Ratings Roundup Report For 2011 And Outlook For 2012: Pressure To Maintain Stable Credit Profiles Will Rise In 2012, Particularly For The Corporate Sector

2011/12/29

Taiwan Ratings Corp. expects the improvement in the overall credit quality of its rated pool since late 2009 to halt in the coming few quarters amid heightening concerns over the slowing global economy. We expect the likely deterioration in economic activity and rising capital market volatility to weaken the operating performance of Taiwan's corporate and financial sectors in 2012.

Weaker-than-expected demand or a longer-than-expected economic downturn could add further pressure to the credit quality of Taiwan Ratings' rated population, particularly in the corporate sector. In our view, local corporations are likely to experience greater downward pressure on their credit profiles over the next four quarters due to the heavy reliance of Taiwan's export-oriented economy on external demand. This is also evidence by the higher negative bias in rated corporate issuers than in other sectors. We also expect the operating performances of the local financial sector to be increasingly volatile in 2012, particularly for the life insurance sector amid ongoing global capital market volatility. That said, we expect a stable or slightly positive performance trend for rated transactions in the structured finance sector, supported by transactions' seasoned asset pools.

However, we believe that a relatively stable domestic financial system is likely to prevent as sharp and deep a deterioration in the credit quality of our rated population as that which occurred in 2008 and early 2009. At that time, the Taiwan economy experienced a sharp correction and decline in export activities with negative 1.8% GDP growth in 2009. Nonetheless, according to Standard & Poor's Ratings Services estimation, Taiwan's GDP is likely to grow 2.3%-2.8% in 2012 (please see "Growing Global Risks Eclipse Asia-Pacific Economic Growth In 2012" published on www.globalcreditportal.com on Dec.16, 2011). Moreover, we expect market confidence to remain stable in 2012, backed by good market liquidity and the Taiwan government's track record supporting local corporate and financial sectors during economic downturns.

The gradual slowdown in the macro economy in the latter half of 2011 resulted in negative rating actions (including rating downgrades and negative outlook revisions) outpacing positive actions in the second half of the year. This was particularly true in the fourth quarter if excluding the rating actions relating to the recent implementation of Standard & Poor's revised bank criteria (see charts 1 and 2 and tables 1 and 2). In addition, most of the negative rating actions were in the corporate sector, reflecting the greater impact of recent economic turmoil on the credit quality of the corporate sector than the financial sector.

In Taiwan's corporate and financial sectors, the total number of issuer upgrades exceeded downgrades in full-year 2011, with 15 upgrades against eight downgrades (see table 1). Excluding the rating adjustments from the implementation of the revised bank criteria, which happened in late November to mid December 2011, there were six upgrades against three downgrades. However, most of the upgrades occurred in the first half of 2011, while downgrades came mostly in the second half (excluding the one-off bank criteria adjustment). Similarly, the structured finance market also showed more positive rating actions in 2011 with six upgrades against two downgrades.

In addition, the growing negative bias in Taiwan Ratings' rated pool in the second half of 2011 reflects growing pressures on the credit quality, particularly of rated corporate entities, amid a deteriorating economic outlook. At the end of June 2011, there was a 12% positive bias--defined as the ratio of entities listed on CreditWatch Positive or with a positive outlook to total ratings--in Taiwan Ratings' rated pool in the corporate and financial sectors had and no negative bias. The negative bias, however, surged to 9%, while the positive bias dipped slightly to 9% as of Dec. 23, 2011. The negative bias came mostly from the corporate sector, while positive bias largely centered on the financial sector, largely driven by group association or the effect of mergers and acquisitions. We expect the negative bias will gradually exceed positive bias for the following few quarters and accordingly to reverse the overall positive direction experienced in 2010.

In our view, the corporate sector is more susceptible to macroeconomic changes due to the heavy reliance of Taiwan's export-oriented economy on external demand. We therefore expect to see more significant deterioration in credit quality in the corporate sector than in the financial sector. This is particularly true for companies that experience highly cyclical demand, carry high leverage, and lack technology and scale competitiveness, if there is a faster or more severe-than-expected turnaround in the macro economy. Upgrades continued to slightly outnumber downgrades in Taiwan's corporate sector in 2011. However, we expect this to reverse over the next few quarters given the significant negative bias in rated corporate issuers, and the likelihood that the profitability and cash flow of rated entities will deteriorate amid the worsening economic slowdown.

We expect operating performances in the local financial sector to be increasingly volatile in 2012, reversing the upward rating development in 2011 amid slowing economic activity and ongoing volatility in the global capital market. We expect the life insurance sector to become more sensitive than other financial sub-sectors if there is an increase in market risk volatility. In 2011, we upgraded 12 financial institutions, of which nine were due adjustments under the revised bank criteria adjustments, one due to a merger and acquisition, and only two were the result of improving credit profiles. We took six downgrade actions in 2011, of which five were under the revised bank criteria adjustments and one followed the downgrade of a parent group.

Outlook revisions also showed a similar trend to rating actions with 10 upward revisions against three downward revisions. However, it should be noted that most upward revisions were made in the first half of 2011 and half of these were under the same financial holding group, reflecting the group's improved credit profile. Adjusting for the one-off effect of the revised bank criteria, the overall credit profile of Taiwan's financial sector was relatively stable in 2011.

In the structured finance sector, we expect the performance of rated transactions to buck the expected negative changes to the macro economy over the next few quarters, and maintain a stable or slightly positive trend just as we observed in 2011. The likely resilience of structured finance transactions is mostly due to their seasoned asset pools, pass-through structures that help to build up credit enhancement, and structural protection for deal amortization if the credit quality of assets deteriorates quickly. That said, we believe that the performance of structured finance transactions is still sensitive to major unforeseen economic events.

We made six ratings upgrades in structured finance in 2011, including two on collateralized bonds obligations (CBO) and four on real estate asset trust (REAT) transactions, while we downgraded two CBO tranches due to the application of revised bank criteria (see table 3).

The credit quality of rated fixed-income funds was generally stable in 2011, thanks to a stable credit environment, highly liquid portfolio, and satisfactory market confidence despite the expiration of the Taiwan government's blanket guarantee on bank deposits. We expect the credit quality of fixed-income funds to remain relatively stable in 2012, unless the creditworthiness of their underlying assets drastically deteriorates.

CORPORATE RATINGS
Positive rating actions continued to outnumber negative ones in 2011, but 2012 may see a reversal
Upgrades have marginally outnumbered downgrades in the corporate sector for the past two years. In the corporate sector, Taiwan Ratings raised the ratings on three issuers and lowered the ratings on two (see tables 4 and 5).

On April 15, 2011, we raised our long-term and short-term corporate credit ratings on Taiwan-based Wan Hai Lines Ltd. The rating action reflects our view that Wan Hai will remain profitable and prudent in its capital expenditure, enabling the company to maintain its current leverage and cash flow protection measures. Wan Hai has significantly improved these measures over the past four quarters

On May 23, 2011, we raised our long-term corporate credit and issue ratings on Taiwan-based plastics supplier Chi Mei Corp. (CMC). The upgrade reflects our expectation that CMC will continue to improve its leverage and cash flow protection measures with a sustainable operating cash flow, prudent investment strategy, and low likelihood of significant financial support for 17.26%-owned Chimei Innolux Corp. (twBBB+/Stable/twA-2).

On June 21, 2011, we raised our long-term corporate credit rating on Unimicron Technology Corp. The upgrade reflects our view that Unimicron's enhanced competitiveness will support it to maintain its superior profitability compared to its peers'. The rating action also reflects our expectation that Unimicron's disciplined capital expenditures will help to sustain its free operating cash flow and moderate leverage.

On Oct. 7, 2011, we lowered our long-term and short-term corporate credit ratings on Taiwan-based thin film transistor liquid crystal display panel maker, Chimei Innolux Corp. The downgrade reflects our view that Chimei Innolux's debt leverage will remain aggressive over the next three to four quarters. The downgrade also factors in the company's slow progress in reaping the synergy of its three-in-one merger as well as the benefits of its association with the Hon Hai Precision Industry Co. Ltd. (twAA+/Stable/twA-1+) group.

On Oct. 11, 2011, we lowered our long-term corporate credit rating on Yang Ming Marine Transport Corp. (Yangming). The downgrade reflects our view that worsening market conditions are likely to substantially weaken Yangming's profitability and cash flow below our earlier prediction, in which will further deteriorate the company's leverage over the next two to three quarters. Yangming's debt leverage has weakened markedly over the past two quarters amid a sharp industry downturn.

Rising downward outlook revisions reflect rising pressures on credit quality
Downward outlook revisions outpaced upward ones in 2011, as we revised down the outlooks on 12 issuers against two upward, revisions. The 12 downward outlook revisions included six related to the Formosa group, two in the steel sector, and four in the high-tech sector (see table 6). The two upward outlook revisions include Taiwan Mobile Co. Ltd. and Gallop Number One Real Estate Investment Trust (Gallop No.1 REIT). The positive outlook revision on Taiwan Mobile reflected its strengthened financial profile, while the upward outlook revision on Gallop No.1 REIT reflects the significant and faster-than-expected improvement in the occupancy rate for the trust's asset portfolio. As of Dec. 23, 2011, 10 ratings or 18% of our rated pool in the corporate sector carry negative outlooks while five ratings or 9% carry positive outlooks.

Two new issuer credit ratings assigned and no rating withdrawals
Taiwan Ratings assigned two new issuer credit ratings in 2011, including Godex International Co. Ltd and VTC Electronics Corp. Our rating on Godex reflects the company's small operating scale, weak global market position, limited technology resources, and high customer and product concentration. Counterbalancing factors include Godex's quality product offering, competitive cost structure, and moderate debt usage. Our rating on VTC Electronics reflects the company's small operating scale, limited global market position, increasing competition in the fragmented close circuit television market and high customer concentration. Counterbalancing factors include VTC's proven product quality, its growing surveillance service revenue from its hospital credentialing system, and its somewhat conservative debt usage.

FINANCIAL SERVICE RATINGS
Credit profiles remain stable amid lower credit charges and adequate capitalization to buffer against capital market volatility
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 2011, underpinned by a stable credit environment and their adequate capitalization. However, the improvement in individual credit profiles was tepid in 2011 and upgrades were mostly driven by institutions' recovery to pre-2008 (pre-crisis) levels, sustainably good performance, or one-shot adjustments through the application of Standard & Poor's revised bank criteria. We made 12 upgrades compared with six downgrades in 2011 (see tables 8 and 9).

On Aug. 23, 2011, we raised our long-term counterparty credit rating on Sunny Bank. The upgrade mainly reflects our view that Sunny Bank has recovered its profitability to the level before the recent global financial crisis began in 2008. In addition, we expect the bank to maintain its funding profile and asset quality at stable levels over the next one to two years.

On Oct. 3, 2011, we raised our long-term and short-term counterparty credit ratings on Polaris Securities Co. Ltd. The upgrade reflects our view that Polaris Securities' credit profile could improve now that it's a fully owned subsidiary and core member of the Yuanta Financial Holding Co. Ltd. (twA+/Positive/twA-1) group.

On Dec. 13, 2011, we raised our financial strength rating and counterparty credit ratings on Tokio Marine Newa Insurance Co. The upgrade reflects our view that Tokio Marine Newa will continue to enhance its competitive position over the next one to two years by strengthening its distribution channels while maintaining prudent underwriting controls.

In addition, we raised the ratings on nine financial institutions, including Citigroup Global Markets Taiwan Securities, Standard Chartered Bank (Taiwan) Ltd., Agricultural Bank of Taiwan, Chinatrust Commercial Bank, Taiwan Business Bank , The Shanghai Commercial & Savings Bank Ltd., Chang Hwa Commercial Bank Ltd., First Commercial Bank Ltd., and Hua Nan Commercial Bank Ltd. in late November and mid December after applying the new ratings criteria for banks and banking groups, which Standard & Poor's Ratings Services published on Nov. 9, 2011 (see table 9). The key rationale behind the rating changes focused mostly on banks' specific risk features rather than from systemic phenomena. For example, upward rating adjustments might have been attributed to stronger capitalization or the inclusion of government support for systematically important banks under the revised bank criteria.

On March 1, 2011, we lowered our counterparty credit and financial strength ratings on Chartis Taiwan Insurance Co Ltd. The downgrade action followed Standard & Poor's rating actions on the insurer's parent, Chartis group. Chartis Taiwan is a strategically-important group entity and benefits from its parent's support. The insurer's credit risk has therefore moved in tandem with the parent group's credit profile.

In addition, we lowered the ratings on five financial institutions, including China Development Industrial Bank, China Development Financial Holding Corp., Grand Cathay Securities Corp., Mega Financial Holding Co. Ltd., and Bank of Kaohsiung in late November and mid December after applying the new ratings criteria for banks and banking groups. As with the aforementioned upgrades, the key rationale behind the rating downgrades focused mostly on banks' specific risk features rather than systemic phenomena. For example, downward rating actions might have reflected the revised criteria's more conservative view on wholesale funding or higher exposures to volatile banking activities.

The relatively stable outlook on Taiwan's financial sector contrasts with that on the corporate sector
Outlook revisions in 2011 were mostly upward, reflecting the still stable credit environment and ongoing business liberalization, which would help selective players to report consistently good operating track records or improve their business diversification. Nonetheless, we believe that any further improvement in the industry's overall credit profile remains constrained by intense competition. We made 10 upward outlook revisions in 2011, involving four banks, three securities firms, one insurance company, and two financial holding companies. Five of these are under the same financial holding group (see table 10).

As of Dec. 23, 2011, only two ratings or just 2% of Taiwan Ratings' rated population in the financial sector carried negative outlooks, compared with 8% carrying positive outlooks. The negative outlook on Citibank Securities (Taiwan) Ltd. and Citigroup Global Markets Taiwan Securities mainly reflect the negative outlook on their parent group due to their "highly strategic" status to their ultimate parent group.

Seven new issuer ratings assigned and one withdrawal
Taiwan Ratings assigned seven new ratings and withdrew one existing rating on financial institutions in 2011 (see tables 11 and 12).

STRUCTURED FINANCE RATINGS
Rated transactions maintained their stable performances since 2010
Structured finance securities kept up their stable performances throughout 2011, with upgrades and affirmations on our rated structured finance transactions handsomely outnumbering downgrades. We expect this stability and slight positive rating performance to continue over the next few quarters, despite the economic slowdown and rising capital market volatility. We base this view mainly on the transactions' seasoned asset pools, which tend to deliver stable performance due to increased equity portions and lower debt service burdens. Moreover, Taiwan structured finance transactions typically employ a pass-through structure that helps build up credit enhancement when assets are subsequently paid down, or adopt asset performance triggers for deal amortization if asset quality deteriorates rapidly.

2011 saw an upbeat performance in REAT transactions due to active outright transactions and heightened prices. We upgraded four REAT notes because the high sale price of the entrusted properties ensured adequate funds to repay maturing notes. The credit quality of assets backing CBO transactions was generally stable throughout the year. We raised the ratings on two CBO tranches to reflect their increased accumulated credit enhancements.

In 2011, we also lowered our ratings on the Class A1 and A2 notes issued by Capital Securities Collateralized Bond Obligation 2006-1 (Capital Securities CBO 2006-1). The transaction was affected by the downgrade of Citigroup Inc. by Standard & Poor's due to the application of rating agency's revised bank criteria.

Despite the largely stable-to-positive performance of structured finance products and renewed investor demand in 2011, the inherent low-yield issue persisted in most Taiwan assets, which limits deal economy and discourages asset sellers to new transactions. Only one structured finance transaction was closed in 2011.

Ratings assignment
On Nov. 24, 2011, we assigned our ratings to the Class A and Class B trust beneficiary certificates issued through Chailease 2011 Securitization Special Purpose Trust. The certificates are backed by a pool of Taiwan dollar (NT$) denominated lease and installment receivables originated by Chailease Finance Co. Ltd.

Upgrades resumed pace over the past 12 months
Upgrades continued to outnumber downgrades in 2011. We made six upgrades during the year related to two CBOs and four REATs as aforementioned.

On July 18, 2011, we raised our ratings on the Class D and Class E notes issued by Standard Bank CBO 2006-1 Special Purpose Trust. The upgrade reflects the slightly improved average credit quality of the asset pool supporting this transaction after the sequential redemption of underlying bonds, as well as the stable asset performance.

On Sept. 5, 2011, we raised our ratings on the Class B and C notes issued by Shin Kong Life Insurance Song Jiang, Cheng Der, And Panchiao Buildings Real Estate Asset Trust (SKL REAT). The upgrade reflects our view that following the successful liquidation of the properties supporting SKL REAT, the current amount of collateralized cash is sufficient to meet expected senior fees and expenses, and pay down the transaction's rated notes in full in February 2012.

On Nov. 3, 2011, we raised our ratings on the Class B and C notes issued by Shin Kong Life Insurance Tun Hwa Building Real Estate Asset Trust. The upgrade reflects our view that following the successful liquidation of the properties supporting the transaction, the current amount of collateralized cash is sufficient to meet expected senior fees and expenses, and pay down the transaction's rated notes in full in June 2012.

Downgrades on CBO transactions were due to rating action on banks
On Dec. 1, 2011, we lowered our ratings on the Class A1 and Class A2 notes issued by Capital Securities 2006-1 CBO. The downgrade reflects our view that the creditworthiness of the Class A1 and Class A2 notes has deteriorated following Standard & Poor's Rating Services' decision to lower the rating on the largest asset supporting the transaction, which is related to Citigroup Inc.

Ratings on CreditWatch
As of Dec. 23, 2010, no structured finance ratings were on CreditWatch.

FIXED-INCOME FUND RATINGS
Credit risk remains limited in fixed-income funds as a result of asset credit quality and portfolio composition
In our view, rated domestic fixed-income funds have demonstrated stable credit quality after the funds transformed into quasi-money market funds, and subsequently into money market funds. These transitions effectively shorten portfolio duration, offering fund managers more flexibility in assets acquisition and disposition due to the short maturity. Moreover, the regulator's requirement on the minimum asset credit quality and concentration also further limit the credit risks that funds face.

The credit quality of rated fixed-income funds largely remained stable in 2011, along with a stable credit environment, highly liquid portfolio, and satisfactory market confidence. We expect such factors to support continued stability in 2012.

The expiration of the Taiwan government's blanket guarantee on bank deposits led us to lower our ratings on four funds that did not adjust their portfolio accordingly. We also raised our ratings on three other funds to reflect their improved asset quality and satisfactory management. Taiwan Ratings assigned no new ratings in 2011 but withdrew seven 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 2012
There were no defaults in our rated pool of Taiwan's corporates and financial institutions in 2011, just as in 2010, reflecting generally stable creditworthiness, the effect of our small ratings pool, and the adequate access of non-financial corporations to liquidity. In addition, we expect defaults in the corporate and financial sectors to remain relatively rare in 2012, due to the small number of low credit ratings in our rated pool, despite heightened credit risks amid a weakening global economy.

Defaults of structured finance securities are likely to be very limited in 2012
There were no structured finance securities defaults in 2011. Our observation on deal seasoning and structure protection supports our view that securities defaults, if any, will be very limited in the coming year. A noteworthy point is that the majority of outstanding structured finance securities are rated at 'twA (sf)' or higher, and are structured or supported to withstand moderate stress in the macro economy and asset performance.

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Note: Ratings stated are correct as of Dec. 23, 2011.