Ratings Roundup Report: The Weak Economic Environment Dragged Down Ratings Performance In 2009, But 2010 Should See Stabilizing Credit Profiles

2009/12/30

Analyst:	Susan Chu, (886) 2 8722-5813 susan_chu@taiwanratings.com.tw
	Daniel Hsiao, (886) 2 8722-5826 daniel_hsiao@taiwanratings.com.tw
	Andy Chang, CFA; (886) 2 8722-5815 andy_chang@taiwanratings.com.tw
	Aaron Lei , (886) 2 8722-5852 aaron_lei@taiwanratings.com.tw

The continuing dislocation in the global and local financial markets and resultant low economic activity throughout most of 2009 had a strong negative effect on the credit performance of rated entities in Taiwan. This is reflected not only in general negative direction of ratings actions taken by Taiwan Ratings Corp. over the past 12 months, but also in the number. Nonetheless, we have observed signs of stabilizing credit profiles since the second half of 2009 (see chart 1). In Taiwan's corporate and financial sectors, the total number of issuer rating downgrades continued to exceed upgrades in 2009, due mostly to weak macroeconomic conditions, with 27 downgrades against only one upgrade. It should be noted, however, that 25 of these downgrades came in the first half of the year. Under still weak economic conditions, the financial sector led the negative rating migration, followed by some cyclical or highly leveraged industrial sectors. Similarly, the fragile global economy affected domestic structured finance ratings which also continued their negative trend from 2008, but most negative actions involved a small number of collateralized bond obligation (CBO) transactions with high exposures to foreign corporate and structured finance debts.

Taiwan Ratings expects the performance of rated entities in 2010 will not face the significant pressures experienced in 2009, while there is also the likelihood of stabilization in the capital market and economic environment, locally and globally. However, negative ratings actions could still exceed positive actions over the next 12 months until the wider microenvironment improves substantially. Our negative bias (defined as the ratio of entities listed on CreditWatch Negative or with a negative outlook to total ratings) for the corporate and financial services ratings pool remained a high 19% in December 2009, though this figure is lower than the peak of 23% at the end of June 2009. At the same time, our positive bias gradually rose to 5% in December 2009. Taiwanese entities, especially financial institutions, are likely to continue to experience stress on their profitability, asset quality, and capitalization under current economic conditions (see chart 2).

In the corporate sector, downgrades dominated rating actions in 2009, due to the effect of the continuing global recession on rated entities' performance (see tables 1 and 2). The ten downgrades we made included the steel, petrochemical, transportation, and high-tech sectors. Similarly, we made downward outlook revisions or made CreditWatch placements on three credits, one each in the steel, chemical, and transportation sectors. However, we raised the outlook or removed the CreditWatch status on three corporate credits to reflect our view that the issuers concerned were experiencing credit improvement, which may signal an impending credit recovery.

The financial sector continued to experience negative rating action (including ratings and outlook changes) in the beginning of 2009 under the tough operating environment characterized by sluggish economic growth, low interest rate environment, and continued global financial market volatility. This followed the negative ratings movement since September 2008 when the global financial dislocation began. The downward pressure on ratings has gradually eased since the second half of 2009, when the global and local markets observed the seeds of a likely economic recovery. The potential for upward ratings actions, however, remained limited, and there were no ratings upgrades in 2009.

In the structured finance sector, 2009 featured diverse ratings performance among different asset sectors. CBO transactions with high exposure to foreign corporate and structured finance debts suffered from further deterioration in their underlying credits, while other transactions showed resilience despite the ongoing financial and economic disturbance. Throughout the year, Taiwan Ratings lowered its ratings on nine tranches, all of them from CBO transactions, and upgraded two tranches. Most negative rating actions occurred in the first half of 2009, but more recently we have observed some stabilization in transaction performances after the credit deterioration slowed down. Structured finance investors and originators in Taiwan have stayed on the sideline amid the global turmoil, and there were no new transactions in Taiwan's securitization market in 2009.

The credit quality of fixed-income funds remained stable despite the disruption to financial markets in 2009, partly thanks to the Taiwan government's policy measures to fully guarantee the nation's bank deposits, as well as the transformation of many funds into quasi-money market funds, which have very high liquidity.

CORPORATE SECTOR
Negative rating actions continued to outnumber positive ones

Downgrades have outnumbered upgrades in the corporate sector for two consecutive years, and the ratio of downgrades to upgrades widened to 10 times (x) in 2009 from 1.25x in 2008. In the corporate sector, Taiwan Ratings lowered the ratings on ten credits and raised the ratings on only one, while the overall sector saw balanced outlook revisions, with three downward and three upward.

On May 6, 2009, we lowered our ratings on the Formosa Plastics group (FP group), including Formosa Plastics Corp., Nan Ya Plastics Corp., Formosa Chemicals & Fibre Corp., Formosa Petrochemical Corp., and Mai-Liao Power Corp., an independent power producer that is nearly 100% owned and operated by the FP group. The rating actions reflect the weakened financial risk profiles of the four core companies of the FP group due to the severe industry downturn and the likelihood that weak market conditions will continue to weigh down on the group's profitability and cash flow protection measures over the next two years.

On May 20, 2009, we lowered our issuer rating on Neo Solar Power Corp. (NSP), a small solar cell manufacturer. The rating action reflected the growing risk that the issuer's weakened profitability and cash flow protection measures amid the sharp industry downturn are likely to weaken NSP's credit metrics over the next one year, as we do not anticipate a rapid industry recovery.

On Nov. 13, 2009, we lowered our issue rating on Taiwan High Speed Rail Corp.'s (THSRC) US$300 million unsecured convertible bond. The downgrade reflects the rising risks that THSRC will not be able to fulfill the early redemption requirement on the rated bond in May 2010, as well as the high uncertainties surrounding the corporation's refinancing plan.

On June 25, 2009, we raised our ratings on Ho-Ping Power Co., to reflect our expectation that the power supplier is likely to further reduce its leverage through stable cash flow generation.

Upward revisions to outlooks or CreditWatch status reflect signs of improvement
We made upward revisions to the outlooks or CreditWatch status on two technology issuers (one panel maker and one electronics manufacturing service) and one construction company. We placed the rating on Chi Mei Optoelectronics Corp. on CreditWatch with positive implications due to the company's merger with Innolux Display Corp. We believe the post merger entity will have lower leverage, an enhanced business scale, and vertical integration with the Hon Hai Precision Industry Co. Ltd. group's electronics manufacturing services that will more than offset the risks of integration.

Four new issuer credit ratings assigned
Taiwan Ratings assigned four new issuer credit ratings in 2009, including Taiwan's largest corporate bond issuer, Taiwan Power Co. (Taipower). Our belief in an extremely high likelihood that the Taiwan government would provide extraordinary support if Taipower experiences financial distress underpins the ratings.

Ratings withdrawn on three issuers
Taiwan Ratings withdrew its ratings on three issuers at the companies' requests.

FINANCIAL SECTOR
Negative rating movements continue amid sluggish global and local economies

Taiwan's financial institutions, including banks, insurers, securities companies, and financial holding companies, continued to experience negative rating action in terms of ratings and outlook changes in 2009 as their credit profiles weakened under continuing economic challenges.

Downward rating actions and outlook revisions mostly occurred in the first half of 2009, as the disruption in the global financial market continued. The downward trend of rating actions gradually eased since the second half of 2009, when capital markets observed the seeds of likely economic recovery. Upward ratings actions, however, remained limited, and there we made no ratings upgrade over the past 12 months. In April 2009, we downgraded two large financial groups with leading life insurers, given the difficulties for them to maintain their capitalization and profitability under the prevailing low interest rate environment and tough economic outlook. In June 2009, we downgraded a number of banks or applied a negative rating outlook due to the institutions' poor financial performance and the risk of higher potential credit costs if the economy did not improve.

Downgrades dominated rating actions in 2009 due to unfavorable credit conditions
Taiwan Ratings lowered its credit ratings on 17 financial institutions during 2009, the highest number of downgrades seen over the past five years. There were no upgrades in 2009. The ratings on Land Bank of Taiwan was lowered to reflect that there is a much reduced likelihood for it to merge with Bank Of Taiwan under the evolving regulatory and political environment in Taiwan.

The downgrade on Citigroup Global Markets Taiwan Securities Co. Ltd., Citibank Securities (Taiwan) Ltd. and Morgan Stanley Taiwan Ltd. reflects the deterioration in the standalone credit profile of the entities' US-based parent group and consequently on the weakened level of support we expect the group to provide to these subsidies.

The downgrade on Capital Securities Corp. reflects the company's weakened capitalization, which we believe will constrain its future business growth or geographic diversification.

The downgrade on Aegon Life Insurance (Taiwan) Ltd. reflects the heightened risks on the insurer's business profile and financial flexibility following the announcement by Netherlands-based Aegon N.V. (rated A-/Negative/A-2 by Standard & Poor's Ratings Services) that it has reached an agreement with the Taiwan-based holding company, Zonghwei (not rated), to sell Aegon Life (Taiwan).

The downgrades on Cathay Financial Holding Co. Ltd. (Cathay FHC) and Shin Kong Financial Holding Co. Ltd. (Shin Kong FHC) including the ratings on their core subsidiaries, reflect our view that these groups' profitability and capitalization are unlikely to recover to their previously good level over the next few quarters, given the weak economic outlook and a prevailing low interest rate environment.

The downgrade on Sunny Bank reflects the difficulties that it faces to improve its weakening core earnings capability in the coming one to two years given its weakening market position and a likely increase in credit costs.

The downgrade on Bank of Kaohsiung reflects the erosion of the bank's core earning power, which is unlikely to restore to previous levels over the next two years given the bank's business profile with lower profit margins, slowing business momentum, and a likely increase in credit costs under the current economic downturn.

The downgrade of Bank of Panhsin reflects our expectation that the bank's weakening profitability is unlikely to improve in the coming one to two years given its small market position with a mediocre franchise. In addition, a potential increase in credit costs is likely to add further strain on the bank's profitability.

The downgrade of Cosmos Bank reflects the deterioration of the bank's earnings capability and the potential surge in credit cost over the coming two years, which could weaken the bank's capitalization

Global market disruption and economic slowdown resulted in downward outlook revisions
Outlook revisions at the beginning of 2009 were mostly negative and mainly due to our expectation that certain financial groups will face obstacles to stabilize their operating performance and restore their capitalization during the sluggish global and local economic outlook. We revised the outlooks on quite a few small or mid-sized banks to negative in June 2009, reflecting our concerns that the weakening profitability of these banks will come under further stress over the coming two years given their deteriorated core earning capabilities under weak economic conditions as well as a potential increase in credit costs.

Signs of the global capital market gradually stabilizing that indicated a likely stabilizing global economic outlook since the second half of 2009, led us to revise some of the negative outlooks on financial institutions back to stable if we expected the rated entities to be able to alleviate the earlier uncertainties we had over their weakening operating performance and capitalization. However, only the ratings on three financial institutions have positive outlooks including Capital Securities Corp. and EnTie Securities Finance Co. Ltd., which have demonstrated strengthening capitalization following the announcement of their merger. In addition, the positive outlook on Union Bills Finance Co. Ltd. reflects the likelihood that it will merge into the financially stronger entity, Union Bank of Taiwan.

Three new issuer ratings assigned and eight withdrawals
Taiwan Ratings assigned three new ratings and withdrew five existing ratings on financial institutions in 2009. New ratings were assigned to Taishin International Bank Co. Ltd., Taishin Financial Holding Co. Ltd., and Chang Hwa Commercial Bank Ltd.

The rating withdrawal on Dah Chang Securities Co. Ltd., AEGON Life Insurance (Taiwan) Inc., Morgan Stanley Taiwan Ltd., Chinfon Commercial Bank Co. Ltd., First Financial Holding Co. Ltd., First Securities Inc., and King's Town Bank were at the request of the issuers. The rating withdrawal on Fubon Life Assurance Co. Ltd. was following the insurer's formal merger with ING Life Insurance Co. Ltd. on June 1, 2009.

As of Dec. 25, 2009, the ratings on two financial institutions are on CreditWatch with negative implications--Chinatrust Commercial Bank and Chinatrust Financial Holding Co. Ltd.

STRUCTURED FINANCE SECTOR
2009 saw mixed rating performance across asset sectors and a continued standstill in new deal activity

Taiwan Ratings observed mixed rating performance for domestic structured finance transactions in 2009. The continued deterioration of global corporate credit and structured finance performance weighed some domestic CBO transactions, on which we lowered ratings or placed ratings on CreditWatch. Conversely, domestic collateralized loan obligations (CLO), real estate mortgage-backed securities (RMBS), real estate asset transactions (REAT), and asset-backed securities (ABS) transactions sailed through the impact of the global and local economic downturn, and maintained stable ratings in 2009.

Despite this difference, it appears that investors previously hurt in their structured finance positions are reluctant to review any new offerings, and effectively shut off the primary market throughout 2009, the first zero-transaction year since the market began in 2003.

Ratings assignment

• On Sept. 23, 2009, we assigned ratings on the Class A, Class B, and Class C trust beneficial certificates issued by Shin Kong Life Insurance Tun Hwa Building Real Estate Asset Trust, which closed in June 2005.

Limited ratings upgrades
Ratings upgrades were limited in 2009 as Taiwan's economy dipped into recession and asset performance showed more negative movements. As of Dec. 25, 2009, we had upgraded our ratings on two trust beneficial tranches from one transaction. The upgrade happened in the CLO sector, where steady repayment of assets contributed to quick accumulation of credit enhancement.

On Nov. 11, 2009, we raised our ratings on the Class D and Class E beneficial certificates issued by Chinatrust Commercial Bank Collateralized Loan Obligation 2006-1 Special Purpose Trust (CTCB CLO 2006-1).

CBO transactions recorded multiple ratings downgrades
Taiwan Ratings made 29 downgrade actions on various tranches of two transactions from the onset of 2009 to Dec. 25, 2009. These transactions were CBO deals collateralized by off-shore synthetic collateralized debt obligations (CDO), and our rating actions related to the negative evolution of the underlying assets' credit quality. Most actions happened in the first half of 2009, and there have been signs of stabilization in recent months, as the speed of credit deterioration in global corporate credits slowed down. Whether this stabilization trend can be sustained will be critical to the transaction performance going forward.

• On December 24, 2009, we lowered our ratings on the Class C and Class D notes issued through Industrial Bank of Taiwan Collateralized Bond Obligation 2005-1 (IBT CBO 2005-1).
  
• On August 26, 2009, we lowered our ratings on the Class A-2, B, and C notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).
  
• On July 21, 2009, we lowered our ratings on the Class A-1, A-2, B, C, and D notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).
  
• On June 4, 2009, we lowered our ratings on the Class A-1, A-2, B, C, and D notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).
  
• On May 27, 2009, we lowered our ratings on the Class A and Class B notes issued through Industrial Bank of Taiwan Collateralized Bond Obligation 2005-1 (IBT CBO 2005-1).
  
• On April 21, 2009, we lowered our ratings on the Class B, C, and D notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).
  
• On March 20, 2009, we lowered our ratings on the Class A-2, B, C, and D notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).
  
• On Feb. 19, 2009, we lowered our ratings on the Class C and Class D notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).
  
• On Jan. 15, 2009, we lowered our ratings on the Class A-2, B, and C notes issued by Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1 (Polaris Sec. & BOOC CBO 2006-1).

Ratings on CreditWatch
As of Dec. 25 2009, no structured finance ratings are on CreditWatch status.

FIXED-INCOME FUNDS SECTOR
11 new ratings assigned on increasing investor demand; no rating changes/withdrawals
Taiwan Ratings expanded its rating coverage on fixed-income fund ratings in 2009 following a wave of activity to consolidate funds. In our view, rated domestic fixed-income funds have demonstrated very stable credit quality after the funds transformed into quasi-money market funds, which tend to maintain very high liquidity and generally strong portfolio credit quality.

Still a tough credit environment in 2010
Currently the rating pool rated by Taiwan Ratings still indicates higher negative bias than positive bias, which implies there may be more negative than positive rating actions in the coming year. However, we do not expect rated entities to face the same degree of operating difficulty in 2010 as they did in 2009. Combined with the likelihood of a gradual stabilization in the capital market and economy, locally and globally, this indicates that ratings are likely to come under less pressure in 2010.

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Note: Ratings stated are correct as of Dec. 25, 2009.