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Moody�s Rating Migration and Credit Quality Correlation, 1920-1996 Moody
s Rating Migration and Credit
Quality Correlation, 1920-1996
Special Comment
July 1997
Contact
Phone
New York
Lea V. Carty
(212) 553-1655
Summary
In this study, we examine Moodys bond rating and default databases to document historical pat-
terns in ratings movements and the correlations of the movements of ratings of individual
issuers with each other. While the statistics presented in this report will interest a variety of
readers, we expect that they will be particularly useful to those readers involved in the pricing of
fixed-income instruments and credit derivatives, the credit assessment of pools of corporate debt
issues underlying a variety of structured transactions, and in the development of sophisticated
credit risk management systems. This analysis includes the credit histories of over 14,000 US
and non-US corporate debt issuers since 1920, a time-frame that allows comparison of rating
change patterns over a variety of business, interest rate, and other economic cycles. Briefly, the
results of this study indicate that:
Over the past 77 years sudden large changes in credit quality have been very infrequent. Of
all rating changes since 1920, only 11% involved changes of more than one rating category.
Higher ratings have been generally less likely than lower ratings to be revised over any time
period from one to 15 years. Since 1920, an issuer that started any given year with a rating
of Aaa ended the year with an Aaa 88% of the time. By contrast, an issuer that began the
year with a rating of Ba ended the year with that same rating 76% of the time.
When higher-end investment-grade ratings have changed, they have demonstrated a greater
propensity for downward movement than upward. Corporate issuers rated Aa to A have
demonstrated a greater probability of ending any given year one rating category lower than
that with which they started than they have of ending one rating category higher. However,
at the Baa level, issuers are only slightly more likely to drift below Baa as above in any given
one-year period. Furthermore, as the time horizon expands, non-defaulting Baa-rated
issuers stand a greater probability of moving higher than lower. Continuing down the spec-
trum, there is a relatively greater chance for a non-defaulting B-rated issuer to enjoy a net
upgrade than a non-defaulting Ba-rated issuer.
There is evidence that movements in credit qualities of different issuers are correlated with
each other and that the strength of this correlation is determined, in part, by macroeconom-
ic, industrial, geographic, and temporal factors. The extent to which the changes in credit
quality among different issues in a portfolio are or are not correlated can have a significant
impact on the overall volatility of that portfolio. Possible correlations can be examined
through rating and joint rating transition matrices.
Moodys Rating Migration and Credit
Quality Correlation, 1920-1996
Special Comment 2
Moodys Special Comment
� Copyright 1997 by Moodys Investors Service, Inc., 99 Church Street, New York, New York 10007. All rights reserved. ALL INFORMATION CONTAINED
HEREIN IS COPYRIGHTED IN THE NAME OF MOODYS INVESTORS SERVICE, INC. (MOODYS), AND NONE OF SUCH INFORMATION MAY
BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED
OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY
MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODYS PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODYS
from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided
as is without warranty of any kind and MOODYS, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, me
chantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODYS have any liability to any person or entity for (a) any loss
or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of
MOODYS or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication,
publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without
limitation, lost profits), even if MOODYS is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The
credit ratings, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or
recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS,
COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR
INFORMATION IS GIVEN OR MADE BY MOODYS IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as
one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and
evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling.
Pursuant to Section 17(b) of the Securities Act of 1933, MOODYS hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures,
notes and commercial paper) and preferred stock rated by MOODYS have, prior to assignment of any rating, agreed to pay to MOODYS for appraisal and rating services
rendered by it fees ranging from $1,000 to $350,000.
PRINTED IN U.S.A.
Editor
Crystal Carrafiello
Production Associate
Ruth Manso-Rivera
Table of Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Data & Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Rating Migration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
Trends in Corporate Credit Quality From 1920 Through 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
Rating Change Magnitude . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
Rating Change Magnitude and Direction Rating Transition Matrices . . . . . . . . . . . . . . . . . . . . . . .7
Withdrawn Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
Multi-Year, Rating Transition Matrices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
Rating Transition Rate Volatility and
Credit Quality Correlation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
Rating Transition Rate Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
Credit Quality Correlation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13
The Impact of Credit Quality Correlation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15
Industrial and Geographic Considerations for Credit Quality Correlations . . . . . . . . . . . . . . . . . . . . .16
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Moodys Special Comment 3
Introduction
Practitioners and academics alike have made great strides in the measurement and management of many
financial risks including those attributable to interest rate, exchange rate, and market fluctuations.
Noticeably absent from this list of financial risks is credit risk. The tremendous informational require-
ments and complexity of issuer-specific credit analysis combined with the difficulty of directly observing
the price of credit risk has conspired to hinder progress in the theory and practice of credit risk manage-
ment. Yet there is a real need to more precisely quantify credit exposures, particularly within a portfolio
context