Taiwan's Structured Finance Default And Rating Transition Study, 2003-2011: Credit Quality Remained Stable In 2011

2012/05/30
Primary Credit Analyst: Aaron Lei; (886) 2 8722-5852
aaron_lei@taiwanratings.com.tw
Secondary Contact: Andrea Lin; (886) 2 8722 5853
andrea_lin@taiwanratings.com.tw
Chief Ratings Officer: Susan Chu; (886) 2 8722-5813; susan_chu@taiwanratings.com.tw

Taiwan-originated structured finance securities mainly remained stable in 2011, continuing the stability seen in 2010. This is in contrast to the credit performance of global peers rated by Standard & Poor's Ratings Services, on which downgrades and default rates remained somewhat elevated in 2011 compared with the average over the past decades as a result of adverse collateral performance and updates to ratings criteria.

This study documents the historical default and transition rates for structured finance securities (also referred to as securitization notes) rated by Taiwan Ratings Corp. and provides transparency to their performance.

The study covers 92 ratings (87 long-term ratings and five short-term ratings) from 31 Taiwan-originated structured finance transactions that we have rated from 2003 through 2011. The transition rates included in the tables are calculated on long-term ratings only. An additional section provides insights on the transition and default behavior of our five short-term ratings. The study does not include CreditWatch placements in the calculation of transition and default rates.

It should be noted that the findings of this study may have several limitations due to the relatively small number of securities covered in this study, the short time period involved, the concentration on certain asset types securitized, and the limited default events during this period of review. For this reason, they should not be generalized to understand the credit performance of other existing or new transactions; any comparison between this study and other similar studies may be misleading due to these limitations.

Key Findings

  • The number of upgrades and rating affirmations continued to outweigh that of downgrades in 2011, reflecting the securitizations' stable asset performance and support from their sequential-pay transaction structures.
  • There were no defaults in 2011; the total number of default events remained at four since 2003.
  • The historical transition study shows that higher ratings are associated with higher credit stability or lower transition rates. We believe this is primarily due to Taiwan's relatively stable economy and the transactions' conservative deal structures.
  • CDO Squared transactions, defined as CDOs (collateralized debt obligation) backed by other CDOs, had the highest number of downgrades historically; most positive rating movements related to corporate CLOs (collateralized loan obligations backed by corporate loans) and REAT (real estate asset trust) transactions.

Rated Transactions Maintained Stable-To-Positive Performances In 2011
In 2011, all rating categories had stable to positive transitions except the 'twAAA' rating category (see table 1), which was affected by CDO downgrades after Standard & Poor's revised bank criteria led to the downgrade of some global financial institutions. This performance followed the stability of rated transactions in 2010, and was a reversal of the 2008 and 2009 rating transitions in which downgrades of securitization notes were relatively significant. In terms of rating actions, the number of downgrades dropped to two from four in 2010 and 29 in 2009, and upgrades reached six in comparison with 10 in 2010 and two in 2009.

Table 1
Taiwan Ratings' Structured Finance 2011 Rating Transition (%)
From/to
Beginning no. of ratings
twAAA
twAA
twA
twBBB
twBB
twB
twCCC
twCC
D
NR
Upgrade / stable / NR
Downgrade
twAAA
10
60.00
20.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
20.00
80.00
20.0
twAA
5
0.00
40.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
60.00
100.00
0.0
twA
9
33.33
0.00
55.56
0.00
0.00
0.00
0.00
0.00
0.00
11.11
100.00
0.0
twBBB
6
16.67
0.00
0.00
66.67
0.00
0.00
0.00
0.00
0.00
16.67
100.00
0.0
twBB
0
 
 
 
 
 
 
 
 
 
 
 
 
twB
0
 
 
 
 
 
 
 
 
 
 
 
 
twCCC
2
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
100.00
100.00
0.0
twCC
0
 
 
 
 
 
 
 
 
 
 
 
 
Note: Ratings with modifiers (+ and -) are classified into the ratings in the same category. For instance, 'twAA+', 'twAA', and 'twAA-' are classified as 'twAA' category in this transition table. 'NR' means the securities were repaid in full and we withdrew the ratings for the redemptions. Source: Taiwan Ratings Corp.

Credit stability or improvement prevailed in all asset types (see table 2). REAT tranches, defined as CMBS (commercial mortgage backed securities) in the table, performed particularly well in 2011 and had the most upgrades of any transaction type. During the year we also raised our ratings on a CBO transaction to reflect its lower leverage.

Table 2
Taiwan Ratings' Structured Finance 2011 Rating Transition (%) by Asset Type
Asset Type
Beginning no. of ratings
Stable
Upgrade
Downgrade
Default
ABS Commercial Other
1
100.00
0.00
0.00
0.00
ABS Equipment
4
100.00
0.00
0.00
0.00
CDO Cash Flow CBO
13
69.23
15.38
15.38
0.00
CDO CF CDO of CDO
4
100.00
0.00
0.00
0.00
CMBS
6
33.33
66.67
0.00
0.00
RMBS Prime Jumbo
4
100.00
0.00
0.00
0.00
Total
32
75.00
18.75
6.25
0.00
Note: Stable includes withdrawn ratings due to redemptions during the year. Downgrade rate includes defaults. Rating modifiers (+ and -) are used when determining rating transitions such as upgrades and downgrades. Source: Taiwan Ratings Corp.

The two 'twCCC' rated notes in the beginning of 2011 were repaid in full on their maturity, and there was no securities default in 2011. From 2003 to 2011, there were four defaults out of the 87 long-term ratings we assigned, representing a 4.60% default rate.

Collateral Performance And Sequential-Payment Structures Result In Upgrades In 2011
Collateral delinquencies and obligor credit quality remained stable, supporting rating stability despite the global macroeconomic uncertainty in the second half of 2011. The upgrades in REATs reflected the stable tenant performance of underlying properties and asset price appreciation that has provided adequate coverage on principal repayments. In addition, the sequential-payment structures in most Taiwan-originated transactions also help establish higher credit enhancements as transactions de-lever. This ultimately made the upgrades possible in a CDO transaction and increased rating stability in others.

Taiwan Ratings provided a more detailed review on Taiwan's macroeconomic evolution and deal performance in 2011 in an article titled "Ratings Roundup Report For 2011 And Outlook For 2012: Pressure To Maintain Stable Credit Profiles Will Rise In 2012, Particularly For The Corporate Sector", published on Dec. 29, 2011.

Going forward, we expect underlying collateral performance on outstanding structured finance transactions to be largely stable in 2012, bucking the expected negative changes to the macro economy in 2012. This view is consistent with Standard & Poor's opinion on Asia-Pacific transactions (see "Strong Regional Economies Support A Stable 2012 Outlook For Asia-Pacific Structured Finance", published on www.globalcreditportal.com on Jan. 9, 2012). In general, the reasons for the likely resilience of structured finance transactions in Taiwan include transactions' seasoned asset pools, sequential-pay structures, and structural protection for deal amortization if the credit quality of assets deteriorates quickly.

Transitions And Default Rates Correlate With Rating
The weighted average annual rating transitions continue to show high ratios of upgrades and stability for each rating category from 'twAAA' to 'twBBB' (ratings with modifiers included) over an average 12-month period (see table 3).

Table 3
Taiwan Ratings' Structured Finance Weighted Average One-Year Rating Transition (%), 2003 - 2011
From/to
Beginning no. of ratings
twAAA
twAA
twA
twBBB
twBB
twB
twCCC
twCC
D
NR
Upgrade / stable / NR
Downgrade
twAAA
71
66.20
4.23
1.41
0.00
0.00
0.00
1.41
0.00
0.00
26.76
92.96
7.04
twAA
60
10.00
58.33
0.00
0.00
1.67
0.00
3.33
0.00
0.00
26.67
95.00
5.00
twA
83
7.23
9.64
60.24
0.00
0.00
0.00
1.20
1.20
0.00
20.48
97.59
2.41
twBBB
69
2.90
1.45
15.94
71.01
0.00
0.00
1.45
1.45
0.00
5.80
97.10
2.90
twBB
2
0.00
0.00
50.00
50.00
0.00
0.00
0.00
0.00
0.00
0.00
100.00
0.00
twB
0
 
 
 
 
 
 
 
 
 
 
 
 
twCCC
9
0.00
0.00
0.00
11.11
0.00
0.00
44.44
0.00
22.22
22.22
77.78
22.22
twCC
2
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
100.00
0.00
0.00
100.00
Note: Ratings with modifiers (+ and -) are classified into the ratings in the same category. For instance, 'twAA+', 'twAA', and 'twAA-' are classified as 'twAA' category in this transition table. 'NR' means the securities were repaid in full and we withdrew the ratings for the redemptions. 'Beginning no. of ratings' sums all ratings on the category at the beginning of each year. Source: Taiwan Ratings Corp.

The ratio of ratings stability, defined as ratings unchanged or securities fully repaid in the calendar year, indicates that higher ratings are associated with higher credit stability (see table 4). This finding is generally in line with Standard & Poor's global results and Taiwan Ratings' corporate default study.

Table 4
Taiwan Ratings' Structured Finance Weighted Average One-Year Rating Transition (%) On Stability, 2003 - 2011
From/to
Beginning no. of ratings
Stable
Upgrade
Downgrade
twAAA
71
92.96
0.00
7.04
twAA
60
85.00
10.00
5.00
twA
83
80.72
16.87
2.41
twBBB
69
76.81
20.29
2.90
twBB
2
0.00
100.00
0.00
twB
0
 
 
 
twCCC
9
66.67
11.11
22.22
twCC
2
0.00
0.00
100.00
Note: Stable includes withdrawn ratings due to redemptions during the year. Ratings with modifiers (+ and -) are classified into the ratings in the same category. Source: Taiwan Ratings Corp.

The migration from the initial securities' ratings to current ratings showed a similar pattern as the annual transition shown in table 4. From 2003 to 2011, among the 86 'twAAA', 'twAA', 'twA', and 'twBBB' ratings (with modifiers included) that we initially assigned, we subsequently raised, withdrew after full redemption, or maintained about 90% of the ratings (see table 5), and we lowered about 10%.

Table 5
Taiwan Ratings' Structured Finance Original-to-Current Rating Transition (%), 2003 - 2011
Original/last rating
Original no. of ratings
twAAA
twAA
twA
twBBB
twBB
twB
twCCC
twCC
D
NR
Upgrade / Stable / NR
Downgrade
twAAA
21
28.57
9.52
0.00
0.00
0.00
0.00
0.00
0.00
4.76
57.14
85.71
14.29
twAA
17
5.88
5.88
0.00
0.00
0.00
0.00
0.00
0.00
5.88
82.35
94.12
5.88
twA
26
11.54
3.85
19.23
0.00
0.00
0.00
0.00
0.00
3.85
61.54
96.15
3.85
twBBB
22
4.55
0.00
4.55
18.18
0.00
0.00
0.00
0.00
4.55
68.18
95.45
4.55
twBB
1
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
100.00
100.00
0.00
twB
0 
 
 
 
 
 
 
 
 
 
 
 
 
twCCC
0 
 
 
 
 
 
 
 
 
 
 
 
 
twCC
0 
 
 
 
 
 
 
 
 
 
 
 
 
Note: Full rating categories are used when determining rating transitions such as upgrades and downgrades. Source: Taiwan Ratings Corp.

Table 5 also provides a gauge on transaction default rates in relation to the ratings initially assigned. The results generally echo the market perception that rating differences serve as an indication of the relative likelihood of defaults, but the differences between each rating category are not obvious. We believe this is due to the limited default events, relatively small pool of rating observations, and the short period covered in our analysis.

In this article we do not review the cumulative default rates for each rating category as the data limitations may prevent a reliable cumulative default rate analysis for Taiwan-originated transactions. For instance, the number of outstanding ratings for longer periods is generally small in our analysis because of fewer ratings and the relatively shorter transaction life in Taiwan's deals (most transactions adopt amortization structures). This also makes the cumulative default rates less reliable since there are only limited default events. Moreover, since most structured finance investors in Taiwan tend to buy securities upon their initial offerings and hold them throughout the transaction's maturity, we believe the original-to-current default review in table 5 should be of more relevance and offer greater insight.

In comparison with the global structured finance rating transitions tracked by Standard & Poor's (see tables 6 and 7), there were higher rating upgrades/stability rates and lower downgrades rates in the annual transition and original-to-current transition for Taiwan securitization transactions. We believe this is a result of Taiwan's relatively stable economy since 2003 and the transactions' structures. Even during the recent global financial crisis, institutional and individual obligors in Taiwan endured less stress than their global counterparts in terms of magnitude and duration. The typical sequential-pay structure and short reinvestment periods in Taiwan's transactions, if any, also supported quicker credit enhancement accumulation that provided more buffers upon assets deterioration.

However, we do not believe this observation should be generalized, due to the significant limitations of rating data in Taiwan Ratings' study. The local structured finance market began in 2003, and we have a much smaller rating universe and much shorter periods in structured finance than the global universe (ratings on 87 securities over the past eight years in Taiwan, compared with over 110,000 ratings assigned globally from 1978 to 2011 inclusive). As a result, the ratings migration in aggregate could be sensitive to even a small number of rating actions, and the results would become not so meaningful.

Table 6
Standard & Poor's Global Structured Finance Weighted Average One-Year Rating Transition (%), 1978 - 2011
From/to
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
NR
AAA
79.75
2.55
1.15
0.81
0.61
0.81
0.73
0.21
0.00
0.12
13.25
AA
3.53
75.69
3.14
2.10
1.58
2.04
3.60
0.99
0.01
0.31
7.00
A
0.93
3.14
72.95
3.95
2.40
2.41
4.69
1.90
0.00
0.60
7.01
BBB
0.50
0.82
2.32
69.54
4.44
4.22
6.85
3.48
0.00
1.41
6.41
BB
0.10
0.12
0.67
2.54
64.23
7.09
11.15
6.27
0.02
3.21
4.62
B
0.02
0.03
0.05
0.42
2.17
58.71
16.83
10.78
0.02
8.06
2.92
CCC
0.04
0.01
0.01
0.07
0.41
1.24
40.94
23.92
0.02
29.89
3.46
CC
0.00
0.00
0.00
0.01
0.00
0.07
0.12
50.49
0.00
48.26
1.05
C
0.00
0.00
0.00
0.00
0.00
0.00
4.76
0.00
42.86
52.38
0.00
Note: AAA ratings from the same transaction are treated as a single rating in the calculation of this table. Full rating categories are used when determining rating transitions such as upgrades and downgrades. Each period's outstanding number of unique ratings is used for weighted average statistics. Source: Standard & Poor's Ratings Services

Table 7
Standard & Poor's Global Structured Finance Original-To-Current Rating Transitions (%), 1978 - 2011
Original/last rating
Original no. of ratings
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
NR
Upgrade / Stable / NR
Downgrade
AAA
29478
12.64
5.47
2.67
1.73
1.51
1.68
4.45
2.19
0.00
6.54
61.12
73.76
26.24
AA
25010
1.98
14.10
4.27
2.50
2.36
3.58
6.39
6.66
0.02
22.29
35.86
51.94
48.06
A
24356
0.70
2.43
12.58
3.97
3.11
3.66
5.30
8.95
0.00
26.24
33.07
48.78
51.22
BBB
23433
0.16
0.64
1.49
9.36
3.94
3.66
5.45
10.68
0.00
36.15
28.47
40.11
59.89
BB
9691
0.04
0.29
0.54
1.32
8.41
5.15
8.37
10.41
0.00
42.68
22.79
33.39
66.61
B
4979
0.00
0.06
0.16
0.10
0.64
7.07
5.76
8.92
0.00
57.14
20.14
28.18
71.82
CCC
175
0.00
0.00
0.00
0.00
0.00
1.71
16.57
0.57
0.00
55.43
25.71
44.00
56.00
CC
11
0.00
0.00
0.00
0.00
0.00
0.00
0.00
27.27
0.00
36.36
36.36
63.64
36.36
C
0 
 
 
 
 
 
 
 
 
 
 
 
 
 
Note: 'AAA' ratings from the same transaction are treated as a single rating in the calculation of this table. Full rating categories are used when determining rating transitions such as upgrades and downgrades. Source: Standard & Poor's Ratings Services

Corporate CLO And REAT Transactions Saw Upgrades
Most negative rating migration came from the CDO Squared sector, which had an 89% downgrade ratio and 44% default ratio (see "CDO CF CDO of CDO" in table 8) if we compare the initial ratings with the most recent ratings.

Ratings on other cash flow CDO transactions also showed negative movement due to the obligor and counterparty exposures to financial institutions located in the Euro zone or the U.S., whose ratings were affected by the worsening macroeconomic conditions and Standard & Poor's revised bank criteria in 2011.

In contrast, we raised 76% of our ratings on Corporate CLOs (denoted as "CDO Cash Flow CLO" in table 8). We also raised 67% of our initial ratings on local REAT transactions, the securitization notes backed by commercial properties (see "CMBS" in table 8). This sector benefitted from the robust tenant performance even during the period of macroeconomic stress, and the pickup of properties values during the post-crisis economic recovery.

Table 8
Taiwan Ratings' Original-to-Current Structured Finance Rating Transition (%) by Asset Type, 2003 - 2011
Asset Type
Beginning no. of ratings
Stable
Upgrade
Downgrade
Default
ABS Commercial Other
1
100.00
0.00
0.00
0.00
ABS Consumer Other
1
100.00
0.00
0.00
0.00
ABS Equipment
6
83.33
16.67
0.00
0.00
CDO Cash Flow CBO
19
63.16
26.32
10.53
0.00
CDO CF CDO of CDO
9
11.11
0.00
88.89
44.44
CDO Cash Flow CLO
33
24.24
75.76
0.00
0.00
CDO Other
2
100.00
0.00
0.00
0.00
CMBS
6
33.33
66.67
0.00
0.00
RMBS Prime Jumbo
10
70.00
30.00
0.00
0.00
Total
87
44.83
43.68
11.49
4.60
Note: Stable includes withdrawn ratings due to redemptions, for which the rating before withdrawal was the same as the initially assigned. Downgrade rate includes defaults. Rating modifiers (+ and -) are used when determining rating transitions such as upgrades and downgrades. Source: Taiwan Ratings Corp.

Subsectors' original-to-current rating transition rates varied by the initial rating assignment year (the vintage, see table 9). Most CDO Squared transactions originated in 2005 and 2006, while CLO issuance spanned from 2003 to 2007, explaining the fluctuation of cumulative rating transitions in those years.

Table 9
Taiwan Ratings' Structured Finance Rating Transition (%) by Rating Assignment (Vintage) Year, 2003 - 2011
Vintage Year
Number of ratings
Stable
Upgrade
Downgrade
Default
2003
9
33.33
66.67
0.00
0.00
2004
17
41.18
58.82
0.00
0.00
2005
10
40.00
20.00
40.00
40.00
2006
16
37.50
37.50
25.00
0.00
2007
26
46.15
46.15
7.69
0.00
2008
1
100.00
0.00
0.00
0.00
2009
3
33.33
66.67
0.00
0.00
2010
3
100.00
0.00
0.00
0.00
2011
2
100.00
0.00
0.00
0.00
All
87
44.83
43.68
11.49
4.60
Note: Stable includes withdrawn ratings due to redemptions, for which the rating before withdrawal was the same as the initially assigned. Downgrade rate includes defaults. Rating modifiers (+ and -) are used when determining rating transitions such as upgrades and downgrades.

Transition Of Short-Term Ratings
Taiwan Ratings has assigned five short-term ratings to securities issued in the commercial paper market. Among these, two were related to account receivables transactions, two related to CDO transactions collateralized by RMBS, and one to CDOs backed by corporate bonds.

The two short-term ratings on the CDO of RMBS transactions had moderate negative rating transitions during the recent financial crisis, as we lowered the rating from 'twA-2' to 'twA-3', before the securities were fully redeemed. In contrast, the other three short-term ratings remained unchanged or were withdrawn on full redemption. There were no defaults among Taiwan Ratings' short-term rated securities between 2003 and 2011.

Credit Quality On Global Structured Finance Securities Fell For The Fifth Consecutive Year In 2011
According to a study by Standard & Poor's, the downgrade and upgrade rates in global structured finance notes in 2011 were significantly higher than historical averages. In the year, Standard & Poor's lowered 36% of all structured finance ratings, up from 33.5% in 2010, and the percent of classes upgraded rose to 5.4% from 2.6% in 2010. Despite the volatility, the degree of deterioration declined. In 2011, Standard & Poor's lowered an average of 1.2 notches on ratings on global structured finance securities, compared with 3.5 notches in 2009 and 1.4 notches in 2010.

Standard & Poor's also expects global structured finance ratings to exhibit more stability in 2012 than in recent years, although moderate rating volatility could occur because of the overall fragile economic condition and potential criteria changes.

Performance in different asset sectors and regions continued to diverge in 2011. U.S. CLO and U.S. consumer asset-backed securities (ABS) generally performed well. So did Asia-Pacific structured finance securities. Credit deterioration in U.S. housing market-related sectors, most commercial mortgage backed securities (CMBS) worldwide, and CDOs backed by RMBS, continued to be evident. Standard & Poor's however highlighted that the rating transition for 2011 represent the combination of criteria updates and adverse collateral performance, and therefore the rating transition trend may be less informative of credit trends in recent years than in previous periods, when credit performance primarily drove the rating changes.

In 2011, 78% of global structured securities rated 'AAA' by Standard & Poor's remained at 'AAA' or paid off in full, and only 0.19% defaulted, down from 0.28% a year earlier. ABS has a 83.3% stability rate (where there was no rating change or securities were paid in full) for 'AAA' rated securities in 2011, compared with 84.8% for CDOs, 85.4% for CMBS, and 75.3% for residential mortgage backed securities (RMBS) rated 'AAA' at the beginning of the year.

It should again be noted that the comparison of rating transition and default rates in Taiwan's structured finance securities to Standard & Poor's global results may not be so meaningful due to data limitations. There are many differences in assumptions and data between Taiwan and the global studies, particularly the different rating scales used, which prevent meaningful comparison. Other limitations include the small number of ratings and short time frame, as well as the concentration of issuance on particular asset types, and the limited default events in Taiwan Ratings' study.

Related Criteria And Research

(Unless otherwise stated, related criteria and research are published on www.globalcreditportal.com, access to which requires a registered account)

APPENDIX: Methodology And Terminology

This section provides a detailed discussion of Taiwan Ratings' rating transition and default methodology. It also explains the study's terminology, including definitions of transition windows, rating modifiers versus full-rating categories, and the treatment of rating withdrawals.

Rating transition
The rating transition of a single static pool (cohort approach) is based on the rating of each security at the beginning and end of the observed transition window. For instance, we calculated the transition rates by determining the ratings of each security at the beginning and end of the period. We then tabulated these ratings in a two-dimensional table to calculate the percentage of ratings that stayed the same and the percentage of ratings that changed. During this process, we count every security only once, even if it had more than one rating change during the period. In other words, we use a security's rating on the first day of the period and the last day of the period to calculate the transition rates, while disregarding the interim rating changes.

Weighted average transition
For weighted average transition rates, we calculate the individual transition rates of static pools as described earlier. We then create a single averaged matrix weighted by the number of ratings in each static pool.

Transition window
A transition window refers to a defined period in which we observe a security's rating transition. For example, the 2011 performance transition window starts on Jan. 1, 2011 and ends on Dec. 31, 2011. Transition windows for historical data also follow annual windows, running from January 1 to December 31 of the same year.

Rating modifiers
We use rating modifiers ("+" and "-") to calculate the upgrade and downgrade percentages, as well as the magnitude of rating changes throughout this study. However, some transition tables may use full rating categories for practical reasons. In other words, the use of a full rating category suggests that transitions from, for example, 'twAA' to 'twAA-' or from 'twBBB+' to 'twBBB-' are not considered as rating transitions because the rating remained within the full rating category.

Rating withdrawal
A security with a withdrawn rating at the beginning of a transition window is not included in the transition and default rate calculations for that period.