STRUCTURED FINANCE RESEARCH
Transition Study:
European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid-2010
Primary Credit Analyst: Arnaud Checconi, London (44) 20-7176-3410; checconia@[Link] Secondary Contact: Andrew H South, London (44) 20-7176-3712; [Link]@[Link]
Table Of Contents
Criteria Application Triggers Downgrades Consumer-Related Asset Classes Still Outperform Corporate Transactions The 'AAA' Default Rate Since Mid-2007 Is Only 1.06% At Least 70% Of ABS, Structured Credit, And Covered Bonds Have Redeemed Since Mid-2007 Appendix Related Criteria And Research
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European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid-2010
Only 1.54% (by original balance) of European structured finance notes rated by Standard & Poor's Ratings Servicesand outstanding in mid-2007had defaulted by the end of Q4 2013. By contrast, we estimate that about two-thirds had fully redeemed. This is despite a protracted recession, and only a sluggish European economic recovery unfolding in 2013. The 12-month rolling European structured finance downgrade rate fell to 15% at the end of Q4 2013, while the 12-month rolling default rate dropped to 0.24%the lowest level since Q2 2010. Most defaults were due to interest shortfalls and principal losses in commercial mortgage-backed securities (CMBS). Overview Only 1.54% (by original issuance volume) of European structured finance notes outstanding in mid-2007 have defaulted. The 12-month rolling default rate dropped to 0.24%the lowest level since Q2 2010, while the equivalent downgrade rate fell to 15%, due to the continued weak performance of CMBS transactions. Consumer-related securitizations have outperformed those backed by corporate credit, with cumulative default rates since mid-2007 of 0.05% and 5.01%, respectively. Higher-rated notes outperformed those ranked junior in the capital structure, with only 1.06% of 'AAA'-rated issuance defaulting since mid-2007. On aggregate, 66.5% of notes that were outstanding in mid-2007 have since seen rating withdrawalsusually due to full redemption.
This report is the latest update of our regular transition study, which we originally published on May 17, 2010 (see "European Structured Finance Cumulative Default Rate Since Mid-2007 Remains Below 0.5%"). As before, we quantify credit performance by analyzing rating transitions and defaultsaggregating them by the securities' original issuance volume, rather than by the number of ratings. This approach gives greater weight to higher-value securities, where the most investor funds are actually deployednotably, those more senior in the capital structure and those in asset classes where transactions are typically larger. In this study, we update our analysis to consider cumulative ratings transition and default rates from the beginning of the current financial downturnwhich we assume to be in mid-2007until the end of Q4 2013. We also analyze rating changes on a 12-month rolling basis, to highlight recent trends.
Criteria Application Triggers Downgrades
Based on our calculations, only 42.7 billion of notes from an original issuance volume of 2,774.1 billion have
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Transition Study: European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid2010
defaulted since mid-2007, representing a 1.54% cumulative default rate at the end of Q4 2013. By definition, this cumulative default measure can only increase over time, and it rose from 1.50% in Q3 2013. However, the European structured finance cumulative default rate remains low in absolute terms, for example, compared with the equivalent measure for U.S. structured finance, which is 18.7% (see table 1). Downgrade rates are always higher than default rates because deteriorating creditworthiness is more likely than actual failure to pay, in our view. The cumulative downgrade rate in the 26-quarter observation period between mid-2007 and the end of Q4 2013 was 34.7%, which represents a slight increase compared with 33.8%, quarter-on-quarter. In other words, our ratings on two-thirds of European structured finance notes have either been stable or have risen since mid-2007. See table 3 in the appendix for a full ratings transition matrix for European structured finance in that period. In Q4 2013, the 12-month rolling default rate fell to the lowest level since Q2 2010, at 0.24% (see chart 1). In Q4, most European structured finance defaults were due to interest shortfalls and principal losses on CMBS tranches. The application of our small and midsize enterprise collateralized loan obligation (SME CLO) and European CMBS criteria was the main reason for the 12-month rolling downgrade rate of 15% (see "European CMBS Methodology And Assumptions," published on Nov. 7, 2012 and "European SME CLO Methodology And Assumptions," published on Jan. 10, 2013). See table 4 in the appendix for a full ratings transition matrix for European structured finance over the past 12 months.
Table 1
Summary Mid-2007 To Q4 2013 Ratings Transition, Default, And Withdrawal Rates
By asset class Ratings transition rate* (%) Asset class ABS Credit cards Other consumer ABS Other ABS Structured credit Synthetic corporate Leveraged loan CLO SMEs CDO of ABS Other CDO Total (bil. ) 170.3 33.2 68.0 69.1 534.6 254.4 70.6 103.0 28.9 77.8 Upgraded 4.9 0.0 8.9 3.4 2.5 3.2 2.3 0.8 0.4 3.5 Stable 66.8 97.0 61.5 57.6 54.2 62.5 31.4 52.8 10.7 65.7 Downgraded 28.3 3.0 29.6 39.1 43.3 34.3 66.3 46.4 88.9 30.9 Defaulted (%) 0.1 0.0 0.1 0.0 4.6 2.9 0.1 0.4 41.0 6.5 Withdrawn (%) 82.1 94.3 87.9 70.6 74.4 93.3 23.8 69.7 22.6 83.9
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Table 1
Summary Mid-2007 To Q4 2013 Ratings Transition, Default, And Withdrawal Rates (cont.)
CMBS Corporate securitizations Covered bonds RMBS All consumer transactions All corporate transactions Overall Overall U.S. 163.3 64.9 1.7 8.2 30.0 49.7 68.2 42.0 10.3 0.1 44.9 23.9
1,085.0 756.0 1,942.2 831.9 2,774.1 5,813.1
0.1 0.9 0.7 2.9 1.4 1.2
77.9 58.9 70.2 49.4 64.0 40.1
22.0 40.2 29.1 47.7 34.7 58.7
0.0 0.1 0.1 5.0 1.5 18.7
70.0 60.6 67.4 64.3 66.5 40.8
Note: For ratings outstanding in mid-2007. Based on original issuance volume. *We classify withdrawn ratings according to their levels immediately before withdrawal. ABSAsset-backed securities. SMESmall and midsize enterprise. CLOCollateralized loan obligation. CDOCollateralized debt obligation. CMBSCommercial mortgage-backed securities. RMBSResidential mortgage-backed securities.
Chart 1
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Transition Study: European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid2010
Consumer-Related Asset Classes Still Outperform Corporate Transactions
Many of the ratings transition and default trends vary substantially by asset class. We classify transactions into two broad categories: Consumer: Residential mortgage-backed securities (RMBS), covered bonds, and consumer asset-backed securities (ABS); and Corporate: Corporate securitizations, structured credit, CMBS, and some other ABS. When considering these classifications, consumer transactions have outperformed corporate transactions by a wide marginwith a cumulative default rate of only 0.05% and a cumulative downgrade rate of 29.1%, compared with 5.01% and 47.7%, respectively, for corporate transactions (see table 1 and chart 2).
Chart 2
The overall cumulative downgrade rate increased to 34.7% over the quarter, due to negative rating actions that we took on covered bond programs. For example, we lowered our ratings on covered bonds issued by Caisse Franaise de Financement Local, Socit Gnrale LDG, Socit Gnrale SCF, and Crdit Mutuel Arka Public Sector SCF following the lowering of our long-term sovereign rating on France (see "Ratings On Four Public Covered Bond
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Programs Lowered After Sovereign Rating On France Lowered," published on Nov. 15, 2013, and "France Long-Term Ratings Lowered To 'AA' On Weak Economic Growth Prospects And Fiscal Policy Constraints; Outlook Stable," published on Nov. 8, 2013). The cumulative downgrade rates for RMBS, ABS, and corporate securitizations, were stable overall. For CMBS, downgrades were mainly due to collateralrelated issues, including sharp commercial real estate value declines, which reduced our loan recovery assumptions (see "Related Research"). By contrast, nearing maturities and transaction amortization (or "structural deleveraging") in leveraged loan CLOs helped to marginally lower the cumulative downgrade rate for structured credit to 43.3% from 43.6%, three months earlier. Despite their marginal rise in Q4, the 12-month rolling default rates for ABS and RMBS are still very low in absolute terms, at 0.09% and 0.07%, respectivelya fraction of those for structured credit and CMBS at 0.87% and 3.03%, respectively (see chart 4). We lowered to 'D (sf)' our ratings on 11 CMBS tranches during Q4 2013, mainly due to principal losses and interest shortfalls (see "Ratings On CMBS Transaction Talisman-5 Finance's Class D And E Notes Lowered To 'D (sf)' Following Principal Losses," published on Oct. 4, 2013).
Chart 3
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Transition Study: European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid2010
Chart 4
The 'AAA' Default Rate Since Mid-2007 Is Only 1.06%
In our view, the position of notes in the capital structure affects their credit performance. In fact, the cumulative downgrade rate for speculative-grade notes between mid-2007 and Q4 2013 was 80% higher than for investment-grade notes, with the former recording a cumulative downgrade rate of 62.2%, compared with 34.5% for the latter (see table 2 and chart 5). More significantly, the cumulative default rate for speculative-grade notes over the same period, at 10.69%, has been more than seven times higher than that for investment-grade notes, at 1.49%. This result is not surprising, in our view. The gap in both downgrade and default rates is consistent with our ratings framework: Default propensity and credit stability are key rating factors, and we therefore expect ratings on more senior notes generally to be more stable than those on junior notes experiencing similar stresses (see "Methodology: Credit Stability Criteria," published on May 3, 2010).
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Transition Study: European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid2010
Table 2
Summary Mid-2007 To Q4 2013 Ratings Transition, Default, And Withdrawal Rates
By rating grade Transition rate* (%) Total ( Bil.) Investment-grade 'AAA' only Speculative-grade Overall 2,760.5 2,415.2 13.5 2,774.1 Upgraded 1.3 0.0 9.6 1.4 Stable 64.2 66.4 28.1 64.0 Downgraded 34.5 33.6 62.2 34.7 Defaulted (%) 1.49 1.06 10.69 1.54 Withdrawn (%) 66.6 67.1 52.2 66.5
Note: For ratings outstanding in mid-2007. Based on original issuance volume. *We classify withdrawn ratings according to their levels immediately before withdrawal.
Chart 5
At Least 70% Of ABS, Structured Credit, And Covered Bonds Have Redeemed Since Mid-2007
Regardless of whether note ratings have remained stable, moved up, or moved down, it is also important to consider that much of the principal outstanding in mid-2007 is by now no longer at riskand has been returned to
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Transition Study: European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid2010
noteholdersdue to amortization. In fact, many of these notes have now fully redeemed. We can obtain a proxy for the scale of full note redemptions by considering rating withdrawals, as these have most often occurred following full note redemption. By Q4 2013, we had withdrawn our ratings on 66.5% of notes that were outstanding in mid-2007 (see chart 6). This high number is all the more positive, in our view, given that European structured finance is currently experiencing a period of unusually low prepayment rates on many types of underlying collateral. Withdrawal rates vary widely across different asset classes (see chart 7). ABS, structured credit, and covered bonds report the highest cumulative withdrawal rates at 82%, 74%, and 70%, respectively. Withdrawals were generally for different reasons in each asset class: ABS and covered bonds traditionally have short maturities, which many of the notes outstanding in mid-2007 would now have reached. Structured credit withdrawals often followed early terminations. The CMBS cumulative withdrawal rate is comparatively low at 45% because many of the underlying loans' bullet maturity dates have been extended, making early repayment of the notes unlikely. Although we expect modest European economic recovery to continue this yearmost notably in the U.K. and Germanygrowth is likely to remain weak in many areas. With the specter of deflation looming in some peripheral countries, and unemployment still close to an all-time high, the collateral performance of European structured finance is likely to improve only marginally (see "European Economic Outlook: Out Of Recession, Back In The Slow Lane," published on March 21, 2014).
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Chart 6
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Transition Study: European Structured Finance 12-Month Rolling Default Level Drops To Its Lowest Since Mid2010
Chart 7
Appendix
Table 3
Mid-2007 To Q4 2013 Ratings Transition Matrix For All European Structured Finance
Rating to (%) Original issuance volume Rating (bil. from equivalent) AAA AA A BBB BB B CCC 2,415.2 164.1 106.9 74.4 11.2 1.8 0.6
AAA 66.4 9.0 1.4 2.9 0.1 -
AA 14.4 57.4 3.1 0.4 4.0
A 11.7 10.8 54.6 10.0 1.4 -
BBB 3.6 3.1 22.9 53.8 4.1 -
BB 0.9 3.6 4.0 11.5 39.1 0.2 -
B 1.1 2.1 6.0 6.7 27.9 23.9 -
CCC 0.8 9.6 3.6 8.3 16.9 73.3 6.1
CC 0.1 0.0 0.6 0.6 2.7 3.2
DUpgraded 1.1 4.3 4.0 5.9 7.9 2.6 86.7 9.1 4.5 13.2 5.6 0.2 4.0
Stable Downgraded 66.4 57.4 54.6 53.8 39.1 23.9 6.1 33.6 33.6 40.9 32.9 55.3 75.9 90.0
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Table 3
Mid-2007 To Q4 2013 Ratings Transition Matrix For All European Structured Finance (cont.)
Ending 2,774.1 original issuance volume (bil. equivalent) 1,623.0 446.4 365.8 156.1 44.4 44.8 47.2 3.7 42.8 30.2 1,801.9 942.1
Table 4
12-Month Rolling Ratings Transition Matrix For All European Structured Finance
Rating to (%) Original issuance volume Rating (bil. from equivalent) AAA AA A BBB BB B CCC CC 1,220.1 608.6 550.4 247.2 39.0 57.0 24.5 4.4
AAA 98.1 2.5 0.1 0.0 1,212.4
AA 1.3 86.8 2.3 0.0 0.8 557.4
A 0.6 9.7 89.6 2.0 0.2 0.0 564.4
BBB 0.0 0.8 6.4 93.2 4.9 0.2 272.6
BB 0.2 1.2 3.9 70.0 11.8 0.4 51.4
B 0.5 0.8 20.4 76.6 1.6 56.6
CCC 0.1 3.1 7.0 85.8 4.9 26.6
CC 0.0 0.2 1.7 59.4 3.1
DUpgraded 0.0 0.0 1.4 3.3 10.5 35.7 6.7 2.5 2.4 2.0 5.0 12.9 2.0 4.9 43.1
Stable Downgraded 98.1 86.8 89.6 93.2 70.0 76.6 85.8 59.4 2,543.2 1.9 10.7 8.1 4.7 24.9 10.5 12.1 35.7 164.9
Ending 2,751.2 original issuance volume (bil. equivalent)
Note: Based on original issuance volume. To Q4 2013.
Related Criteria And Research
European Economic Outlook: Out Of Recession, Back In The Slow Lane, March 21, 2014 European CMBS Monthly Bulletin (January 2014): Repayment Rates May Suffer Due To Fewer Maturing Multifamily Loans, Feb. 14, 2014 European CMBS Monthly Bulletin (December 2013): Credit Performance Could Remain Weak In 2014, Dec. 24, 2013 European CMBS Monthly Bulletin (November 2013): 10 Billion Of Loans May Need Refinancing In 2014, Dec. 3, 2013 Ratings On Four Public Covered Bond Programs Lowered After Sovereign Rating On France Lowered, Nov. 15, 2013 France Long-Term Ratings Lowered To 'AA' On Weak Economic Growth Prospects And Fiscal Policy Constraints; Outlook Stable, Nov. 8, 2013 Ratings On CMBS Transaction Talisman-5 Finance's Class D And E Notes Lowered To 'D (sf)' Following Principal Losses, Oct. 4, 2013 Counterparty Risk Framework Methodology And Assumptions, June 25, 2013
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European SME CLO Methodology And Assumptions, Jan. 10, 2013 European CMBS Methodology And Assumptions, Nov. 7, 2012 European Structured Finance Cumulative Default Rate Since Mid-2007 Remains Below 0.5%, May 17, 2010 Methodology: Credit Stability Criteria, May 3, 2010 Understanding Standard & Poor's Rating Definitions, June 3, 2009
Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.
Additional Contact: Structured Finance Europe; StructuredFinanceEurope@[Link]
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