rated for more than one year is counted as many times as the number of years it was rated. For instance, an issuer continually rated from the middle of 1998 to the middle of 2003 would appear in the four consecutive one-year transition matrices from 1999 to 2002. All 1999 static pool members still rated on Dec. 31, 2008, had nine one-year transitions, while companies first rated between Jan. 1, 2008, and Dec. 31, 2008 had only one. Each one-year transition matrix displays all rating movements between letter categories from the beginning of the year through year-end. For each rating listed in the matrix's left-most column, there are nine ratios listed in the rows, corresponding to the ratings from 'twAAA' to 'D,' plus an entry for N.R. Practical Application Of Transition Rates Rating transition rates are useful to investors and credit professionals for whom rating stability is important. For instance, investors restricted by law or inclination to invest in top-grade bonds would want to assess the likelihood that Taiwan Ratings' analysts will continue to assign top ratings to their investments. Conversely, investors buying high-yield bonds in hopes of profiting from a rating upgrade would be able to gauge that expectation realistically. The credit community might also use rating transition information, in part, to determine maturity exposure limits or to measure credit risk in the context of the value-at-risk models. Rating transition matrices could also be constructed to produce stressed default rates. Such matrices are often used in the area of credit risk measurement. In addition, multiyear transition matrices are valuable tools that can be used to forecast future rating distributions and may be better suited for certain applications than are one-year transition matrices. Comparing Transition Rates With Default Rates Rating transition rates may be compared with the marginal and cumulative default rates described in the previous section. For example, note that the one-year default rate column of Table 2 is equivalent to column 'D' of the average one-year transition matrix found in Table 5. Cumulative average default rates are the summary of all static pools from 1998 through 2008, while the number of pools used in the average transition rate is limited by the transition's time horizon.
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