Ratings Roundup Report: Creditworthiness Has Stabilized But The Unsettled Economy Remains A Key Risk Factor In 2011

2010/12/30

 

Primary Analyst:	Raymond Hsu, CFA; (886) 2 8722-5827, raymond_hsu@taiwanratings.com.tw
	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

Taiwan's corporate and financial sectors strengthened their operating performance much faster than our expectation, due mostly to strong export restoration under the stabilizing global economy as well as greater stability in the domestic financial market. Accordingly, the creditworthiness of Taiwan Ratings' rated population stabilized over the past few quarters, evidenced by the higher number of rating upgrades to downgrades as well as the number of upward outlook revisions over the past 12 months that returned most negative rating outlooks back to stable (see chart 1, chart 2, table 1 and table 2). However, we expect a moderate degree of ratings volatility to remain across our rated pool in view of the still bumpy global economic recovery and the highly competitive operating environment in Taiwan.

In Taiwan's corporate and financial sectors, the total number of issuer rating upgrades exceeded downgrades in 2010 for the first time in three years, due mostly to stabilizing macroeconomic conditions, with eight upgrades against four downgrades (see table 1). Despite the improvement, the recovery in the credit profiles of the corporate and financial sectors came only gradually over the past 12 months, compared with a more condensed 27 downgrades in 2009. Unlike the developments that year, Taiwan's financial sector and the corporate sector improved at a similar pace in 2010, with both sectors each experiencing single-digit upgrades and downgrades. The structured finance market also experienced similar improvement in 2010 with ten upgrades against four downgrades in 2010, compared with 29 downgrades and 2 upgrades in 2009 (see table 3).

Taiwan Ratings expects the rating performance of its rated pool in 2011 to continue to exhibit a mild degree of improvement, as the global economy continues its uneven pace of recovery. Meanwhile, credit provision costs are likely to continue to decline in Taiwan's financial markets, and credit spreads stabilize. Nonetheless, further improvement is likely to be limited in the near term, particularly for the financial sector, due to significant obstacles brought by the competitive environment. Resultantly, as at Dec. 24, 2010, Taiwan Ratings' rated pool in the corporate and financial sectors only carried a limited number of positive bias--defined as defined as the ratio of entities listed on CreditWatch Positive or with a positive outlook to total ratings (see chart 2).

In our opinion, the corporate sector is likely to experience faster improvement in credit quality than the financial sector, as it receives more direct benefits from the recovering global economy. In the corporate sector, positive rating actions dominated in 2010, as the global recovery in demand for products from petrochemical, transportation, high-tech, and automotive sectors significantly improved the profitability and cash flow of those sectors. In addition, we expect more positive rating actions in the corporate sector in 2011, given our expectation of sustained profitability and cash flow over the next 12 months.

In our view, the local financial sector will maintain its stable credit matrix, benefiting from the stable and benign credit environment. However, we expect the number of upgrades to be limited in 2011, due to the sector's very thin profitability under the very competitive environment. Following a period of generally negative outlook revisions in 2009, we made a high number of upward outlook revisions in the financial sector in 2010. These revisions were mostly from to stable from negative as a result of the stabilizing domestic capital market, lower credit losses and the moderate pace of gradual upward interest rate movement in Taiwan. Upgrades in the financial sector also exceeded downgrades in 2010, following a significant number of downgrades in 2009. However, the improvement in the credit profiles of rated financial entities remained tepid and most of the upgrades we made were to reflect the impact of merger and acquisition activity, or the improved credit factors of parent companies instead of a substantial enhancement in the rated entities' stand alone credit profiles.

In the structured finance sector, we expect to see at least stability if not further improvement in 2011, following a somewhat calm year in 2010 when the impact of the global financial market dislocation faded and the sequential pay out of rated notes' underlying assets. Negative ratings actions related to collateralized bond obligation (CBO) transactions with a high exposure to foreign corporate and structured finance debts largely came to an end over the past 12 months along with the stabilizing global financial market. Taiwan Ratings lowered its ratings on 2 tranches, both of them from Industrial Bank of Taiwan CBO 2005-1, and upgraded 10 tranches in one ABS, one CLO, one CBO, and one RMBS transaction in 2010.

The credit quality of rated fixed-income funds remained stable in 2010, despite the disruption to financial markets, partly as a result of 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. However, the end of the government's full guarantee on the nation's bank deposits at the end of 2010, in our opinion, is likely to cause rated fixed-income funds to tighten up their credit risk policy due to heightened credit risk going forward.

CORPORATE RATINGS
Positive rating actions outnumbered negative ones
In 2010, upgrades outnumbered downgrades in the corporate sector for the first time in three years. The ratio of downgrades to upgrades narrowed to 0.67x for the past year, down from 10x in 2009. In the corporate sector, Taiwan Ratings raised the ratings on three credits and lowered the ratings on two:

On May 18, 2010, we raised our issue rating on Taiwan High Speed Rail Corp.'s (THSRC) US$300 million unsecured convertible bond due May 2012 based on the company's improved liquidity. The rating action reflects our expectation that THSRC's improved liquidity now that a debt-refinancing plan has been implemented will support the company's ability to fulfill its financial obligation on the convertible bond.

On Aug. 24, 2010, we raised our long-term corporate credit rating on Taiwan-based J Touch Corp. The upgrade reflects our view that the full conversion of J Touch's Taiwan dollar (NT$) 660 million convertible bond, a NT$855 million new equity injection, and recent stabilization in J Touch's profitability have strengthened the company's leverage and cash flow protection measures.

On Nov. 26, 2010, we raised our long-term corporate credit rating on Taiwan-based China Airlines Ltd. (CAL). The upgrade reflects our view that a recovering economy and growing direct flights between China and Taiwan will continue to support CAL's profitability and enable the company to further strengthen its leverage and cash flow protection measures, despite the risk of rising oil prices in 2011.

On Feb. 9, 2010, we lowered our corporate credit ratings on Gallop Number One Real Estate Investment Trust (Gallop No. 1 REIT). The rating action reflects the REIT's weakened profitability due to a lower-than-expected occupancy rate in the trust's CTCI Building and Honeywell Information Building. We believe the trust is unlikely to restore its profitability to the previous level over the next 12 months.

On June 22, 2010, we lowered our long-term corporate credit rating on Kee Tai Star Real Estate Investment Trust (Kee Tai Star REIT). The downgrade reflects the REIT's further weakening profitability due to a 25% rental cut in its renewed lease contract with the City Lake Hotel that became effective on Feb. 1, 2010. The rental cut was the second in 13 months, and follows from a 20% reduction on Jan. 1, 2009, due to the hotel's poor operating results.

The improvement in credit profiles is likely to continue over the next several quarters
Upward outlook revisions also outpaced downward ones in 2010, as we made upward revisions to the outlooks on ten issuers, including three in the transportation sector, four in the high tech sector, and one each in the auto finance, petrochemical, and food & beverage sectors. We removed the rating on Chi Mei Optoelectronics Corp. from CreditWatch with positive implications due to our view that the synergy associated with the company's merger with Innolux Corp. and TPO Displays Corp. will not materialize as soon as we had previously expected. As at Dec. 25, 2010, five ratings or 11.1% of our rated pool in the corporate sector carry positive outlooks with no negative outlooks.

Three new issuer credit ratings assigned
Taiwan Ratings assigned three new issuer credit ratings in 2010, including Chimei Innolux Corp., the post-merger entity resulting from the merger of Innolux Display Corp., Chi Mei Corp. and TPO Displays Corp. The other new issuer ratings were on USI Corp.--a major petrochemical group in Taiwan--and Dragon Steel Corp., which is a wholly owned subsidiary of China Steel Corp. (twAA+/Stable/twA-1). Our ratings on Dragon Steel Corp. reflect the high likelihood that China Steel will provide necessary support to maintain Dragon Steel's financial viability due to Dragon Steel's strategic role in China Steel's future growth plans and its increasing integration with China Steel's operations.

Ratings withdrawn on four issuers
Taiwan Ratings withdrew its ratings on three issuers at the request of the companies. The withdrawal of the ratings on Chi Mei Optoelectronics Corp. was a result of its merger with Innolux Display Corp.

FINANCIAL SERVICE RATINGS
Credit profiles stabilized amid rising interest rates, lower credit charges, and a stable capital market
Taiwan's financial institutions, including banks, insurers, securities companies, and financial holding companies experienced positive credit evolution in terms of ratings and outlook changes in 2010, under the stabilizing domestic and global financial markets. However, the improvement in the credit profiles of Taiwanese financial institutions was still tepid in 2010 and the upgrades were mostly driven by merger and acquisition activity or the improved credit factors of the rated entities' parents who provide them with implicit support. There were five upgrades compared with two downgrades in 2010.

On March 1, 2010, we raised our long-term and short-term counterparty credit ratings on EnTie Securities Finance Co. Ltd. (EnTie SFC). The rating action brings the ratings on EnTie SFC into line with those on Capital Securities Co. Ltd. (twA/Stable/twA-1), which acquired the company in 2010.

On June 23, 2010, we raised our long-term and short-term counterparty credit rating on Capital Securities Co. Ltd. The rating actions mainly reflect our view that Capital Securities has strengthened its capitalization and demonstrated a good track record of risk management over recent quarters. We expect these efforts to help the company solidify its business position and competitiveness in Taiwan's highly competitive securities market.

On Aug. 13, 2010, we raised our long-term and short-term counterparty credit ratings on Union Bills Finance Co. Ltd. The rating action brings the ratings on Union BFC in line with those on Union Bank of Taiwan (UBOT; twA-/Negative/twA-2), to reflect the bills finance company's merger with UBOT on Aug. 15, 2010.

On Dec. 17, 2010, we raised the ratings on Citibank Securities (Taiwan) Ltd. and Citigroup Global Market Taiwan Securities--reflecting the upgrade of the stand alone credit profile of their respective parents--due to the core status of these two Taiwanese subsidiaries.

On April 20, 2010, we lowered our insurer financial strength and counterparty credit ratings on Metlife Taiwan Insurance Co. Ltd. The rating action reflects our view that Metlife Taiwan's business risk profile and financial flexibility face higher risks following the announcement by U.S.-based Metlife Inc. (rated A-/ Negative/A-2 by Standard & Poor's Ratings Services) that it has reached an agreement to sell Metlife Taiwan to Taiwan-based Waterland Financial Holding Co. Ltd. (not rated). However, Taiwan's regulator later rejected the transaction.

On Oct. 22, 2010, we lowered our insurer financial strength rating and counterparty credit rating on Fubon Insurance Co. Ltd. The downgrade reflects our expectation that the company's obligation to support other weaker group members and to share resources will grow over the next two to three years. In addition, integration between the insurer and the parent group has increased in terms of operation control, investment strategy, market risk management, and cross selling. We believe that as a core entity of the Fubon Financial Holding Co. Ltd. (insert ratings) group, Fubon Insurance will continue to follow the group's strategic direction to strengthen integration amongst group members.

The outlook on most rated financial institutions is stable
Outlook revisions in 2010 were mostly upward and this mainly reflects our view that a continued economic recovery will bring a more stable operating environment for the island's financial sector. In addition, we observed financial institutions' declining credit provision costs over the past 12 months, due in most part to Taiwan's general economic recovery as well as the Taiwan government's corporate loan restructuring scheme that began in late 2008. We made 19 upward outlook revisions in 2010, on nine banks, three each on securities firms, insurance, and financial holding companies, and on one leasing company.

However, we believe that rapid credit improvement in Taiwan's financial sector is not on the horizon, due to still-low interest rates and credit spreads under a very competitive environment (see chart 3). Notably, the upward outlook revisions in 2010 were mainly to bring the originally negative outlooks back to stable, rather than indicating a strong likelihood of significant improvement in the rated entities' credit profiles. As at Dec. 25, 2010, only two ratings or just 2.5% in Taiwan Ratings' rating population in the financial sector carried positive outlooks, compared with two negative outlooks. The positive outlook on Sunny Bank reflects our view that the bank is likely to maintain its current core earning power with manageable credit costs over the coming 12 months. The positive outlook on Tokio Marine Newa Insurance reflects our expectation that the insurer's overall credit profile could improve over the coming one to two years, following the recent improvement in its competitive position.

By contrast, the negative outlook on Union Bank of Taiwan reflects our continued concern on the bank's capacity to restore a satisfactory core earnings profile commensurate with its current ratings in the next one to two years. Also the negative outlook on Chartis Taiwan Insurance reflects the outlook direction of the AIG group, as the ratings on Chartis Taiwan have in the past moved in tandem with the ratings on the AIG group's property/casualty companies, given the insurer's strategic importance to the group.

Two new issuer ratings assigned and five withdrawals
Taiwan Ratings assigned two new ratings and withdrew five existing ratings on financial institutions in 2010. The new ratings were assigned to HSBC Bank (Taiwan) Ltd. and E.SUN Financial Holding Co. Ltd.

The rating withdrawals on EnTie Commercial Bank, Fubon Securities Finance Co. Ltd., and First-Aviva Life Insurance Co. Ltd., were at the request of the issuers. The rating withdrawals on Union Bills Finance Co. Ltd. and EnTie Securities Finance Co. Ltd. were made following their mergers with Union Bank of Taiwan on Aug. 16, 2010 and EnTie Commercial Bank on March 1, 2010, respectively.

As of Dec. 25, 2010, the rating on one financial institution remained on CreditWatch with developing implications--MetLife Taiwan Insurance Co. Ltd.--due to our concern over the insurer's credit profile as a result of a potential shareholder change, which we believe could affect the company's business and financial profiles.

STRUCTURED FINANCE RATINGS
The impact of global financial market dislocation on securities ratings slowly faded in 2010
The deterioration of structured finance securities largely came to an end in 2010, with upgrades and affirmations on Taiwan structured finance transactions outnumbering downgrades this year, compared with understatedly negative rating action in 2009. In addition, the stabilizing domestic financial market and recovering local economy support our expectation for the continued performance of rated transaction assets over the coming few quarters, and the gradual return of momentum in the domestic structured finance market next year. In 2010, the four downgrades we made were all on the Class A and B notes issued by Industrial Bank of Taiwan Collateralized Bond Obligation 2005-1 (IBT CBO 2005-1), which was affected by the deterioration of underlying synthetic collateralized debt obligations (SCDO) linked to foreign corporations.

Domestic collateralized loan obligation (CLO), residential mortgage-backed securities (RMBS), real estate asset trust (REAT), asset-backed securities (ABS), and some collateralized bond obligation (CBO) transactions maintained their stable performance and resultantly stable or upward ratings movement in 2010. Despite the stabilizing performance of structured finance products, it appears that investors previously hurt in their structured finance positions are not ready to participate in new offerings soon, and the market remained inactive throughout 2010 with only one ABS transaction closed.

Ratings assignment

• On March 15, 2010, we assigned our ratings to the Class B certificates issued by Jih Sun Securities Co. Ltd. 2007-1 Collateralized Bond Obligation Special Purpose Trust. The transaction is backed by a number of Taiwan dollar (NT$) denominated bonds and USD denominated credit-linked notes. The transaction was closed on July 10, 2007.
  
• On Aug. 13, 2010, we assigned our ratings to the Class A and Class B certificates of a lease and installment backed securitization transaction originated by Chailease Finance Co. Ltd. (twA/Stable/twA-2).
  

Ratings upgrades resumed pace over the past 12 months
Ratings upgrades increased in 2010, and Taiwan's stabilizing economy and asset performance is likely to support further credit improvement over the next few quarters, in our view. The upgrades involved all sectors, including CLO, ABS, CBO, and RMBS transactions. These transactions have benefitted from the steady repayment of assets that contributed to the quick accumulation of credit enhancement, as well as to positive creditworthiness migration in the underlying portfolios.

• On March 17, 2010, we raised our rating on the Class 4 senior beneficial certificates issued by Industrial Bank of Taiwan Corporate Loan Securitization Special Purpose Trust 2006-1 (IBT CLO 2006-1). The rating action reflects the certificates' increased credit enhancement level against the credit risk they are exposed to.
  
• On July 14, 2010, we raised our ratings on the Class A-1, 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). The rating actions reflect the portfolio's improved credit quality due to the positive rating migration in the reference portfolio of the transaction's underlying USD SCDO.
  
• On Sept. 15, 2010, we raised our ratings on the Class C notes issued by Capital Securities Corp. Collateralized Bond Obligation 2006-1 (Capital Securities CBO 2006-1). The rating action reflects the stable performance of the transaction's underlying portfolio and the improvement on the underlying pool's credit profile due to the repayment of underlying Taiwan dollar denominated bonds.
  
• On Nov. 12, 2010, we raised our ratings on the Class B notes issued by Chailease 2007 Securitization Special Purpose Trust (Chailease ABS 2007-1). The rating upgrades reflect the increased coverage on the expected collateral credit loss for the rated notes. This coverage improvement is a result of the increased credit enhancement level versus the stable performance of underlying receivables and the realized recovery on defaulted receivables.
  
• On Dec. 17, 2010, we raised our ratings on the Class B, C, and D notes issued by Chinatrust Commercial Bank RMBS 2004-A Special Purpose Trust (CTCB RMBS 2004-A). The rating upgrades reflect the increased credit enhancement levels for the rated notes under respective rating scenarios, which are attributed to the sequential repayment of issued notes and improved mortgage pool characteristics.

Downgrades on CBO transactions decreased substantially
Taiwan Ratings took two downgrade actions on the same tranches of Industrial Bank of Taiwan Collateralized Bond Obligation 2005-1 (IBT CBO 2005-1) between the start of 2010 and Dec. 25, 2010. The transaction was collateralized by an offshore SCDO, and our rating action was related to the negative evolution of the underlying assets' credit quality.

• On April 28, we lowered our ratings on the Class A and B notes issued by Industrial Bank of Taiwan Collateralized Bond Obligation 2005-1 (IBT CBO 2005-1). The rating action reflects the impact of specific credit events on certain reference entities in the two underlying US dollar SCDO assets of the transaction.
  
• On Sept. 27, 2010, we subsequently downgraded the abovementioned securities to 'D (sf)' due to the failure of the IBT CBO 2005-1 to make full interest payment to the Class A and B notes according to their stated coupons in the issuing documents.
  

Ratings on CreditWatch
As of Dec. 25 2010, no structured finance ratings were on CreditWatch.

FIXED-INCOME FUND RATINGS
Credit risk will rise following the expiration of the government's full guarantee on bank deposits
In our view, rated domestic fixed-income funds have demonstrated stable credit quality after the funds transformed into quasi-money market funds in 2007--such funds tend to maintain very high liquidity and generally strong portfolio credit quality. The government's continued full guarantee on bank deposits has also somehow protected fixed-income funds from credit losses in 2009-2010. In addition, the transformation of rated funds into money market funds at the end of 2010 will further shorten the duration and strengthen the liquidity of the funds, in our view. However, we expect some rated funds to adjust their portfolio to protect them from rising credit risk after the expiration of the government's full guarantee on bank deposits at the end of 2010. Taiwan Ratings added no new ratings in 2010 but withdrew two ratings at the funds' requests during the same period.

DEFAULT EXPERIENCE IN THE CORPORATE, FINANCIAL, AND STRUCTURED FINANCE SECTORS
Defaults are likely to remain rare in the corporate and financial sectors in 2011
Our rated pool in the corporate and financial sector continued to record no defaults in 2010, the same as in 2009, reflecting generally stabilizing creditworthiness, the effect of our small ratings pool, the Taiwan government's efforts in maintaining the stability of the domestic financial system, and the adequate access of non-financial corporations to liquidity. In addition, we expect that defaults in the corporate and financial sectors will remain relatively rare in 2011, given the improving market conditions and stable financial markets.

Defaults of structured finance ratings may decline in 2011
Our rating pool in the structured finance sector experienced two defaults in 2010--the Class A and B notes issued by Industrial Bank of Taiwan Collateralized Bond Obligation 2005-1 (IBT CBO 2005-1). In 2009, the Class C and D notes issued by IBT CBO 2005-1 defaulted. These four are the only defaults among the 90 ratings that Taiwan Ratings has assigned to structured finance instruments since 2003. We expect that defaults in 2011 may decline further given our expectation that transaction asset performance will remain largely unchanged as the impact of recent global financial dislocation continues to fade.

2011 TO BE CHARACTERIZED BY CAUTIOUS OPTIMISM DESPITE THE POTENTIAL FOR FURTHER RATINGS VOLATILITY
We are cautiously optimistic about the credit evolution of Taiwan Ratings' rated population, including the corporate, financial and structured finance ratings in 2011, in view of the recovering, albeit still unsettled, global and domestic economies, as well as the stabilizing financial markets. Our currently moderate positive rating bias in the corporate and financial sectors, suggests the possibility of more positive than negative rating actions in the coming year. In addition, we expect the continuation of the current transaction asset performance to enhance the rating performance of Taiwan Ratings' structure finance rating pool over the next few quarters.
However, we believe that any improvement, particularly in the financial sector, will not be speedy due to significant obstacles in the operating environment, including thin credit spread, a low interest rate, and very intense competition. We also believe that some adverse developments such as rising production costs in China, the appreciation of the Taiwan dollar, and volatile commodity prices may continue to cause volatility in the operating performance and therefore the credit quality of the corporate sector in Taiwan Ratings' rated population. In addition, with their asset performance highly correlated to the performance of the corporate and financial sectors, structured finance and fixed-income fund ratings are mostly likely to face continuing volatility, albeit to a lesser extent, in our view.
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Note: Ratings stated are correct as of Dec. 24, 2010.