Japanese Corporate Default Rates and Rating Transition Matrices (FY1978-FY2014)

Japanese Corporate Default Rates and Rating Transition Matrices (FY1978-FY2014) June 30, 2015 ・ One company defaulted in FY2014. Unitika Ltd. defaulted through a petition for or implementation of financial assistance (debt restructuring). The company had been rated more than 30 years ago, and the single year default rate for the companies that had R&I's ratings as of April 1, 2014 was 0%. This marks the fifth consecutive year of 0% single year default rates since FY2010, equaling the previous record of five years from FY1987 to FY1991. ・ As regards the relationship between credit ratings and defaults, the study results continued to show that a high credit rating corresponds to a low default rate, and that the lower the level of the credit rating, the higher the default rate. ・ On the whole, credit ratings moved higher in FY2014 due primarily to a decrease in the number of downgrades. While the number of upgrades in FY2014 was slightly larger than in FY2013 (FY2013: 11 upgrades, FY2014: 13 upgrades), the number of downgrades declined sharply (FY2013: 11 downgrades, FY2014: 2 downgrades), suggesting lower rating volatility for two consecutive years. ・ Although single year default rates for rated entities continued to be 0% both in the FY2010-FY2014 period and the FY1987-FY1991 period, rating transitions indicate substantial differences in the credit environment. In the FY2010-FY2014 period, credit ratings moved lower in FY2011, a year when the historical appreciation of the yen and confused political circumstances were added to the stress of natural disasters from the Great East Japan Earthquake and floods in Thailand. In FY2012 and FY2013, the number of upgrades and the number of downgrades were equal, followed by overall upward transitions in FY2014. In the FY1987-FY1991 period, on the other hand, credit ratings leaped during the bubble economy, and the direction of rating transitions turned downward following the burst of the bubble economy. Akira Ishiwata, Chief Analyst [email protected] Shohei Tanaka, Senior Analyst [email protected] Credit Rating Planning and Research Division Phone: +81-(0)3-3276-3512 Table of Contents Page Introduction 3 Default Rates 3 Defaults in Recent Years 3 Relationship between Credit Ratings and Defaults 5 Credit Rating Transitions 6 Trend of Rating Transitions 6 Rating Transition Matrix 8 Rating Transitions during Periods When No Defaults Occurred 9 Study Methodology 12 Data Tables 16 The data provided in the Data Tables are available in an Excel file format. [Contact] Capital Market Marketing Department +81-(0)3-3276-3437 Copyright(C) 2015 Rating and Investment Information, Inc. All rights reserved. 2 Introduction This report has been prepared to promote greater understanding of the relationship between R&I credit ratings and defaults and illustrates, as default rates and rating transition matrices, the results of a study of default events and rating transitions pertaining to 1,490 Japanese firms for which R&I has assigned a credit rating. This year's report is the 19th review in the series, which R&I has prepared annually since 1997. The conclusion that can be drawn from the study results is that a high R&I credit rating corresponds to a low default rate, and that the lower the level of the credit rating, the higher the default rate. Each year R&I extends the study period by one year and updates the study results, using April 1, 1978 as the starting point. Default rates and rating transition matrices reflect the results of the follow-up study on ratings and the occurrence of default events each year for the firms to which a credit rating had been assigned at the beginning of each fiscal year, covering 37 years from FY1978 through FY2014. The follow-up study methodology is based on the characteristics of Japan's bond market, which is comprised of issuers that have comparatively high credit ratings. In the past, when the creditworthiness of a firm that had obtained a credit rating from R&I had declined and refinancing of its bonds through new bond issuance had become difficult, the credit rating of the firm was frequently withdrawn when the bonds were redeemed. As a result, compared with Europe and the U.S., remarkably few issuers to whom a credit rating has been assigned experienced a default. Because of this consideration, R&I continues the follow-up study of default events at previous rated issuers even after credit ratings have been withdrawn. The study methodology is explained in detail in the Study Methodology section. R&I has not made any changes to its study methodology since the previous report. Default Rates Defaults in Recent Years Table 1 shows the change in the number of defaults since FY1978. When we look at the movement since the financial crisis that erupted from the subprime loan problem in the U.S. in 2007, there were four defaults in FY2008, followed by an increase to seven in FY2009. When the default events in FY2009 are examined, one notable cause was restructuring based on an application for turnaround ADR proceedings. The number of defaults declined in the following year, and in FY2011 the number of defaults fell to zero for the first time in 18 years, since 1993. In FY2012 there were two defaults, and in FY2013 the number of Table 1 Change in Number of Defaults (By Default Event) Recession phase Restructuring Failure to pay Legal bankruptcy 14 12 10 8 6 4 2 0 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Fiscal year - Recession phase shows that the economy was in "recession" at the beginning of said fiscal year. [Source: Prepared by R&I from R&I Rating Transition Statistics (RTS) and the "Reference Dates of Business Cycle" available on the Cabinet Office website] Copyright(C) 2015 Rating and Investment Information, Inc. All rights reserved. 3 defaults once again was zero. With only one default in FY2014, a situation in which almost no defaults occurred has continued. The default in FY2014 was a petition for or implementation of financial assistance for Unitika Ltd. To replenish its equity capital eroded in conjunction with structural reforms including withdrawal from the fibers & textiles business on which it was founded, in May 2014 the company requested financial assistance in the form of (1) an underwriting of preferred stock to its main financial institutions for the purpose of repaying obligations owed to those entities and (2) debt restructuring with the goal of maintaining its outstanding obligations to other financial institutions, and this financial assistance was subsequently implemented. Unitika had been assigned a credit rating of B at the beginning of FY1981 and FY1982, but had not been assigned a credit rating at the beginning of any other fiscal year. As a result of this default, for firms with a credit rating in the BB category or lower, the cumulative default rate for 34 years from the beginning of FY1981 was approximately 24% (47 firms in the initial period sample, of which R&I continued to track 32 firms at the beginning of FY2014), and the cumulative default rate for 33 years from the beginning of FY1982 was about 26% (46 firms in the initial period sample, of which R&I continued to track 30 firms at the beginning of FY2014). For firms with a credit rating in the BBB category or higher, the cumulative default rate for 34 years from the beginning of FY1981 and the cumulative default rate for 34 years from the beginning of FY1982 were both around 7% (Table 2) (the number of firms in the initial period sample and the number of firms R&I continued to track at the beginning of FY2014 were 265 firms and 239 firms for the cumulative default rate for 34 years from the beginning of FY1981 and 281 firms and 254 firms for the cumulative default rate for 33 years from the beginning of FY1982). From these figures we can see that, through a period of more than 30 years from the 1980s, about 90% of the firms rated in the BBB category or higher, and about 70% of the firms rated in the BB category or lower, have survived. Table 2 Long-term Cumulative Default Rates (Unit: %) Cumulative default rate for 34 years from the beginning of FY1981 Cumulative default rate for 33 years from the beginning of FY1982 30 26 25 24 20 15 10 7 7 5 0 BBB or higher BB or lower [Source: Prepared by R&I from RTS] As in the case of Unitika, for all five defaults in the most recent five years, no credit rating had been assigned at the beginning of the fiscal year in which the default occurred, and for rated entities the single year default rate was 0% for five consecutive years (Table 3). This was the longest such period since the five-year period that began from FY1987. Looking just at the events of default, the most recent five-year period has been a time when credit risk was low and stable. However, while events of default are important, to better understand the credit environment they must be viewed together with rating transitions. This is discussed under "Credit Rating Transitions" beginning from page 6. Copyright(C) 2015 Rating and Investment Information, Inc. All rights reserved. 4 Table 3 Change in Default Rates of Rated Entities (Unit: %) Recession phase Single year default rate 1.0 0.8 0.6 0.4 0.2 0.0 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Fiscal year - Recession phase shows that the economy was in "recession" at the beginning of said fiscal year.

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