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Abstract:
This paper analyzes the impact of various assumptions about the association between aggregate default probabilities and the loss given default on bank loans and corporate bonds, and seeks to empirically explain this critical relationship. Moreover, it simulates the effects on mandatory capital requirements like those proposed in 2001 by the Basel Committee on Banking Supervision. We present the analysis and results in four distinct sections. The first section examines the literature of the last three decades of the various structural-form, closed-form and other credit risk and portfolio credit value-at-risk (VaR) models and the way they explicitly or implicitly treat the recovery rate variable. Section 2 presents simulation results under three different recovery rate scenarios and examines the impact of these scenarios on the resulting risk measures: our results show a significant increase in both expected and unexpected losses when recovery rates are stochastic and negatively correlated with default probabilities. In Section 3, we empirically examine the recovery rates on corporate bond defaults, over the period 1982-2000. We attempt to explain recovery rates by specifying a rather straightforward statistical least squares regression model. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities. Our econometric univariate and multivariate time series models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. Finally, in Section 4 we analyze how the link between default probability and recovery risk would affect the procyclicality effects of the New Basel Capital Accord, due to be released in 2002. We see that, if banks use their own estimates of LGD (as in the "advanced" IRB approach), an increase in the sensitivity of banks' LGD due to the variation in PD over economic cycles is likely to follow. Our results have important implications for just about all portfolio credit risk models, for markets which depend on recovery rates as a key variable (e.g., securitizations, credit derivatives, etc.), for the current debate on the revised BIS guidelines for capital requirements on bank credit assets, and for investors in corporate bonds of all credit qualities.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
Using data from three countries (US, Italy and Australia) and surveying related studies from several other countries in Europe, we investigate the effects of the New Basel Capital Accord (Basel II) on bank capital requirements for small and medium sized enterprises (SMEs). For each country, we analyze different possibilities that banking organizations have in considering SMEs, as either retail or as corporate, with a special discount linked to the firm's sales size. We find that, for all the countries, banks will have significant benefits, in terms of lower capital requirements, when considering small and medium sized firms as retail customers. But they will be obliged to use the Advanced IRB approach (providing their own estimates of probability of default (PD) and loss given default (LGD) for each counterparty) and to manage them on a pooled basis. For SMEs as corporate, however, the results show that capital requirements will be slightly greater than under the existing Basel I Capital Accord. We believe that most eligible banks will use a blended approach (considering some SMEs as retail and some as corporate). Through a breakeven analysis, we find that for all of our countries, banking organizations will be obliged to classify as retail at least 20% of their SME portfolio in order to, at a minimum, maintain the current capital requirement (8%). Moreover, we show that the percentage of SMEs to be classified as retail increases to at least 40% if banks will want to enjoy lower capital requirements by implementing the Advanced IRB instead of the Standardized approach. Since one of the main goals of the new Basel Capital Accord is to improve the efficiency of banks risk management systems, we conclude that a likely impact will be an additional motivation for banks to consider and manage their SMEs clients as retail customers.

SME finance, basel II, bank capital requirements, retail banking

Abstract:
Until the last few years, the high yield bond market was essentially a solely U.S. capital market phenomena. That this non-investment grade, fixed income asset class has grown so impressively in the U.S. and now is possibly on the verge of an explosion of new issuance in Europe is primarily based on a simple summary performance statistic -- an average annual net return to investors of about 250 basis points per year above the risk-free rate for the past two decades. Just as the U.S. high yield market rebounded from its debacles in the late 1980's and the Mexican Eurobond market from its peso crisis in early 1995, the long-term key factor in Europe will be the fundamental health of firms issuing bonds. Despite short-term gyrations and flights to quality, there is still no substitute for careful and objective analysis of the underlying firms and securities that comprise the market.

Abstract:
The market for investing in distressed and defaulted debt is continuing to receive a great deal of attention despite the shrinkage in the supply of new securities in the last few years and the recent (1997-98) poor return performance to investors. This is primarily due to the expected growth in the supply of new distressed and defaulted public and private debt paper, the perception that prices are now at attractive levels and the documented relatively low correlation of returns with the more traditional debt and equity markets. This article reviews some of the important attributes of this unique investment vehicle and updates our analysis of the risk and return performance of defaulted debt.

Abstract:
Considering the fundamental role played by small and medium sized enterprises (SMEs) in the economy of many countries and the considerable attention placed on SMEs in the new Basel Capital Accord, we develop a distress prediction model specifically for the SME sector and to analyze its effectiveness compared to a generic corporate model. The behavior of financial measures for SMEs is analyzed and the most significant variables in predicting the entities' credit worthiness are selected in order to construct a default prediction model. Using a logit regression technique on a panel of over 2,000 US firms (with sales less than $65 million) over the period 1994-2002, we develop a one-year default prediction model. This model has an out of sample prediction power which is almost 30% higher than a generic corporate model. An associated objective is to observe our model's ability to lower bank capital requirements considering the new Basel Capital Accord's rules for SMEs.

SME finance, Modeling credit risk, Basel II, Bank capital requirements

Abstract:
In recent years, credit risk has played a key role in risk management issues. Practitioners, academics and regulators have been fully involved in the process of developing, studying and analyzing credit risk models in order to find the elements which characterize a sound risk management system. In this paper we present an integrated model, based on a reduced pricing approach, for market and credit risk. Its main features are those of being mark to market and that the spread term structure by rating class is contingent on the seniority of debt within an arbitrage-free framework. We introduce issues such as, the integration of market and credit risk, the use of stochastic recovery rates and recovery by seniority. Moreover, we will characterize default risk by estimating migration risk through a "mortality rate", actuarial based, approach. The resultant probabilities will be the base for determining multi-period risk-neutral transition probability that allow pricing of risky debt in the trading and banking book.

statistical simulation methods, financial risk management, credit risk measurement model, asset pricing, debt & debt management

Abstract:
In recent years, credit risk has played a key role in risk management issues. Practitioners, academics and regulators have been fully involved in the process of developing, studying and analysing credit risk models in order to find the elements which characterize a sound risk management system. In this paper we present an integrated model, based on a reduced pricing approach, for market and credit risk. Its main features are those of being mark to market and that the spread term structure by rating class is contingent on the seniority of debt within an arbitrage-free framework. We introduce issues such as, the integration of market and credit risk, the use of stochastic recovery rates and recovery by seniority. Moreover, we will characterise default risk by estimating migration risk through a "mortality rate", actuarial based, approach. The resultant probabilities will be the base for determining multi-period risk-neutral transition probability that allow pricing of risky debt in the trading and banking book.

Abstract:
During the last two years, credit risk has been playing a key role in risk management issues. Practitioners, academics and regulators have been fully involved in the process of developing, studying and analysing credit risk models in order to find the elements, which characterize a sound risk management system. In this paper we present an integrated model, based on a reduced form pricing, for market and credit risk and its main features are those of being mark to market and that the spread term structure by rating class is adjusted for a spread term structure which is contingent on the seniority of debt within an arbitrage-free framework. We introduce issues such as, the integration of market and credit risk, the use of stochastic recovery rates and recovery by seniority. Moreover, we will characterise default risk by estimating migration risk through a 'mortality rate' - actuarial based - approach. The resultant probabilities will be the base for determining multi-period risk-neutral transition probability that allow to price risky debt trading and banking book plain vanilla type securities.

statistical simulation methods, financial risk management, credit risk measurement model, pricing models, debt & debt management, portfolio choice

Abstract:
This paper analyses the impact of various assumptions about the association between aggregate default probabilities and the loss given default on bank loans and corporate bonds, and seeks to empirically explain this critical relationship. Moreover, it simulates the effects of this relationship on the procyclicality of mandatory capital requirements like those proposed in 2001 by the Basel Committee on Banking Supervision. We present the analysis and results in four distinct sections. The first section examines the literature of the last three decades of the various structural-form, closed-form and other credit risk and portfolio credit value-at-risk (VaR) models and the way they explicitly or implicitly treat the recovery rate variable. Section 2 presents simulation results under three different recovery rate scenarios and examines the impact of these scenarios on the resulting risk measures: our results show a significant increase in both expected an unexpected losses when recovery rates are stochastic and negatively correlated with default probabilities. In Section 3, we empirically examine the recovery rates on corporate bond defaults, over the period 1982-2000. We attempt to explain recovery rates by specifying a rather straightforward statistical least squares regression model. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities. Our econometric univariate and multivariate time series models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. Finally, in Section 4 we analyse how the link between default probability and recovery risk would affect the procyclicality effects of the New Basel Capital Accord, due to be released in 2002. We see that, if banks are let free to use their own estimates of LGD (as in the advanced IRB approach), an increase in their sensitivity to economic cycles would follow. Our results have important implications for just about all portfolio credit risk models, for markets which depend on recovery rates as a key variable (eg securitisations, credit derivatives, etc), for the current debate on the revised BIS guidelines for capital requirements on bank credit assets, and for investors in corporate bonds of all credit qualities.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
This paper examines the price reaction of loans relative to bonds prior to and surrounding information intensive events, such as corporate (loan and bond) defaults, and bankruptcies using a unique dataset of daily secondary market prices of loans. Specifically, we find that risk-adjusted loan prices fall more than risk-adjusted bond prices prior to an event, and less than risk-adjusted bond prices of the same borrower during a short time period surrounding an event. This evidence is consistent with a monitoring advantage of loans over bonds. Our results are robust to a different empirical methodology (Vector Auto Regression based Granger causality), and to alternative explanations which control for security-specific characteristics, such as seniority, collateral, recovery rates, liquidity, covenants, and for multiple measures of cumulative abnormal returns.

Bankruptcy, bonds, default, loans, monitoring, spillovers, stocks

Abstract:
Dr. Altman has earned an international reputation as an expert on corporate bankruptcy, high yield bonds, distressed debt and credit risk analysis. In this article, Altman and his team provide a comprehensive review of the 2005 high yield bond market. The article provides detailed long-term analysis of the US market, as well as trends in default, bankruptcy, recovery and returns for investors. Against this historical backdrop, the article offers some guidance on expected default rates and market performance in the burgeoning high-yield distressed bond market.

Corporate bonds, bankruptcy, distressed debt

Abstract:
The first quarter 2004 default rate for U.S. (and Canada) dollar-denominated high yield bonds was 0.41% based on $3.6 billion of defaults. This rate was just slightly higher than the fourth quarter 2003's very low rate of 0.36%. The latter was the lowest quarterly rate since the third quarter of 1998. The four-quarter rate as of March 31, 2004 continued its downward trend to 4.02% from 4.66% as of year-end 2003. There has only been one fallen angel default issue from a single company so far in 2004 compared to a total of 24 issues from 15 companies for all of 2003.

New issues totaled a robust $43.8 billion, somewhat lower than the average quarterly figure for 2003 (which was almost a record high year). Returns on high yield bonds in the first quarter were 1.81% with a spread of -2.80% compared to ten-year Treasuries, which return 4.61%. The distressed ratio on high yield bonds increased slightly to 6.6%, up from 5.7% as of year-end 2004. In addition, the yield spread on high yield bonds increased by 43 bp over the past three months. While the increase in both the distress ratio and the high yield bond spread were minor, they indicate a market sentiment that is growing slightly more concerned about default risk.

Abstract:
This paper discusses two of the primary motivating influences on the recent development/revisions of credit scoring models, i.e., the important implications of Basel 2 s proposed capital requirements on credit assets and the enormous amounts and rates of defaults and bankruptcies in the US in 2001-2002. Two of the more prominent credit scoring techniques, Z-Score and KMV s EDF models, are reviewed. Finally, both models are assessed with respect to default probabilities in general and in particular to the infamous Enron debacle. In order to be effective, these and other credit risk models should be utilized by firms with a sincere credit risk culture.

Credit Risk Models, Default Probabilities, Basel 2, Z-Score, KMV

Abstract:
This paper discusses two of the primary motivating influences on the recent development/revisions of credit scoring models, i.e., the important implications of Basel 2 s proposed capital requirements on credit assets and the enormous amounts and rates of defaults and bankruptcies in the US in 2001-2002. Two of the more prominent credit scoring techniques, Z-Score and KMV s EDF models, are reviewed. Finally, both models are assessed with respect to default probabilities in general and in particular to the infamous Enron debacle. In order to be effective, these and other credit risk models should be utilized by firms with a sincere credit risk culture.

Credit Risk Models, Default Probabilities, Basel 2, Z-Score, KMV

Abstract:
This paper discusses two of the primary motivating influences on the recentdevelopment/revisions of credit scoring models, i.e., the important implications ofBasel 2 s proposed capital requirements on credit assets and the enormous amountsand rates of defaults and bankruptcies in the US in 2001-2002. Two of the more prominent credit scoring techniques, Z-Score and KMV s EDF models, are reviewed. Finally, both models are assessed with respect to default probabilities in general and in particular to the infamous Enron debacle. In order to be effective, these and other credit risk models should be utilized by firms with a sincere credit risk culture.

Credit Risk Models, Default Probabilities, Basel 2, Z-Score, KMV

Abstract:
This paper explores the impressive growth in the high-yield, leveraged loan and distressed debt markets and comments on the unusually low current default rates and high recoveries in these markets. The main reasons for these low default rates are the unprecedented growth in liquidity from non-traditional lenders, like hedge and private equity funds, as well as, again, from traditional lenders. We speculate on whether this excess liquidity will continue to dominate the market or will we observe a regression to the long-term mean and where default and recoveries will once again be based on firm-fundamental and more traditional demand/supply risk patterns.

defaults, liquidity, credit risk, hedge funds

Abstract:
In recent years, the literature of financial distress has been enriched by the development of formal models. This paper develops a synthesis of that formal analysis, linking it to related finance literature and corporate strategies for distressed financial restructuring. Several key assumptions generate different results which predict the effects of financial distress on investment efficiency and restructuring strategy. Central to these strategies are the recontracting arrangements proposed between owners, creditors and other relevant stakeholders. The critical factors in the alternative models are: (1) the term structure of the firm s debt, (2) the role of the seniority of debts, (3) the effects of exchange offers, (4) the effects of an automatic stay on debt payments, and (5) the role of alternative voting rules.

Abstract:
We are experiencing dynamic changes in the interest and concern with credit risk management despite historically low default rates and losses in the loan and corporate bond markets. The reasons are that lending institutions are increasingly comfortable with transacting their assets in counterparty arrangements whereby credit risk exposed is shifted. This motivation has helped to stimulate the congruence of several important ingredients for the sophisticated treatment of corporate credit evaluation and management including stand-alone valuation techniques, portfolio management approaches, comprehensive and reliable relevant data bases and the growth in credit derivative and other types of credit insurance structures. We expect these dynamic forces to continue over the next several years.

Abstract:
This paper discusses two of the primary motivating influences on the recent development/revisions of credit scoring models - the important implications of Basel II's proposed capital requirements on credit assets and the enormous amounts and rates of defaults and bankruptcies in the United States in 2001-2002. Two of the more prominent credit scoring techniques, our Z-Score and KMV's EDF models, are reviewed. Both models are assessed with respect to default probabilities in general and in particular to the infamous Enron and WorldCom debacles in particular. In order to be effective, these and other credit risk models should be utilized by firms with a sincere credit risk culture, observant of the fact that they are best used as an additional tool, not the sole decision making criteria, in the credit and security analyst process.

Credit Risk Models, Default Probabilities, Basel II, Z-Score, KMV

Abstract:
This paper discusses two of the primary motivating influences on the recentdevelopment/revisions of credit scoring models, - the important implications ofBasel II s proposed capital requirements on credit assets and the enormous amountsand rates of defaults and bankruptcies in the United States in 2001-2002. Two ofthe more prominent credit scoring techniques, our Z-Score and KMV s EDF models, are reviewed. Both models are assessed with respect to default probabilities in general and in particular to the infamous Enron and WorldCom debacles in particular. In order to be effective, these and other credit risk models should be utilized by firms with a sincere credit risk culture, observant of the fact that they are best used as an additional tool, not the sole decision making criteria, in the credit and security analyst process.

Credit Risk Models, Default Probabilities, Basel II, Z-Score, KMV

Abstract:
Surveys on the use of agency credit ratings reveal that most investors believe that rating agencies are relatively slow in adjusting their ratings. A well-accepted explanation for this perception on the timeliness of agency ratings is the "through-the-cycle" methodology, which agencies apply in their rating assessments, while investors have a "point-in-time" perception on the creditworthiness. The â¬Sthrough-the-cycleâ¬? methodology aims to suppress the sensitivity of the ratings to short-term fluctuations in credit quality. This article focuses on the migration policy of rating agencies as a second source of rating stability. In a benchmark study with credit scoring models we show that both the "through-the-cycle" methodology and the conservative migration policy are responsible for the investors' perception of the rigidity of agency ratings.

Rating Agencies, "through-the-cycle" rating methodology, migration policy, credit scoring models

Abstract:
Evidence from many countries in recent years suggests that collateral values and recovery rates on corporate defaults can be volatile and, moreover, that they tend to go down just when the number of defaults goes up in economic downturns. This link between recovery rates and default rates has traditionally been neglected by credit risk models, as most of them focused on default risk and adopted static loss assumptions, treating the recovery rate either as a constant parameter or as a stochastic variable independent from the probability of default. This traditional focus on default analysis has been partly reversed by the recent significant increase in the number of studies dedicated to the subject of recovery rate estimation and the relationship between default and recovery rates. This paper presents a detailed review of the way credit risk models, developed during the last thirty years, treat the recovery rate and, more specifically, its relationship with the probability of default of an obligor. Recent empirical evidence concerning this issue is also presented and discussed.

credit rating, credit risk, recovery rate, default rate

Abstract:
This paper has examined two specific aspects of stage 1 of the (BIS's) Bank for International Settlement's proposed reforms to the 8% risk-based capital ratio. We argue that relying on "traditional" agency ratings could produce cyclically lagging rather leading capital requirements, resulting in an enhanced rather than reduced degree of instability in the banking and financial system. Despite this possible shortcoming, we believe that sensible risk based weighting of capital requirements is a step in the right direction. The current risk based bucketing proposal, which is tied to external agency ratings, or possibly to internal bank ratings, however, lacks a sufficient degree of granularity. In particular, lumping A and BBB (investment grade corporate borrowers) together with BB and B (below investment grade borrowers) severely misprices risk within that bucket and calls, at a minimum, for that bucket to be split into two. We examine the default loss experience on corporate bonds for the period 1981-1999 and propose a revised weighting system which more closely resembles the actual loss experience on credit assets.

Abstract:
This paper has examined two specific aspects of stage 1 of the (BISâ¬"s) Bank for International Settlementâ¬"s proposed reforms to the 8% risk-based capital ratio. We arguethat relying on â¬Straditionalâ¬? agency ratings could produce cyclically lagging rather leading capital requirements, resulting in an enhanced rather than reduced degree of instability in the banking and financial system. Despite this possible shortcoming, we believe that sensible risk based weighting of capital requirements is a step in the right direction. The current risk based bucketing proposal, which is tied to external agency ratings, or possibly to internal bank ratings, however, lacks a sufficient degree of granularity. In particular, lumping A and BBB (investment grade corporate borrowers) together with BB and B (below investment grade borrowers) severely misprices risk within that bucket and calls, at a minimum, for that bucket to be split into two. We examine the default loss experience oncorporate bonds for the period 1981-1999 and propose a revised weighting system whichmore closely resembles the actual loss experience on credit assets.

Abstract:
This paper analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults, over the period 1982-2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role. Such a link would bring about a significant increase in both expected and unexpected losses as measured by some widespread credit risk models, and would affect the procyclicality effects of the New Basel Capital Accord. Our results have also important implications for investors in corporate bonds and bank loans, and for all markets (e.g., securitizations, credit derivatives, etc.) which depend on recovery rates as a key variable.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
This paper analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults, over the period 1982-2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role. Such a link would bring about a significant increase in both expected and unexpected losses as measured by some widespread credit risk models, and would affect the procyclicality effects of the New Basel Capital Accord. Our results have also important implications for investors in corporate bonds and bank loans, and for all markets (e.g., securitizations, credit derivatives, etc.) which depend on recovery rates as a key variable.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
This paper analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults, over the period 1982-2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role. Such a link would bring about a significant increase in both expected and unexpected losses as measured by some widespread credit risk models, and would affect the procyclicality effects of the New Basel Capital Accord. Our results have also important implications for investors in corporate bonds and bank loans, and for all markets (e.g., securitizations, credit derivatives) that depend on recovery rates as a key variable.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
This paper analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults, over the period 1982-2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. The central thesis is that aggregaterecovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role. Such a link would bring about a significant increase in both expected and unexpected losses as measured by some widespread credit risk models, and would affect the procyclicality effects of the New Basel Capital Accord. Our results have also important implications for investors in corporate bonds and bank loans, and for all markets (e.g.,securitizations, credit derivatives, etc.) which depend on recovery rates as a key variable.

credit rating, capital requirements, credit risk, recovery rate, defaul, procyclicality

Abstract:
This paper analyzes the impact of various assumptions about the association between aggregate default probabilities and the loss given default on bank loans and corporate bonds, and seeks to empirically explain this critical relationship. Moreover, it simulates the effects on mandatory capital requirements like those proposed in 2001 by the Basel Committee on Banking Supervision. We present the analysis and results in four distinct sections. The first section examines the literature of the last three decades of the various structural-form, closed-form and other credit risk and portfolio credit value-at-risk (VaR) models and the way they explicitly or implicitly treat the recovery rate variable. Section 2 presents simulation results under three different recovery rate scenarios and examines the impact of these scenarios on the resulting risk measures: our results show a significant increase in both expected and unexpected losses when recovery rates are stochastic and negatively correlated with default probabilities. In Section 3, we empirically examine the recovery rates on corporate bond defaults, over the period 1982-2000. We attempt to explain recovery rates by specifying a rather straightforward statistical least squares regression model. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities. Our econometric univariate and multivariate time series models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. Finally, in Section 4 we analyze how the link between default probability and recovery risk would affect the procyclicality effects of the New Basel Capital Accord, due to be released in 2002. We see that, if banks use their own estimates of LGD (as in the "advanced" IRB approach), an increase in the sensitivity of banks LGD due to the variation in PD over economic cycles is likely to follow. Our results have important implications for just about all portfolio credit risk models, for markets which depend on recovery rates as a key variable (e.g., securitizations, credit derivatives, etc.), for the current debate on the revised BIS guidelines for capital requirements on bank credit assets, and for investors in corporate bonds of all credit qualities.

Abstract:
This paper analyzes the impact of various assumptions about the association between aggregate default probabilities and the loss given default on bank loans and corporate bonds, and seeks to empirically explain this critical relationship. Moreover, it simulates the effects on mandatory capital requirements like those proposed in 2001 by the Basel Committee on Banking Supervision. We present the analysis and results in four distinct sections. The first section examines the literature of the last three decades of thevarious structural-form, closed-form and other credit risk and portfolio credit value-at-risk (VaR) models and the way they explicitly or implicitly treat the recovery rate variable. Section 2 presents simulationresults under three different recovery rate scenarios and examines the impact of these scenarios on the resulting risk measures: our results show a significant increase in both expected and unexpected losses when recovery rates are stochastic and negatively correlated with default probabilities. In Section 3, we empirically examine the recovery rates on corporate bond defaults, over the period 1982-2000. We attempt to explain recovery rates by specifying a rather straightforward statistical least squares regression model. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities. Our econometric univariate and multivariate time series models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. Finally,in Section 4 we analyze how the link between default probability and recovery risk would affect the procyclicality effects of the New Basel Capital Accord, due to be released in 2002. We see that, if banks use their own estimates of LGD (as in the â¬Sadvancedâ¬? IRB approach), an increase in the sensitivity ofbanksâ¬" LGD due to the variation in PD over economic cycles is likely to follow. Our results have important implications for just about all portfolio credit risk models, for markets which depend on recovery rates as a key variable (e.g., securitizations, credit derivatives, etc.), for the current debate on the revised BIS guidelines for capital requirements on bank credit assets, and for investors in corporate bonds of all credit qualities.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
The authors findings also suggest that a credible corporate distress prediction model could be used as an independent, unbiased method for assessing the future viability of proposed reorganization plans. Another potential application of the model is by the creditors of the “old” company when assessing the investment value of the new package of securities, including new equity, offered in the plan.The author reports that those companies that filed second bankruptcy petitions were both significantly less profitable and more highly leveraged than those that emerged and continued as going concerns. Indeed, the average financial profile and bond rating equivalent for the “Chapter 22” companies on emerging from their first bankruptcies were not much better than those of companies in default.Despite the long experience in the U.S. with restructuring companies in bankruptcy, there remains a persistent tendency for companies to emerge from Chapter 11 with too much debt and too little profitability. In this article, the author uses a variant of his well-known “Z-Score” bankruptcy prediction model to assess the future viability of companies when emerging from bankruptcy, including the likelihood that they will file again — a surprisingly common phenomenon that is now referred to as “Chapter 22.”

The author reports that those companies that filed second bankruptcy petitions were both significantly less profitable and more highly leveraged than those that emerged and continued as going concerns. Indeed, the average financial profile and bond rating equivalent for the “Chapter 22” companies on emerging from their first bankruptcies were not much better than those of companies in default.

The authors findings also suggest that a credible corporate distress prediction model could be used as an independent, unbiased method for assessing the future viability of proposed reorganization plans. Another potential application of the model is by the creditors of the “old” company when assessing the investment value of the new package of securities, including new equity, offered in the plan.

Abstract:
Forty years ago, I developed a method of predicting bankruptcies by U.S. [public] companies that makes use of equity market values as well as fundamental financial and operating data. Since that time, my 'Z-Score' model has become one of the most widely used methods for assessing the creditworthiness of manufacturing companies throughout the world. And it continues to be used by both finance scholars and practitioners in a variety of ways, including credit and debt analysis, investment decisions, merger and acquisition screens, audit-risk analysis, and receivables management. It has also been used by corporate managers and their advisers when managing turnarounds of distressed companies. This article extends the use of bankruptcy prediction models to a new application: the assessment of the health of industrial companies as they emerge from the Chapter 11 bankruptcy process, including the probability that the companies will have to file for bankruptcy again - the so-called 'Chapter 22' phenomenon. Using a modified Z-Score model, I find significant economic differences between those companies that emerge from Chapter 11 and survive as going concerns and those that later file again. In particular, companies that filed a second Chapter 11 had significantly higher leverage and lower profitability shortly after emerging the first time. The predictive ability of this modified Z-Score suggests it can be used as a effective tool for evaluating the quality and efficacy of the bankruptcy reorganization plan.

Abstract:
This paper analyzes the association between aggregate default and recovery rates on credit assets, and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults, over the period 1982-2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across all seniority and collateral levels. The central thesis is that aggregate recovery rates are basically a function of supply and demand for the securities, with default rates playing a pivotal role. Such a link would bring about a significant increase in both expected and unexpected losses as measured by some widespread credit risk models, and would affect the procyclicality effects of the New Basel Capital Accord. Our results have also important implications for investors in corporate bonds and bank loans, and for all markets (e.g., securitizations, credit derivatives) that depend on recovery rates as a key variable.

credit rating, capital requirements, credit risk, recovery rate, default, procyclicality

Abstract:
The defaulted and distressed, public and private debt markets in the United States increased enormously to a record $942 billion (face value) at the end of 2002. The market value of this increasingly attractive alternative investment segment was approximately $512 billion.Defaulted securities performed below average in 2002; absolute returns, as measured by our various defaulted debt indexes, were - 6.0% on bonds, +3.0% on bank loans, and - 0.5% on the combined defaulted public bonds and private bank loans index. The Altman-NYU Salomon Center Index of Defaulted Bonds grew to a face value of $61.5 billion. The market-to-face value ratio of the Bond Index fell to 0.17 from 0.21 one year ago. The face value of our Defaulted Bank Loan Index was $37.7 billion and the market-to-face value ratio dropped to a record low level of 0.46 by the end of 2002.The recovery rate on defaulted bonds (price just after default) was very low at 25 cents on the dollar; likewise, the weighted average bank loan recovery rate in 2002 dropped to 52 cents on the dollar. With new defaulted bonds rising in 2002 to a record $96.9 billion (default rate of 12.8%) and the default outlook for 2003 high, but lower than for 2002, investment opportunities should abound in the distressed debt market.Indications are that distressed investors (both old and new entities) are successfully raising funds because investor expectations are buoyant.

Abstract:
The defaulted and distressed, public and private debt markets in the United States increased enormously to a record $942 billion (face value) at the end of 2002. The market value of this increasingly attractive alternative investment segment was approximately $512 billion. Defaulted securities performed below average in 2002; absolute returns, as measured by our various defaulted debt indexes, were - 6.0% on bonds, +3.0% on bank loans, and - 0.5% on the combined defaulted public bonds and private bank loans index. The Altman-NYU Salomon Center Index of Defaulted Bonds grew to a face value of $61.5 billion. The market-to-face value ratio of the Bond Index fell to 0.17 from 0.21 one year ago. The face value of our Defaulted Bank Loan Index was $37.7 billion and the market-to-face value ratio dropped to a record low level of 0.46 by the end of 2002. The recovery rate on defaulted bonds (price just after default) was very low at 25 cents on the dollar; likewise, the weighted average bank loan recovery rate in 2002 dropped to 52 cents on the dollar. With new defaulted bonds rising in 2002 to a record $96.9 billion (default rate of 12.8%) and the default outlook for 2003 high, but lower than for 2002, investment opportunities should abound in the distressed debt market. Indications are that distressed investors (both old and new entities) are successfully raising funds because investor expectations are buoyant.

Abstract:
# The defaulted and distressed, public and private debt markets in the United States increased enormously to a record $942 billion (face value) at the end of 2002. The market value of this increasingly attractive alternative investment segment was approximately $512 billion.# Defaulted securities performed below average in 2002; absolute returns, as measured by our various defaulted debt indexes, were - 6.0% on bonds, +3.0% on bank loans, and - 0.5% on the combined defaulted public bonds and private bank loans index. The Altman-NYU Salomon Center Index of Defaulted Bonds grew to a face value of $61.5 billion. The market-to-face value ratio of the Bond Index fell to 0.17 from 0.21 one year ago. The face value of our Defaulted Bank Loan Index was $37.7 billion and the market-to-face value ratio dropped to a record low level of 0.46 by the end of 2002.# The recovery rate on defaulted bonds (price just after default) was very low at 25 cents on the dollar; likewise, the weighted average bank loan recovery rate in 2002 dropped to 52 cents on the dollar. With new defaulted bonds rising in 2002 to a record $96.9 billion (default rate of 12.8%) and the default outlook for 2003 high, but lower than for 2002, investment opportunities should abound in the distressed debt market.# Indications are that distressed investors (both old and new entities) are successfully raising funds because investor expectations are buoyant.

Abstract:
This article assesses and analyzes the size and performance of defaulted bonds and bank loans for the period 1987-2002. Defaulted bonds and bank loans performed somewhat poorly during 2002, reversing the relatively good performance of the preceding year, but more in line with several of the past recent years. This "asset class" has attracted an increasing amount of new capital, however, as the supply of distressed and defaulted debt securities continued its substantial growth over the past four years. Indeed, the estimated supply of defaulted public and private, distressed and defaulted, debt reached an enormous total of $942 billion by year-end 2002. The outlook for distressed investing was extremely bullish at the start of 2003, given the supply/demand dynamics and the likely regression to the mean of the market to face value ratio.

Abstract:
The market for investing in distressed and defaulted debt is continuing to receive a great deal of attention despite the shrinkage in the supply of new securities in 1993-1995 (first half). This is primarily due to the continued excellent return performance of defaulted bonds, the expected growth in the supply of new distressed and defaulted public and private debt paper, and the clearly documented relatively low correlation of returns with the more traditional debt and equity markets. This study reviews some of the important attributes of this unique investment vehicle and updates our analysis of the risk and return performance of the most extreme component of the distressed market defaulted debt.

Abstract:
Business failure identification and early warnings of impending financial crisis are important not only to analysts and practitioners in the United States. Indeed, countries throughout the world, even non-capitalist nations, have been concerned with individual entity performance assessment. Developing countries and smaller economies, as well as the larger industrialized nations of the world, are vitally concerned with avoiding financial crises in the private and public sectors. Some policy makers in smaller nations are particularly concerned with financial panics resulting form failures of individual entities.

Abstract:
A number of banks have recently undertaken a reassessment of their credit-lending process. The banksâ¬" endeavors coincided with the efforts of a small, but growing number of vendors who have developed systems to assess both public and private corporations. The purpose of this article is to define the qualities of a carefully developed and rigorously tested credit modeling system for assessing the attractiveness of lending opportunities. We identify and discuss several types of credit evaluation systems and their relative importance. These systems are classified as primary (â¬Sgroup upâ¬? or â¬Sfirm-intrinsicâ¬? approach) and supplementary (â¬Stop-downâ¬? or â¬Sfirm capital marketâ¬?) approaches. The crucial step in evaluating any of these systems is the thorough testing of the results and the establishment of rigorous standards for acceptance. In addition to these standards, we discuss the role that an acceptable credit system can play as the link between individual loan assessment and logically derived estimates of expected loss rates and loan pricing criteria.

Abstract:
A number of banks have recently undertaken a reassessment of their credit-lending process. The banks' endeavors coincided with the efforts of a small, but growing number of vendors who have developed systems to assess both public and private corporations. The purpose of this article is to define the qualities of a carefully developed and rigorously tested credit modeling system for assessing the attractiveness of lending opportunities. We identify and discuss several types of credit evaluation systems and their relative importance. These systems are classified as primary ("ground up" or "firm-intrinsic" approach) and supplementary ("top-down" or "firm capital market") approaches. The crucial step in evaluating any of these systems is the thorough testing of the results and the establishment of rigorous standards for acceptance. In addition to these standards, we discuss the role that an acceptable credit system can play as the link between individual loan assessment and logically derived estimates of expected lossrates and loan pricing criteria.

Abstract:
Bond ratings are usually first assigned by rating agencies to public debt at the time of issuance and are periodically reviewed by the rating companies. If deemed warranted, changes in ratings are assigned after the review. A change in a rating reflects the agencyâ¬"s assessment that the companyâ¬"s credit quality has improved (upgrade) or deteriorated (downgrade). A coincident effect, in some proximity to the date of the rating change, is a change in the price of the issue. This article reports on an in-depth investigation of ratings changes (drift) over the time as well as the implied impact on the price of the bond and on investment strategies. Our analysis compares rating changes from the two major agencies, Moodyâ¬"s and S&P, over the period 1970-1995, as well as yield and duration results by rating class from 1985-1996. For the first time, results from several studies which have documented and analyzed these data patterns are contrasted. Depending upon which study one uses, the results and implications can be very different. We expect that the findings will have implications for such diverse users as bond investors who concentrate on any or all segments of the corporate bond market, eg., high yield bond and â¬Scrossoverâ¬? investors (those who typically invest in investment grade bonds but who can invest in split-rated issues or the highest grade of non-investment grade bonds), mark-to-market analysts and traders in the new and growing market for credit-spread-derivatives. The latter market enables banks and other institutions to trade and hedge small shifts in a borrowerâ¬"s credit risk as well as the extreme negative migration to default.

Abstract:
The role and performance of credit rating agencies are currently under debate. Several surveys conducted in the United States reveal that most investors believe that rating agencies are too slow in adjusting their ratings to changes in corporate creditworthiness. Well known is that agenciesachieve rating stability by their through-the-cycle methodology. This study aims to provide quantitative insight in this methodology and to quantify the effects of this methodology on rating stability, rating timeliness and default prediction performance, from an investor's point-in-timeperspective. We believe that our results can guide the search for an optimal balance between rating stability, rating timeliness and default prediction performance.

Abstract:
This paper examines the informational efficiency of loans relative to bonds surrounding loan default dates and bond default dates. We examine this issue using a unique dataset of daily secondary market prices of loans over the 11/1999-06/2002 period. We find evidence consistent with a monitoring role of loans. Specifically, consistent with a view that the monitoring role of loans should be reflected in more precise expectations embedded in loan prices, we find that the price decline of loans is less adverse than that of bonds of the same borrower around loan and bond default dates. Additionally, we find evidence that the difference in price decline of loans versus bonds is amplified around loan default dates that are not preceded by a bond default date of the same company. Our results are robust to several alternative explanations, and to controlling for security-specific characteristics, such as seniority, collateral, covenants, and for multiple measures of cumulative abnormal returns. Overall, we find that the loan market is informationally more efficient than the bond market around loan default dates and bond default dates.

Words: monitoring, default, spillovers, event study, loans, bonds, stocks

Abstract:
The authors are the Max L. Heine and John M. Schiff Professors of Finance, Stern School of Business, NYU. This is an updated and revised paper from the authors report on "An Analysis and Critique of the BIS Proposal on Capital Adequacy and Ratings," (submitted to the BIS and published in the Journal of Banking & Finance, Vol. 25, #1, January, 2001). The authors wish to thank Sreedar Bharath for his computational assistance and Robyn Vanterpool of the NYU Salomon Center for her coordination.This paper was first prepared for the NYU Salomon Center/University of Maryland research project on "The Role of Credit Reporting Systems in the International Economy," sponsored by the Center for International Political Economy. It was prepared for the project s conference in Washington D.C. on March 1-2, 2001 at the headquarters of the World Bank.

Abstract:
This is an updated and revised paper from the authorsâ¬" report on â¬SAn Analysis and Critique of the BIS Proposal on Capital Adequacy and Ratingsâ¬? [S-CDM-00-02] (submitted to the BIS and published in the Journal of Banking & Finance, Vol. 25, #1, January, 2001).This paper was first prepared for the NYU Salomon Center/University of Maryland research project on â¬SThe Role of Credit Reporting Systems in the International Economy,â¬? sponsored by the Center for International Political Economy. It was prepared for the projectâ¬"s conference in Washington D.C. on March 1-2, 2001 at the headquarters of the World Bank.

Abstract:
This is an updated and revised paper from the authorsâ¬" report on â¬SAn Analysis and Critique of the BIS Proposal on Capital Adequacy and Ratingsâ¬? [S-CDM-00-02] (submitted to the BIS and published in the Journal of Banking & Finance 25:1 January, 2001). This paper was first prepared for the NYU Salomon Center/University of Maryland research project on â¬SThe Role of Credit Reporting Systems in the International Economy,â¬? sponsored by the Center for International Political Economy. It was prepared for the projectâ¬"s conference in Washington D.C. on March 1-2, 2001 at the headquarters of the World Bank.

Abstract:
In this paper we have presented a new approach to measure the return-risk trade-off in portfolios of risky debt instruments, whether bonds or loans. The use of complex statistically based portfolio techniques to manage assets of financial institutions and fixed income portfolio money managers is very much in its early phase and will continue to evolve, perhaps more quickly in the near future. Our approach substitutes the concept of unexpected loss for the more traditional variance of return measure used in equity securities analysis. Preliminary empirical tests indicate some reason to be optimistic about this approach.

Abstract:
In this paper we have presented a new approach to measure the return-risk trade-off in portfolios of risky debt instruments, whether bonds or loans. The use of complex, statistically based portfolio techniques to manage assets of financial institutions and fixed income portfolio money managers is very much in its early phase and will continue to evolve, perhaps more quickly in the near future. Our approach substitutes the concept of unexpected loss for the more traditional variance of return measure used in equity securities analysis. Preliminary empirical tests indicate some reason to be optimistic about this approach.

Abstract:
The year 2002 was remarkably difficult on many fronts for most financial markets. For the high yield bond market, it was again a year of record amounts of defaults which contributed to low recovery rates and slightly negative absolute returns. The default rate registered a massive 12.8%, based on $757 billion outstanding. Despite these record default totals and rates, the market s decline was orderly with little panic and actually ended the year with reduced defaults and highly positive returns in the fourth quarter. Default amounts registered its fourth consecutive record year and almost topped $100 billion ($97.9 billion) for the first time. This total was more than 52% higher than last year s record. Combined with a near record low recovery rate of 25 cents on the dollar, weighed down by Telecom s average recovery rate of 16%, loss rates from defaults reached record levels of about 10% -- even adjusted for fallen angel default recoveries. The pervasive influence of WorldCom s massive default had a profound effect on both the default and recovery rates. Without WorldCom, the year s default rate would have been 9.27% -- a differential of about 3.5%. This report documents and comments upon the high yield bond market s risk and return performance over the period 1971-2002. We will present traditional, dollar-denominated default rates as well as our own mortality rate statistics. Default rate analysis will be complemented by discussion on corporate bankruptcies and the immense impact of fallen angels on the high yield market. We conclude with our annual estimate of the size of the distressed debt market and our forecast for defaults in 2003. Our analysis will include an update on our default recovery forecasting model which was extremely accurate in estimating 2002 s recovery rate of about 25%. Based on the fourth quarter s reduction in default rate to 1.82% and our aging-mortality conceptual framework, we are predicting a reduction in the dollar denominated default rate to 7.5-8.0%, as much as 5% less than 2002 (but still far above the average rate). This should help provide a more attractive environment for high yield debt new issues and returns in 2003. In 2002, there was $65.6 billion in new high yield bond issuance, down from 2001 s $88.2 billion. We expect new issuance in 2003 to escalate unless the economic/political scene motivates another flight to quality in our financial markets.

Abstract:
The year 2002 was remarkably difficult on many fronts for most financial markets. For the high yield bond market, it was again a year of record amounts of defaults which contributed to low recovery rates and slightly negative absolute returns. The default rate registered a massive 12.8%, based on $757 billion outstanding. Despite these record default totals and rates, the market s decline was orderly with little panic and actually ended the year with reduced defaults and highly positive returns in the fourth quarter.Default amounts registered its fourth consecutive record year and almost topped $100 billion ($97.9 billion) for the first time. This total was more than 52% higher than last year s record. Combined with a near record low recovery rate of 25 cents on the dollar, weighed down by Telecom s average recovery rate of 16%, loss rates from defaults reached record levels of about 10% -- even adjusted for fallen angel default recoveries. The pervasive influence of WorldCom s massive default had a profound effect on both the default and recovery rates. Without WorldCom, the year s default rate would have been 9.27% -- a differential of about 3.5%.This report documents and comments upon the high yield bond market s risk and return performance over the period 1971-2002. We will present traditional, dollar-denominated default rates as well as our own mortality rate statistics. Default rate analysis will be complemented by discussion on corporate bankruptcies and the immense impact of fallen angels on the high yield market. We conclude with our annual estimate of the size of the distressed debt market and our forecast for defaults in 2003. Our analysis will include an update on our default recovery forecasting model which was extremely accurate in estimating 2002 s recovery rate of about 25%.Based on the fourth quarter s reduction in default rate to 1.82% and our aging-mortality conceptual framework, we are predicting a reduction in the dollar denominated default rate to 7.5-8.0%, as much as 5% less than 2002 (but still far above the average rate). This should help provide a more attractive environment for high yield debt new issues and returns in 2003.In 2002, there was $65.6 billion in new high yield bond issuance, down from 2001 s $88.2 billion. We expect new issuance in 2003 to escalate unless the economic/political scene motivates another flight to quality in our financial markets.

Abstract:
The year 2002 was remarkably difficult on many fronts for most financial markets. For the high yield bond market, it was again a year of record amounts of defaults which contributed to low recovery rates and slightly negative absolute returns. The default rate registered a massive 12.8%, based on $757 billion outstanding. Despite these record default totals and rates, the market s decline was orderly with little panic and actually ended the year with reduced defaults and highly positive returns in the fourth quarter.Default amounts registered its fourth consecutive record year and almost topped $100 billion ($97.9 billion) for the first time. This total was more than 52% higher than last year s record. Combined with a near record low recovery rate of 25 cents on the dollar, weighed down by Telecom s average recovery rate of 16%, loss rates from defaults reached record levels of about 10% -- even adjusted for fallen angel default recoveries. The pervasive influence of WorldCom s massive default had a profound effect on both the default and recovery rates. Without WorldCom, the year s default rate would have been 9.27% -- a differential of about 3.5%. This report documents and comments upon the high yield bond market s risk and return performance over the period 1971-2002. We will present traditional, dollar-denominated default rates as well as our own mortality rate statistics. Default rate analysis will be complemented by discussion on corporate bankruptcies and the immense impact of fallen angels on the high yield market. We conclude with our annual estimate of the size of the distressed debt market and our forecast for defaults in 2003. Our analysis will include an update on our default recovery forecasting model which was extremely accurate in estimating 2002 s recovery rate of about 25%.Based on the fourth quarter s reduction in default rate to 1.82% and our aging-mortality conceptual framework, we are predicting a reduction in the dollar denominated default rate to 7.5-8.0%, as much as 5% less than 2002 (but still far above the average rate). This should help provide a more attractive environment for high yield debt new issues and returns in 2003.In 2002, there was $65.6 billion in new high yield bond issuance, down from 2001 s $88.2 billion. We expect new issuance in 2003 to escalate unless the economic/political scene motivates another flight to quality in our financial markets.

Abstract:
Surveys on the use of agency credit ratings reveal that some investors believe that rating agencies are relatively slow in adjusting their ratings. A well-accepted explanation for this perception on the timeliness of ratings is the "through-the-cycle" methodology that agencies use. According to Moody's, through-the-cycle ratings are stable because they are intended to measure the risk of default risk over long investment horizons, and because they are changed only when agencies are confident that observed changes in a company's risk profile are likely to be permanent. To verify this explanation, we quantify the impact of the long-term default horizon and the prudent migration policy on rating stability from the perspective of an investor - with no desire for rating stability. This is done by benchmarking agency ratings with a financial ratio-based (credit scoring) agency-rating prediction model and (credit scoring) default-prediction models of various time horizons. We also examine rating migration practices. Final result is a better quantitative understanding of the through-the-cycle methodology.By varying the time horizon in the estimation of default-prediction models, we search for a best match with the agency-rating prediction model. Consistent with the agencies' stated objectives, we conclude that agency ratings are focused on the long term. In contrast to one-year default prediction models, agency ratings place less weight on short-term indicators of credit quality.We also demonstrate that the focus of agencies on long investment horizons explains only part of the relative stability of agency ratings. The other aspect of through-the-cycle rating methodology - agency rating-migration policy - is an even more important factor underlying the stability of agency ratings. We find that rating migrations are triggered when the difference between the actual agency rating and the model predicted rating exceeds a certain threshold level. When rating migrations are triggered, agencies adjust their ratings only partially, consistent with the known serial dependency of agency rating migrations.

Abstract:
This study is an attempt to construct and test a distress classification model for Korean companies. Utilizing a sample of 34 distressed firms from the most recent 1990-1993 period and a matched (by industry and year) sample of non-failed firms, we observe the classification accuracy of two models. Both models utilize measures of firm size, asset turnover, solvency and leverage with one model available for testing only on publicly traded companies and one model is applicable to all public and private entities. We observe excellent classification accuracy based on data from the first two years prior to distress. And, although the accuracy drops off after t-2, the models still provide effective early warnings of distress in many cases. The results of this study are of particular relevance in the current financial market scenario of increased deregulation and greater individual financial institution decisions making.

Abstract:
This study is an attempt to construct and test a distress classification model for Korean companies. Utilizing a sample of 34 distressed firms from the most recent 1990-1993 period and a matched (by industry and year) sample of non- failed firms, we observe the classification accuracy of two models. Both models utilize measures of firm size, asset turnover, solvency and leverage with one model available for testing only on publicly traded companies and one model is applicable to all public and private entities. We observe excellent classification accuracy based on data from the first two years prior to distress. And, although the accuracy drops off after t-2, the models still provide effective early warnings of distress in many cases. The results of this study are of particular relevance in the current financial market scenario of increased deregulation and greater individual financial institution decision making.

Abstract:
Full year 1999 was again a mixed performance year for the high yield bondmarket in the United States but for different reasons than the mixed 1998performance. Once again, total returns were lackluster, registering just +1.73%. But, unlike last year s companion negative return spread vs. U.S. ten-year Treasuries, the return spread in 1999 was a positive 10.1%, as yield spreads increased significantly and Treasuries tumbled. And again, new issuance of high yield bonds was impressive, topping $100 billion for the third consecutive year, but aggregate defaults increased dramatically to an all-time record level of over $23 billion (face value). The default rate registered a sizeable increase, topping 4% (4.15%) for the first time since 1991 and significantly above the 1.6% level of one year earlier.Combined with a relatively low recovery rate of below 30 cents on the dollar, thedefault loss rate was 3.2% in 1999, compared to a historical arithmetic annualaverage of 1.9%. Despite 1999 s low absolute return, net returns (after deducting losses from defaults, rating migrations and interest rate changes) for the 1978-1999 period continued to show an attractive compounded return spread over U.S. Treasury bonds of close to 3.0% per year (2.96%). This report documents the high yield bond market s risk and returnperformance by presenting traditional and mortality default rate statistics andproviding a matrix of performance statistics over the relevant periods of themarket s evolution. Our analysis covers the 1971-1999 period for defaults and the 1978-1999 period for returns. In addition, we present our annual forecast of expected defaults for the next three years (2000-2002). Our 1999 forecast was for substantially higher defaults than 1998, but we underestimated the record defaultlevels. Default levels and rates were swelled in 1999 due to a number of factors,including the huge new issuance in the 1997-1999 period, a trend toward earlier defaults, deteriorating credit quality of new issues, pockets of industry fragility, and the continued vestige of 1998 s flight to quality. For 2000, we expect default levels to decline to about $17.5 billion and the default rate to regress to around three percent of the amount outstanding.

Abstract:
In 2008 and 2009, bondholders of ailing companies were affected by a reemergenceof an important corporate restructuring strategy, known as a Distressed Exchange.Fourteen companies in 2008 completed this desperate attempt to avoid a formal bankruptcy filing – about twice as many as any single year in the last 25 years, involving twice as much in dollar amount than in the entire prior history (1984-2007). And, in just the first fourmonths of 2009, nine firms have already completed distressed exchanges. The recovery rate to bondholders participating in distressed exchanges over the last 25 years is significantly higher than recoveries on other, more dramatic types of default – namely payment defaults and bankruptcies. But, there is no guarantee that a distressed exchange will permanently immunize the firm from further distress, with almost 50% of all companies completing distressed exchanges prior to 2008 ultimately filing for bankruptcy.

Abstract:
The role and performance of credit rating agencies are currently under debate. Several surveys conducted in the United States reveal that most investors believe that rating agencies are too slow in adjusting their ratings to changes in corporate creditworthiness. Well known is that agencies achieve rating stability by their through-the-cycle methodology. This study aims to provide quantitative insight in this methodology and to quantify the effects of this methodology on rating stability, rating timeliness and default prediction performance, from an investor's point-in-time perspective. We believe that our results can guide the search for an optimal balance between rating stability, rating timeliness and default prediction performance.

Abstract:
This report presents a discussion of the investment performance of those bonds that have defaulted and continue trading in the public market while the issuing firm attempts a financial reorganization. Monthly total returns measures are compiled based on the Altman-NYU Salomon Center Index of Defaulted Debt Securities and compared with the total returns of common stocks and high yield bonds. Returns based on our market weighted index are presented for the past year, 1995, as well as the nine year period 1987-1995. 1995 was a modest year of performance for defaulted bonds especially when compared to our two other risky indexes and to risk free government bonds. The return performance of our three indexes for the nine year sample period shows that common stocks are now the number one performer with defaulted bonds in second place followed by high yield bonds. All three asset classes have done quite well in the last decade. Diversification and seasonal movements are also analyzed in this report. Finally, current and future supply estimates for the defaulted and distressed market are presented.

Abstract:
This report presents a discussion of the investment performance of those bonds that have defaulted and continue trading in the public market while the issuing firm attempts a financial reorganization. Monthly total returns measures are compiled based on the Altman-NYU Salomon Center Index of Defaulted Debt Securities and compared with the total returns of common stocks and high yield bonds. Returns based on our market weighted index are presented for the past year, 1995, as well as the nine year period 1987-1995. 1995 was a modest year of performance for defaulted bonds especially when compared to our two other risky indexes and to risk free government bonds. The return performance of our three indexes for the nine year sample period shows that common stocks are now the number one performer with defaulted bonds in second place followed by high yield bonds. All three asset classes have done quite well in the last decade. Diversification and seasonal movements are also analyzed in this report. Finally, current and future supply estimates for the defaulted and distressed market are presented.

Abstract:
This report presents a discussion of the investment performance of those bonds that have defaulted and continue trading in the public market while the issuing firm attempts a financial reorganization. Monthly total returns measures are compiled based on the Altman-NYU Salomon Center Index of Defaulted Debt Securities and compared with the total returns of common stocks and high yield bonds. Returns based on our market weighted index are presented for the past year, 1995, as well as the nine year period 1987-1995. 1995 was a modest year of performance for defaulted bonds especially when compared to our two other risky indexes and to risk free government bonds. The return performance of our three indexes for the nine year sample period shows that common stocks are now the number one performer with defaulted bonds in second place followed by high yield bonds. All three asset classes have done quite well in the last decade. Diversification and seasonal movements are also analyzed in this report. Finally, current and future supply estimates for the defaulted and distressed market are presented.

Abstract:
While acknowledging the challenges of resolving some relatively new kinds of inter-creditor conflicts, most of the panelists expressed confidence that today's distressed investors, working within the context of a streamlined Chapter 11 process, can be expected to play a major role in preserving values for creditors. At the same time, such investors will help perform the critical economic function of ensuring, in Douglas Baird's words, that those companies that should survive do survive and that corporate assets, whether liquidated piecemeal or kept within the firm, end up in their highest-valued uses with their most efficient users. The second half of the discussion focuses on some of the potential problems, or obstacles to the working of these market forces. For example, how will distressed situations play out in cases involving dispersed creditors, such as the holders of CDOs and CLOs? Will there be negative side effects from other financial innovations such as credit derivatives? Against the current backdrop of troubled credit markets and the possibility of growing defaults, a distinguished group of bankruptcy academics and practitioners explore a number of questions raised by the emergence of increasingly active distressed investors: Are these relatively new market forces and mechanisms at least partly responsible for today's historically low default rates? Can they be expected to continue keeping default rates low, even if the economy goes into recession? And perhaps most important, by preventing or delaying defaults, will these new reorganization methods end up increasing recoveries and preserving value? The second half of the discussion focuses on some of the potential problems, or obstacles to the working of these market forces. For example, how will distressed situations play out in cases involving dispersed creditors, such as the holders of CDOs and CLOs? Will there be negative side effects from other financial innovations such as credit derivatives? While acknowledging the challenges of resolving some relatively new kinds of inter-creditor conflicts, most of the panelists expressed confidence that today's distressed investors, working within the context of a streamlined Chapter 11 process, can be expected to play a major role in preserving values for creditors. At the same time, such investors will help perform the critical economic function of ensuring, in Douglas Baird's words, that those companies that should survive do survive and that corporate assets, whether liquidated piecemeal or kept within the firm, end up in their highest-valued uses with their most efficient users.

Abstract:
High yield bond defaults in 2003 declined significantly from record 2002 levels closing the year at $38.5 billion for a default rate of 4.66%. The fourth quarter s rate of 0.36% was the lowest quarterly rate since the fourth quarter of 1997. The default loss rate for 2003 also declined to just 2.76% based on a weighted average recovery rate of about 45% -- a majorimprovement from the 25% levels of the prior several years. Fourteen of the 86 defaultingcompanies had issues that were investment grade sometime prior to default. These fallenangels accounted for 33% of defaulting issues and 46.3% of the defaulted volume in 2003.The high-yield bond market returned an impressive 30.62% for the year, the third highest one-year return since 1978 (when we first began tracking returns). The return spread over ten-year US Treasuries was a record high 29.4%, bringing the historic average annual return spread to 2.22% per year. The concurrent yield spread at year-end fell to 3.74%, the lowest year-end figure since 1997 and 4.82% less than one year ago. New issues in 2003 recorded anear record level of $137.4 billion; the vast majority was used for refinancing existing loan and bond issues.Based on our mortality rate methodology and assuming different measures of credit risk ofrecent new issuance, we expect default rates to continue their decline in 2004 to between3.2% - 3.8%, with rates increasing in 2005 to above 4.0%.

Abstract:
This report presents results and discussion of the investment performance of those bonds and bank loans that have defaulted on their scheduled payments to creditors andcontinue trading while the issuing firm attempts a financial reorganization. Monthly total return measures are compiled based on the Altman-NYU Salomon Center Indexes of Defaulted Bonds and Defaulted Banks Loans, as well as an index that combines bonds and loans. These returns are compared to the total returns of common stocks and high yield corporate bonds. Returns are based on our market-weighted indexes and presented for the past year (1999), as well as for the last 13 years (for bonds) and four years for bank loans.We also estimate the expected supply of new defaulted debt in the United States for thecoming three years. Nineteen ninety-nine was a mixed year for investors in distressed debt securities. Although the Defaulted Public Bond Index increased by a respectable 11.34% in 1999, the positive rate of increase was mainly a function of the excellent performance over a threemonthperiod in the earlier part of the year (February, March and April) when the size ofthe index was comprised of a relatively small number of securities and when the movement of a few issues had a significant influence on the Index. Still, the positive annual performance reversed the negative annual returns that we had observed in the prior two years. On a comparative note, our Defaulted Public Bond Indexâ¬"s return of 11.34% was slightly higher than Salomon Smith Barneyâ¬"s Bankrupt Bond Index return of 8.42%. Defaulted bank loans did not fare as well, recording a slight increase for the year of 0.65%. Except for the initial year (1996) of our Bank Loan Index, performance has been lackluster in the past three years. Finally, the Combined Public Bond and Private Bank Loan Index recorded a positive annual return in 1999 of 4.45%, resulting in a basically flat performance over the four years of the combined index calculation period. Comparative returns for the thirteen-year period (1987-1999), show that common stocks strengthened its number one asset class return/risk position. High yield bonds, while performing relativelypoorly in 1999 (+1.7%), maintained a slight average annual return advantage over defaulted bonds. The two â¬Sbrightâ¬? or positive factors related to the defaulted bond and bank loan markets in 1999 were the enormous increase in the supply of new defaulted issues and the record low average market value to face value ratio of the Index at the end of the year. The size of the Index more than doubled in number of issues and tripled in face and market values over the past twelve months as the default amount of high yield bonds reached arecord high level in 1999 and the default rate went from 1.6% to over 4.0% (see ourcompanion report on Defaults and Returns in the High Yield Bond Market). Based on ourforecast of future defaults, we expect the number and amounts of the issues in both theBond and Bank Loan indexes to continue to grow, albeit at a lower rate, in the next three years. Going forward, we suggest that this increased supply, and the relatively low marketto-face value ratio of defaulted bonds at the end of 1999, may present significant investment opportunities.

Abstract:
Nineteen-ninety-eight was a mixed performance year for the high yield bond market in the United States , with much below average returns and spreads over default-risk-free Treasury Bonds but continued relatively low default rates and losses and another record year of new insurance. Returns and new insurance were excellent through the first seven months of the year but returns reversed and new issues dried up, temporarily, in the wake of August's Russians default and the emerging market turmoil, causing another short-term flight to quality. Returns in 1998 on high yield bonds in the U.S. were slightly above 4.0% for the entire year, about 8.5% lower than historical averages. Return spreads also were much below average (-8.7%).The default rate was again relatively low, 1.60%, and losses from default 1.1%. Despite 1998's low relative return, net returns (after deducting losses from defaults) over the last two decades continue to show a compound result over 12% per year and spreads over U.S. Treasuries of over 2.5% per year. New insurance of high yield debt in 1998 totaled a record $152 billion, with $120 billion of the total in the first seven and a half months.This report documents the high yield debt market's risk and return performance by presenting default and morality statistics and providing a matrix of average returns and other performance statistics over relevant periods of the market's evolution. Our analysis covers the period 1971-1998 for defaults and 1978-1998 for returns. In addition, we present our annual forecast of expected defaults for the next three years (1999-2001). Two other reports, published by the NYU Salomon Center, comprehensively document the performance of defaulted public bonds and bank loans and the default rate experience on syndicated bank loans.

Abstract:
Surveys on the use of agency credit ratings reveal that some investors believe that credit-rating agencies are relatively slow in adjusting their ratings. A well-accepted explanation for this perception on rating timeliness is the through-the-cycle methodology that agencies use. Through-the-cycle ratings are intended to measure default risk over long investment horizons and to respond only to changes in the permanent component of credit quality. A second aspect of the through-the-cycle methodology is the prudent migration policy. In a benchmark study with a financial ratio-based credit-scoring models - an agency-rating prediction model and default-prediction models with various time horizons - we confirm the exclusive focus of agencies on the permanent component of credit quality and we model and quantify the agencies' prudent migration policy. A rating migration is triggered only when the rating predicted by the agency-rating prediction model differs by at least a threshold level of 1.8 notch steps from the actual agency rating. If triggered, ratings are only partly adjusted by 70 per cent at the downside and 60 per cent at the upside. From a 1-year point-in-time perspective, weighting temporary fluctuations in credit quality, the through-the-cycle methodology lowers the rating-migration probability by a factor of 3.5. Both aspects of the through-the-cycle methodology contribute equally to this factor. The partial adjustment of ratings lowers the rating-reversal probabilities on short term and introduces rating drift, the known serial correlation in agency-rating migrations.

Abstract:
The third-quarter 2002 default rate for high yield bonds was 4.95%, based on $37.48 billion of defaults. The quarterly default rate is the highest in history, surpassing the first quarter of 1991 rate of 4.80%. One massive default, WorldCom, accounted for $28.30 billion of defaults (76%). Without WorldCom, the third quarter default rate would have only been 1.2%. The dollar weighted default rate for the first three quarters has already broken the record for a single calendar year reaching 10.98%. And, the latest four-quarters default rate of 15.01% has also set a record. Again, WorldCom s huge default contributed about 4% of this record total. The persistently high default rate through the third quarter has resulted in a near record yield spread of 10.10% -- second only to 1990 s 10.50%. The current yield spread is more than 5% above the historical average. We believe the default rate has peaked in Q3-2002 and depending on the size of the decline, we believe the huge yield spread could reflect an over-sold market. Counting WorldCom ($46.0 billion in liabilities), there were more than $197 billion in liabilities of firms which filed for Chapter 11 protection through the third quarter and 26 firms had liabilities greater than $1 billion. The count was 22 firms through the first-half of the year, so the third-quarter number was "only" four, including WorldCom. There were 39 of such firms in 2001 - - a record year.

Abstract:
Evidence from many countries in recent years suggests that collateral values and recovery rates (RRs) on corporate defaults can be volatile and, moreover, that they tend to go down just when the number of defaults goes up in economic downturns. This link between RRs and default rates has traditionally been neglected by credit risk models, as most of them focused on default risk and adopted static loss assumptions, treating the RR either as a constant parameter or as a stochastic variable independent from the probability of default (PD). This traditional focus on default analysis has been partly reversed by the recent significant increase in the number of studies dedicated to the subject of recovery-rate estimation and the relationship between default and RRs. This paper presents a detailed review of the way credit risk models, developed during the last 30 years, treat the RR and, more specifically, its relationship with the PD of an obligor. Recent empirical evidence concerning this issue is also presented and discussed.

Abstract:
This report presents a discussion of the investment performance of those bond issues that have defaulted and continue trading in the public market while the issuing firm attempts a financial reorganization. Monthly total returns measures are compiled based on the Altman-NYU Salomon Center of Defaulted Debt Securities and compared with the total returns of common stocks and high yield bonds. Returns based on our market weighted index are presented for the past year, 1994, as well as the eight year period 1987-1994. While 1994 was at best a modest year of performance for defaulted bonds, these securities performed very well compared to our two other risky indexes and to risk free government bonds. The superior return performance of defaulted bonds is also manifest for the eight year sample period. The volatility of this portfolio is greater than that of our comparable indexes. Diversification ad seasonal movements are also analyzed in this report. Finally, future supply and demand estimates for the defaulted and distressed market are discussed.

Abstract:
This report presents a discussion of the investment performance of those bond issues that have defaulted and continue trading in the public market while the issuing firm attempts a financial reorganization. Monthly total returns measures are compiled based on the Altman-NYU Salomon Center Index of Defaulted Debt Securities and compared with the total returns of common stocks and high yield bonds. Returns based on our market weighted index are presented for the past year, 1994, as well as the eight year period 1987-1994. While 1994 was at best a modest year of performance for defaulted bonds, these securities performed very well compared to our two other risky indexes and to risk free government bonds. The superior return performance of defaulted bonds is also manifest for the eight year sample period. The volatility of this portfolio is greater than that of our comparable indexes. Diversification and seasonal movements are also analyzed in this report. Finally, future supply and demand estimates for the defaulted and distressed market are discussed.

Abstract:
Nineteen-ninety-four was a relatively lackluster year for the high yield market with relatively low defaults combined with slightly negative total returns. When viewed in comparative terms with other fixed income securities markets, however, high yield debt performed quite well. Compared to long term U.S. Government securities, the average yield spread on high yield debt dropped to the lowest year-end level (3.44%) since 1984. This report documents the high yield debt market s risk and return performance in 1994 by presenting default and mortality statistics and provides a matrix of average returns and other performance statistics over the relevant periods of the market s evolution. Our analysis covers the period 1971-1994 for defaults and 1978-1994 for returns.

Abstract:
Nineteen-ninety-four was a relatively lackluster year for the high yield market with relatively low defaults combined with slightly negative total returns. When viewed in comparative terms with other fixed income securities markets, however, high yield debt performed quite well. Compared to long term U.S. Government securities, the average yield spread on high yield debt dropped to the lowest year-end level (3.44%) since 1984. This report documents the high yield debt market's risk and return performance in 1994 by presenting default and mortality statistics, and provides a matrix of average returns and other performance statistics over the relevant periods of the market's evolution. Our analysis covers the period 1971-1994 for defaults and 1978-1994 for returns.

Abstract:
Considering the fundamental role played by small and medium sized enterprises (SMEs) in the economy of many countries and the considerable attention placed on SMEs in the new Basel Capital Accord, we develop a distress prediction model specifically for the SME sector and to analyse its effectiveness compared to a generic corporate model. The behaviour of financial measures for SMEs is analysed and the most significant variables in predicting the entities' credit worthiness are selected in order to construct a default prediction model. Using a logit regression technique on panel data of over 2,000 U.S. firms (with sales less than $65 million) over the period 1994-2002, we develop a one-year default prediction model. This model has an out-of-sample prediction power which is almost 30 per cent higher than a generic corporate model. An associated objective is to observe our model's ability to lower bank capital requirements considering the new Basel Capital Accord's rules for SMEs.

Abstract:
Nineteen-ninety five was an excellent year for the high yield market with relatively low defaults combined with returns of almost 20%, the highest since 1991. When viewed in comparative terms with other fixed income securities markets, however, the high yield debt market s performance in 1995 was not exceptional. This report documents the high yield debt market s risk and return performance by presenting default and mortality statistics and providing a matrix of average returns and other performance statistics over the relevant periods of the market s evolution. Our analysis covers the period 1971-1995 for defaults and 1978-1995 for returns.

Abstract:
The third-quarter 2002 default rate for high yield bonds was 4.95%, based on $37.48 billion of defaults. The quarterly default rate is the highest in history, surpassing the first quarter of 1991 rate of 4.80%. One massive default, WorldCom, accounted for $28.30 billion of defaults (76%). Without WorldCom, the third quarter default rate would have only been 1.2%. The dollar weighted default rate for the first three quarters has already broken the record for a single calendar year reaching 10.98%. And, the latest four-quarters default rate of 15.01% has also set a record. Again, WorldCom s huge default contributed about 4% of this record total. The persistently high default rate through the third quarter has resulted in a near record yield spread of 10.10% -- second only to 1990 s 10.50%. The current yield spread is more than 5% above the historical average. We believe the default rate has peaked in Q3-2002 and depending on the size of the decline, we believe the huge yield spread could reflect an over-sold market. Counting WorldCom ($46.0 billion in liabilities), there were more than $197 billion in liabilities of firms which filed for Chapter 11 protection through the third quarter and 26 firms had liabilities greater than $1 billion. The count was 22 firms through the first-half of the year, so the third-quarter number was "only" four, including WorldCom. There were 39 of such firms in 2001 -- a record year.

Abstract:
Within the commercial client segment, small business lending is gradually becoming a major target for many banks. The new Basel Capital Accord has helped the financial sector to recognize small and medium sized enterprises (SMEs) as a client, distinct from the large corporate. Some argue that this client base should be treated like retail clients from a risk management point of view in order to lower capital requirements and realize efficiency and profitability gains. In this context, it is increasingly important to develop appropriate risk models for this large and potentially even larger portion of bank assets. So far, none of the few studies that have focused on developing credit risk models specifically for SMEs have included qualitative information as predictors of the company credit worthiness. For the first time, in this study we have available non-financial and 'event' data to supplement the limited accounting data which are often available for non-listed firms. We employ a sample consisting of over 5.8 million sets of accounts of unlisted firms of which over 66,000 failed during the period 2000-2007. We find that qualitative data relating to such variables as legal action by creditors to recover unpaid debts, company filing histories, comprehensive audit report/opinion data and firm specific characteristics make a significant contribution to increasing the default prediction power of risk models built specifically for SMEs.

SME lending, Credit Risk Modeling, Bankruptcy, Small Business failure

Abstract:
The defaulted and distressed, public and private debt markets in the United States swelled to a record $680 billion (face value) at the end of 2001. The market value of this "niche" segment was approximately $400 billion.

Defaulted security investors enjoyed an excellent year on average, as returns in 2001 were 17.5% on bonds, 13.9% on bank loans, and 15.6% combined defaulted public bonds and private bank loans.

The Altman-New York University Salomon Center Index of Defaulted Bonds grew to over 200 individual issues and a face value of $56.2 billion; the market value was only $11.8 billion. The market-to-face value ratio of the Bond Index grew somewhat to 0.21 from 0.15 one year ago, but remained at a relatively low figure. The face value of our Defaulted Bank Loan Index also grew to $44.7 billion and the market-to-face value ratio remained quite low at 0.53.

The recovery rate on defaulted bonds (price just after default) was very low at 25 cents on the dollar; likewise, the bank loan recovery rate in 2001 was also relatively low at 55 cents on the dollar. With new defaulted bonds rising in 2001 to a record $63.6 billion (default rate of 9.80%) and the default outlook for 2002 high, but lower than for 2001 investment opportunities should abound in the distressed debt market.

Indications are that distressed investors (both old and new) are successfully raising funds because investor expectations are buoyant.

Abstract:
The year 2001 was remarkable on many fronts. For the high yield market, it was a year of crushing record numbers of defaults and distressed exchanges, combined with predictable low recovery rates. Despite these fundamental problems and the "flight to quality" following the terrorist attacks in September, the high yield market displayed impressive resiliency.This report documents and comments upon the high yield bond market's risk and return performance by presenting traditional and mortality rate statistics and providing performance data over the market's history. Our analysis covers the period 1971-2001. In addition, we present our forecast of expected defaults.

Two new innovations to our analysis of the high yield bond market are also introduced. We adjust our traditional measure of default loss rates by factoring in the impact of fallen angel defaults where the "investment" in these issues is typically much below par value. Finally, we summarize some recently completed work, on analyzing default recovery rates, with an econometric model that has explained over 90% of the variation in recoveries over the last two decades.

Abstract:
The year 2001 was remarkable on many fronts. For the high yield market, it was a year of crushing record numbers of defaults and distressed exchanges, combined with predictable low recovery rates. Despite these fundamental problems, and the "flight to quality" following the terrorist attacks in September, the high yield market displayed impressive resiliency and confidence going forward. Returns were positive and quite good relative to most other asset classes and high yield new issuance was buoyant, approaching $90 billion.

Default amounts registered its third consecutive record year and topped $60 billion, more than double the previous high of $30 billion in 2000. The default rate was 9.80%, just below the record years of 1990 and 1991. Combined with a near record low recovery rate of 25 cents on the dollar, including the unusual FINOVA default, and about 21 cents without FINOVA, loss rates from defaults were about 7.76%, again second only to 1990's rate.

This report documents and comments upon the high yield bond market's risk and return performance by presenting traditional and mortality rate statistics and providing a matrix of performance data over the market's history. Our analysis covers the period 1971-2001 for most defaults and the 1978-2001 period for returns. In addition, we present our annual forecast of expected defaults. Last year, 2001, we originally expected about a 7.0% default rate and revised our forecast to 9.6% as the year's events unfolded. For 2002, we are predicting a 7.0-8.0% rate, still quite above average but below the 2001 rate. Again, the major uncertainty is the nation's economic performance.

Finally, in this report we introduce two new innovations in our analysis of the high yield bond market. We adjust our traditional measure of default loss rates by factoring in the impact of fallen angel defaults where the "investment" in these issues is typically much below par value. We also summarize some recently completed work on analyzing default recovery rates, with an econometric model that has explained over 90% of the variation in recoveries over the last two decades and was dead-on in predicting the recovery rate in 2001.

Abstract:
The Financial Economists Roundtable (FER) is a group of senior financial economists who meet annually to discuss current policy questions relating to investments, corporate finance, financial institutions, and financial markets. The FER issues statements from time to time about specific topics of current importance to increase the awareness and understanding of public policymakers, the financial economics profession, the communications media, and the general public.At its 1995 meeting, the FER examined reporting requirements for financial assets and liabilities as well as derivatives. Its statement here reflects the consensus view of the majority of members attending. In brief, it recommends that: 1. All financial assets and liabilities, and derivatives used to hedge them, should be recorded at fair value, i.e., should be marked to market. 2. Profits and losses on derivatives used to hedge non- financial assets or future expenditures should be recognized in the same period that the specified event or hedged item is taken into income or expense. 3. External reporting must be supported by an adequate risk management internal control system.

Abstract:
In recent years, the literature on financial distress has been enriched by the development of formal models. This paper develops a synthesis of that formal analysis, linking it to related finance literature and corporate strategies for distressed financial restructuring. Several key assumptions generate different results which predict the effects of financial distress on investment efficiency and restructuring strategy. Central to these strategies are the recontracting arrangements proposed between owners, creditors and other relevant stakeholders. The critical factors in the alternative models are: (1) the term structure of the firm's debt, (2) the role of the seniority of debts, (3) the effects of exchange offers, (4) the effects of an automatic stay on debt payments, and (5) the role of alternative voting rules.

Abstract:
This study is an attempt to construct and test a distress classification model for Korean companies. Utilizing a sample of 34 distressed firms from the recent 1990-1993 period and a matched (by industry and year) sample of non-failed firms, we observe the classification accuracy of two models. Both models utilize measures of firm size, asset turnover, solvency and leverage with one model available for testing only on publicly traded companies and one model applicable to all public and private entities. We observe excellent classification accuracy based on data from the first two years prior to distress. And, although the accuracy drops off after t-2, the models still provide effective early warnings of distress in many cases. The results of this study are of particular relevance in the current financial market scenario of increased deregulation and greater individual financial institution decision making. It is somewhat ironic for us to be proposing the use of a financial distress early-warning model given the current robust economic growth and low bankruptcy rate in Korea. But, the financial problems in Japan are a sobering reminder that high growth can be followed by financial excesses, increased business failures and large loan losses.

Abstract:
The most fundamental aspect of credit risk models is the rating of the underlying assets and the associated expected and unexpected migration patterns. The most important migration is to default. While default rate empirical studies of corporate bonds are now commonplace, there has never been a study on the corporate bank loan market. This paper assesses, for the first time, the default rate experience on large, syndicated bank loans. The results are stratified by original loan rating using a mortality rate framework for the 1991-1996 period. We find that the mortality rates on bank loan are remarkably similar to that of corporate bonds and asses the bias in the magnitude of our findings given that the study period covered a benign credit cycle in the United States. Our results provide important new information for assessing the risk of corporate loans not only for bankers but also mutual fund investors and analysts of structured financial products, credit derivatives and credit issuance.