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2016 Inaugural Global Financial Services Default Study and Rating Transitions

Financial services entities rated by S&P Global Ratings, including the bank, nonbank financial institution (NBFI), and insurance sectors, experienced overall high ratings stability and credit quality in 2016, even amid rising global pressures and uncertainty, from volatile commodity prices to rising geopolitical risks, along with political votes that shifted the global dynamic, including the Brexit referendum. A total of 16 rated global financial services issuers defaulted in 2016, an increase from 12 rated defaults in 2015, marking the highest number of defaults from rated financial entities since 2009. These defaults included several NBFIs from the U.S. in advance of pending regulatory actions, along with several banks from Russia and Central and Eastern Europe that defaulted through a regulatory directive. Meanwhile, the largest default of the year was a U.S. bank, the Government Development Bank for Puerto Rico, and the highest-rated defaulter was Panamanian reinsurer Istmo Compania de Reaseguros Inc., which was rated 'BBB' as of the beginning of 2016. This marked the first time in five years that a financial services company defaulted in a year in which it was rated investment grade ('BBB-' or higher) as of the beginning of the year.

Despite rising uncertainty and defaults, ratings remained stable for the majority of financial services entities during the year, and measures of credit quality and ratings stability remained generally in line with historical averages. Default rates were above average only for the lowest rating categories of 'B' and 'CCC'. The default rate for speculative-grade (rated 'BB+' or lower) financial entities globally rose to 2.71% in 2016, and while this was the highest rate since 2010, it remained below the default rate for speculative-grade nonfinancial companies. While the default rate for financial services companies has been rising in recent years, the pace of defaults slowed through the first half of 2017.

Overview

  • The number of rated financial entities that defaulted rose to 16 in 2016 from 12 in 2015. The highest rated among the year's defaults was Istmo Compania de Reaseguros, which was rated 'BBB' as of the beginning of 2016, marking the first investment-grade default from a financial services company since the default of MF Global in 2011.
  • The trailing-12-month default rate for speculative-grade financial entities rose to 2.71% in 2016 from 2.33% in 2015, considerably lower than the 4.19% speculative-grade default rate for corporate entities globally.
  • The ratings on financial entities were largely stable in 2016, with 77.1% of ratings remaining unchanged during the year.
  • The Gini coefficient, which we use to measure ratings performance, had a long-term (since 1981) weighted average of 79.56% for financial services companies. The one-year Gini coefficient rose to 91.77% in 2016 from 91.5% in 2015.

This is the inaugural global financial services study, where we review the defaults, transitions, and ratings performance of the broad financial services sector, including the bank, NBFI, and insurance sectors. Our findings in this study show that ratings continue to serve as effective indicators of relative credit risk for financial services companies. We identified a clear negative correspondence between ratings and defaults: The higher the issuer credit rating, the lower the observed default frequency. Historically, financial services issuers tend to have lower default rates than in the nonfinancial corporate sectors, though they also tend to be more sensitive to changes in investor confidence. For those companies that do default, the decline in credit quality can be swift once lenders and counterparties lose confidence in the entity.

Defaults of financial services companies have often involved some type of asset/liability mismatch, wherein a combination of illiquid assets and accelerating liabilities is ignited by a collapse in confidence (such as in the institution or in the value of the assets), sparking a "run on the bank" scenario, where depositors, policyholders, or lenders make demands that cannot be met, either due to illiquidity or insolvency. In many cases, this leads to a regulatory intervention, such as when a bank or insurer is taken under regulatory supervision by its regulator or, as we saw during the 2008-2009 period, when a government steps in to provide extraordinary support to a systemically important financial institution.

Defaults of banks and NBFIs are often cyclical, with defaults rising during periods of recession or other times of financial stress. Some of the notable periods of financial stress that contributed to elevated default rates for banks and NBFIs included the housing crash and Great Recession of 2008-2009, as well as the savings and loan crisis in 1989. Additionally, global financial services default rates have risen in years with a sovereign default, such as following that of the Russian Federation in 1999 and of Argentina in 2001 and 2002. Meanwhile, though the insurance sector also experiences periods of rising defaults, these cycles tend to follow industry trends of aggressive pricing or reserving and do not necessarily follow the broader business cycle.

Our study of global financial defaults identified a clear negative correlation between ratings and defaults. We show this relationship with a Gini ratio, which is a measure of the rank-ordering power of ratings over a given time horizon (see table 1). This measure shows the ratio of actual rank-ordering performance to theoretically perfect rank ordering. Despite the increasing number of defaults in 2016, including one investment-grade default, the one-year Gini ratio--a key measure of the relative ability of ratings to differentiate risk--remained elevated because most of the year's defaults came from the lowest-rated companies.

The one-year Gini ratio rose to 91.77% in 2016 from 91.5% in 2015 and remains above its long-term average. In recent years, financial services ratings have had one-year Gini coefficients well above the average, holding above 90% over the past five years as multiple central banks have pursued quantitative easing. Over longer time horizons, Gini ratios continue to attest to ratings as effective indicators of relative default risk. The one-year weighted-average Gini coefficient for financial entities is 79.56%, the three-year is 68.44%, the five-year is 60.87%, and the seven-year is 55.91%. These weighted-average Gini ratios are weighted by yearly issuer counts since 1981 (see Appendix II for Gini methodology details).

Gini Coefficients For Financial And Nonfinancial Issuer Ratings (1981-2016)

  --Time Horizon--
  One-year Three-year Five-year Seven-year
Financials        
Weighted average 79.56 68.44 60.87 55.91
Average 81.67 74.23 65.79 58.76
Standard deviation (20.93) (14.58) (15.87) (14.21)
Nonfinancials
Weighted average 80.77 73.03 69.92 68.15
Average 84.14 76.87 73.03 70.03
Standard deviation (6.11) (5.34) (5.62) (5.27)

Note: Financials consist of banks, NBFIs, and insurance companies. Nonfinancials consist of all nonfinancial corporates. Numbers in parentheses are standard deviations. Sources: S&P Global Fixed Income Research and S&P Global Market Intelligence's CreditPro®.