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EXHIBIT 5 Rating drift dipped in Q4 Include utility upgrades4%2%0%-2%-4%-6%-8%-10%-12%-14%-16%Exclude utility upgradesJan-90Jan-98Jan-94Jan-96Jan-88Jan-99Jan-93Jan-00Jan-08Jan-04Jan-86Jan-06Jan-89Jan-95Jan-92Jan-09Jan-03Jan-85Jan-05Jan-02Jan-97Jan-87Jan-07Jan-10Jan-11Quarter_EndJan-01Jan-14Jan-91Jan-13Jan-12Source: Moody’s Investors Service Across regions and sectors, we find that the credit quality of European financial institutions began to
deteriorate in the second half of 2014 after some stabilization in the first half. Nevertheless, the rating drift in the European financial sector in 2014, though still negative, was much improved over the double dips in 2011 and 2012. This can be seen in Exhibit 6, which shows the recent quarterly rating drifts by region and sector. Banks contributed the large majority of the downgrades among European financial institutions in 2014. In addition to deteriorated credit profiles, some of the European bank ratings were lowered following the downgrades of their corresponding sovereign ratings or Moody’s reassessment of the likelihood of systemic support.
EXHIBIT 6 European financial institutions weakened in the second half European Non-FinanceNorth America Non-Finance10%5%0%-5%-10%-15%-20%-25%-30%-35%-40%-45%European FinanceNorth America FinanceJun-08Jun-09Jun-10Jun-11Dec-10Jun-14Jun-13Mar-10Sep-08Sep-09Mar-14Mar-13Dec-08Dec-09Mar-08Mar-09Quarter_EndDec-14Jun-12Mar-12Dec-13Dec-12Sep-11Sep-10Dec-11Sep-14Mar-11Sep-13Sep-12Source: Moody’s Investors Service 2014’s recovery rates broadly higher than their historical averages
In Exhibit 7, we present the average recovery rates for debt defaulted in the past two years and put them in context with the historical averages. Last year’s recovery rates were for the most part correlated with the priority of claim in the capital structure, with a higher priority of claim enjoying a higher average rate of recovery. The only exception was that senior subordinated bonds recovered at a slightly higher rate of 46.9% relative to the senior unsecured bonds’ 43.3%, though that senior subordinated average is based on
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only four defaults (see Exhibit 19 for more details).11 Exhibit 7 further shows that 2014’s recoveries were mostly in line with their 2013 levels and higher compared to their long-term averages. For example, the average recovery rate for first lien loans was 78.4% in 2014 versus 66.6% for the period of 1982-2014, while the senior unsecured bond recovery rates averaged 43.3% last year, compared to the historical average of 37.4%.
EXHIBIT 7
Average corporate debt recovery rates measured by post-default trading prices
Lien Position
Issuer-weighted 2014
2013
1982-2014
Volume-weighted 2014
2013
1982-2014
1st Lien Bank Loan 2nd Lien Bank Loan* Sr. Unsecured Bank Loan Sr. Secured Bond Sr. Unsecured Bond Sr. Subordinated Bond* Subordinated Bond** Jr. Subordinated Bond
78.4% 10.5% n.a. 59.5% 43.3% 46.9% 38.8% n.a.
75.1% 78.7% n.a. 59.8% 43.8% 20.7% 26.4% n.a.
66.6% 31.8% 47.1% 52.8% 37.4% 31.1% 31.4% 24.7%
80.6% 10.5% n.a. 76.5% 34.3% 28.3% 38.0% n.a.
67.7% 69.2% n.a. 59.5% 29.2% 26.6% 33.7% n.a.
62.5% 28.5% 40.2% 52.4% 33.6% 26.0% 26.3% 17.1%
* The average recovery rates for 2014's and 2013's second lien bank loans and senior subordinated bonds were each based on fewer than five defaults. ** The average recovery rates for 2014's subordinated bonds were based on fewer than five defaults.
The above recovery data are based on trading prices at or post default.12 An alternative recovery measure is based on ultimate recoveries, or the value creditors realize at the resolution of a default event. For example, for issuers filing for bankruptcy, the ultimate recovery is the present value of the cash and/or securities that the creditors actually receive when the issuer exits bankruptcy, typically 1-2 years following the initial default date.13
In Exhibit 8, we present data on ultimate recovery rates for North American non-financial companies
included in Moody’s Ultimate Recovery Database (“URD”).14 The average “firm-wide” recovery rate15 for the five default resolutions was 65.4% in 2014 compared to 66.2% for the 20 companies which emerged from default in 2013. During both 2014 and 2013, the family recovery rate exceeded the historical average rate of 54.9%. The higher family recovery can be mostly attributed to the fact that out of the five default resolutions, four were pre-arranged bankruptcies, which have historically been characterized by higher
family recovery rates than regular bankruptcies. In 2013, we observed a similar pattern, which featured 55% (or eleven) pre-packs of the entire sample of companies that emerged in that year. However, considering the small sample size of default resolutions in 2014, we cannot draw any statistical conclusions about an unusual nature of family recovery rates during this period.
11
Average recovery rates of senior unsecured bonds and other debts can be based on different defaulters because some defaulters may have senior unsecured bonds and no other debts.
Among those 2014 defaulters which have recovery estimates on both senior unsecured and senior subordinated bonds, the recovery estimates for the senior unsecured bonds are consistently higher than the senior subordinated bonds of the same issuers. Please see Exhibit 19 for more details.
12
For distressed exchanges, we take trading prices at default. For other types of defaults, we take trading prices approximately one month after default. For details, see Moody’s Special Comment Moody’s Ultimate Recovery Database, April 2007. 14
The analysis on ultimate recovery is provided by David Keisman and Julia Chursin. The data are from Moody’s Ultimate Recovery Database which includes robust detailed recovery
13
information for over 5,100 loans and bonds from more than 1,000 North American corporate defaulters since 1987.
15
For a given issuer, the firm-wide recovery rate is the weighted-average recovery rate across all of the issuer’s debts where the weights are the size of the debts.
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EXHIBIT 8
Average corporate debt recovery rates measured by ultimate recoveries, 1987-2014
Lien Position
2014
Emergence Year
2013
1987-2014
2014
Default Year
2013
1987-2014
Loans*
Senior Secured Bonds** Senior Unsecured Bonds*** Subordinated Bonds
81.0% 57.1% 44.6% 0.0%
76.7% 84.2% 61.3% 21.0%
80.2% 63.0% 48.8% 28.2%
68.4% 59.4% 0.0% 0.0%
76.6% 56.9% 34.4% 21.0%
80.2% 63.0% 48.8% 28.2%
* 2014 Loans' recovery rate is based on seven observations (by year of default) and 14 observations (by year of emergence).
** Unusually high recoveries of 2013’s Sr. Secured Bonds stem from a small sample of 17 observations, which were a part of only seven defaults (by year of emergence), with debt instruments from the American Airlines bankruptcy skewing the average recovery rate toward the higher side. *** Average recovery rate of Sr. Unsecured Bonds which emerged in 2013 is impacted by a high proportion of American Airlines Sr. Unsecured Bonds (53% of the entire sample) , that recovered fully upon emergence from bankruptcy.
Moody’s credit ratings are opinions of relative expected credit losses, which are a function of both the
probability of default and severity of default (“LGD”). Exhibit 9 shows annual average credit loss rates from 1982 through 2014 for Moody’s-rated corporate issuers. The chart indicates that the average credit loss rate among all Moody’s-rated issuers declined to 0.6% in 2014 from 0.8% in 2013. To put this in historical perspective, the average annual credit loss rate for Moody’s-rated issuers since 1982 is 1.0%.
EXHIBIT 9 Credit loss rates lower in 2014 Inv-Grade9%8%7%6%5%4%3%2%1%0%Spec-GradeAll-Rated198719971991200020082004200620092003200520021990200720102011198819841986200120141998199419961999198919832013199319951992198519822012Source: Moody’s Investors Service Default rate expected to rise modestly in 2015
At the beginning of 2014 Moody’s default rate forecasting model (“Credit Transition Model” or “CTM”) predicted that the global speculative-grade default rate would finish at 2.3% by the end of the year. The model’s prediction turned out to be fairly close to the realized rate of 2.0%.16
Looking forward, CTM forecasts that the global speculative-grade default rate will rise modestly in 2015, ranging from 2.0% - 2.7% over the next 11 months (see the light blue line in Exhibit 10). The global rate is expected to finish 2015 at 2.7%, which if realized, will be higher than 2014’s closing level of 2.0% but well below the 4.5% historical average. The upward pressure primarily stems from widening spreads,
16
See Moody’s December Default Report, Jan 2014.
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geopolitical concerns, lackluster economic growth outside of the US, and potential interest rate actions by the Fed. On the other hand, an improving US economy, together with healthy corporate earnings and manageable maturity profiles, should keep the default rate low by historical standards. In addition, monetary policy continues to be accommodative globally and market access for speculative-grade companies is expected to remain in place as investors continue to search for yield.
The above-mentioned 2.7% default rate projection, which implies approximately 76 defaults globally, is made under our baseline scenario. It assumes that the US unemployment rate will ease slightly from its current level of 5.6% to 5.2% by the fourth quarter of 2015 while the high yield spread will widen to 575 bps from 460 bps.17
EXHIBIT 10 Speculative-grade default rate expected to tick up in 2015 Actual16%8%6%4%2%0oseline_ForecastPessimistic_ForecastTrailing 12-month EndingSource: Moody’s Investors Service While the recent drop in energy prices has raised concerns of rising default risk in the overall high yield market, we believe this should not lead to a spike in the near term default risk for Moody’s speculative-grade universe.18 Whereas Moody’s Liquidity Stress Index indicates a sharp rise in the Energy sector to 9.6% as of mid-February from 4.5% in December, the non-energy LSI remained unchanged at 2.9% from January, which was a 19-month low.19 Similarly, recent rating distribution and watchlist/outlook assignments show some heat among Oil & Gas companies, but there are no particular warning signs pointing to increased stress in the overall high yield market (see Exhibit 11). Although declining oil prices are deleterious for E&P and related companies, they represent a positive for consumer, transportation and a few materials-related industries. Overall, we believe lower oil prices will give the US and Indian economies a boost in the next two years, though they are unlikely to lift global growth significantly as headwinds from the euro area, China, Brazil, and Japan hold back economic activity.20
17
These are option-adjusted, three-month moving averages. 18
More discussion on the credit impact of lower oil prices on the energy and other sectors can be found at https://www.moodys.com/Pages/Credit-Impact-of-Lower-Oil-Prices.aspx 19
See Moody’s SGL Monitor - Liquidity Pressure Confined to Energy, February 2015. 20
See Moody’s Global Macro Outlook 2015-16 - Lower oil price fails to spur global growth, February 2015.
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EXHIBIT 11
Recent rating distribution and watchlist/outlook assignments in the speculative-grade universe
Sector
As of
Share of Caa-C isusers within the
SG universe
Share of Caa-C issuers on watch for downgrade or with negative
outlook
Oil & Gas
All Sectors
Beginning of 2014 Beginning of 2015 Mid-Feb 2015 Beginning of 2014 Beginning of 2015 Mid-Feb 2015
24.7% 27.3% 29.4% 27.1% 29.3% 29.6%
17.0% 18.5% 28.6% 24.9% 24.3% 25.4%
Although our baseline scenario remains relatively benign, we acknowledge that there is risk associated with the economic conditions, in particular outside of the US. In Europe, for example, downside risks include policy uncertainty and reform fatigue which could lead investors to reassess the degree of risk in the region and result in a tightening in financing conditions; uncertainties from geopolitical developments in Ukraine, Russia, and the Middle East; negative effects on the Russian economy from declining oil prices; and a
slowdown in the Chinese economy that would result in weaker demand for European exports. We cannot rule out the risk that the region falls back into recession. In our pessimistic scenario, the global economy will contract with the unemployment rate climbing to 9.7% and the high yield bond spread widening to 940 bps. In that case, the global high yield default rate is expected to rise to 9.9%, which will more than double the long-term average of 4.5% but still be well below the 2008-2009 peak of 13.9% (see the dark blue line in Exhibit 11).
Across industries, default rates for all of Moody’s-rated issuers are expected to be highest in the
Environmental sector in the US and in the Aerospace & Defense sector in Europe by the end of this year. Exhibit 12 shows the baseline one-year default rate forecasts across industries in both the US and Europe, sorted by the US rates in descending order.21 In each region, the same economic assumptions are applied to all industries, so the only factors driving the different forecasted default rates are the underlying rating histories and current ratings of the issuers in those industries.
EXHIBIT 12
One-year corporate default rate forecasts by industry
Industry
US
Europe
Industry
US
Europe
Environmental Industries* Services: Consumer Hotel, Gaming, & Leisure Metals & Mining Services: Business Consumer goods: Durable* Retail Wholesale* Aerospace & Defense Containers, Packaging, & Glass Media: Advertising, Printing & Publishing
21
5.9% 4.3% 3.8% 3.6% 3.0% 2.8% 2.8% 2.8% 2.7% 2.5% 2.4%
1.8% 2.0% 1.5% 1.6%
2.0%
3.8% 2.2% 1.2%
Transportation: Cargo Capital Equipment
Healthcare & Pharmaceuticals High Tech Industries Utilities: Oil & Gas Construction & Building Chemicals, Plastics, & Rubber Energy: Electricity* Transportation: Consumer Media: Diversified & Production* FIRE: Insurance
1.3% 1.2% 1.2% 1.2% 1.0% 1.0% 0.9% 0.8% 0.6% 0.5% 0.5%
0.8% 0.8% 1.2% 0.7% 0.5% 1.2% 0.7%
0.9%
2.1%
The industry default rate forecasts include both investment-grade and speculative-grade issuers.
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