Lower Default Rates Research Articles

Is There a Relationship Benefit in Credit Ratings?*

This paper shows that firms with longer rating agency relationships have better credit ratings, conditional on observables. The paper also finds that (1) controlling for observables, firms with longer relationships, while having higher average ratings, do not have lower default rates, (2) relationship benefits are larger among firms with a greater incentive to game their information supplied to agencies or to pressure agencies into giving higher ratings, and (3) investors demand a (price) discount on bonds sold by relationship firms and the correlation between bond yield spreads and ratings is decreasing with relationship length. In sum, the evidence is inconsistent with first-order credit quality explanations but rather supports a ‘‘learning-to-gaming’’ and an ‘‘adverse incentives’’ story.

Financial Stability, Regulatory Buffers, and Economic Growth: Some Postrecession Regulatory Implications

Over the past 40 years, regulatory reforms have been undertaken on the assumption that markets are efficient and self-corrective, crises are random events that are unpreventable, the purpose of an economic system is to grow, and economic growth necessarily improves well-being. This narrow framework of discussion has important implications for what is expected from financial regulation, and for its implementation. Indeed, the goal becomes developing a regulatory structure that minimizes the impact on economic growth while also providing high-enough buffers against shocks. In addition, given the overarching importance of economic growth, economic variables like profits, net worth, and low default rates have been core indicators of the financial health of banking institutions.This paper argues that the framework within which financial reforms have been discussed is not appropriate to promoting financial stability. Improving capital and liquidity buffers will not advance economic stability, and measures of profitability and delinquency are of limited use to detect problems early. The paper lays out an alternative regulatory framework and proposes a fundamental shift in the way financial regulation is performed, similar to what occurred after the Great Depression. It is argued that crises are not random, and that their magnitude can be greatly limited by specific pro-active policies. These policies would focus on understanding what Ponzi finance is, making a difference between collateral-based and income-based Ponzi finance, detecting Ponzi finance, managing financial innovations, decreasing competitions in the banking industry, ending too-big-to-fail, and deemphasizing economic growth as the overarching goal of an economic system. This fundamental change in regulatory and supervisory practices would lead to very different ways in which to check the health of our financial institutions while promoting a more sustainable economic system from both a financial and a socio-ecological point of view.

Locally produced ready-to-use supplementary food is an effective treatment of moderate acute malnutrition in an operational setting

Typical treatment of moderate acute malnutrition, simple wasting, in sub-Saharan Africa consists of dietary counselling and/or general or targeted distribution of corn/soy-blended flour (CSB). A randomised clinical effectiveness trial in 2007 showed CSB to be less effective than ready-to-use supplementary food (RUSF). To determine the operational effectiveness of treating moderate acute malnutrition with RUSF. Children aged 6-59 months were recruited in rural southern Malawi. Each child received 65 kcal/kg/d of locally produced soy/peanut RUSF, a product that provided about 1 RDA of each micronutrient. Anthropometric measurements were taken every 2 weeks and additional rations of RUSF were distributed at this time if the child remained wasted. Study participation lasted up to 8 weeks. Of the 2417 children enrolled, 80% recovered, 4% defaulted, 0.4% died, 12% remained moderately wasted and 3% developed severe acute malnutrition. Weight, length and MUAC gain were 2.6 g/kg/d, 0.2 mm/d and 0.1 mm/d respectively. Cost per child treated was $5.39. This intervention proved to be robust, maintaining high recovery rates and low default rates when instituted without the additional supervision and beneficiary incentives of a research setting.

Can Microfinance Reduce Portfolio Volatility?

Microfinance is arguably one of the most effective techniques for poverty alleviation in developing countries. Although traditionally supported by nongovernmental organizations and socially oriented investors, microfinance institutions (MFIs) have increasingly demonstrated their value on a stand‐alone basis, typically exhibiting low default rates combined with attractive returns and growth, encouraging greater commercial involvement. This study addresses a related issue—whether microfinance shows low correlation with international and domestic market performance measures. If so, it could form the empirical basis for MFI access to capital markets and performance‐driven investors in their search for efficient portfolios. Our empirical tests do not show any exposure of microfinance institutions to global capital markets, but significant exposure regarding domestic GDP, suggesting that microfinance investments may have useful portfolio diversification value for international investors, not for domestic investors lacking significant country risk diversification options.

Competition, Financial Innovation and Specialization in Credit Markets

I examine how commercial banks’ lending strategies respond to deregulation-driven credit market competition and the concurrent rise in securitization in the U.S. over the period 1976 to 2003. Banks display greater specialization in their loan portfolios after deregulation, with larger and younger banks making more loans backed by real estate, and smaller and older banks making more non-real-estate-backed commercial and personal loans. A large part of the shift in lending between these groups of banks appears to be driven by larger and younger banks making greater use of innovations in securitization markets. When larger and younger banks make more real-estate-backed loans, they exhibit larger fractions of defaults yet charge lower interest rates on these loans, consistent with these banks lowering the costs of lending and expanding credit for borrowers. In contrast, when smaller and older banks make more commercial and personal loans, they exhibit lower default rates and charge higher interest rates, consistent with these banks restricting lending to higher quality loans. The analysis presents new evidence on the role that competition and innovation in financial markets play in the equilibrium supply of credit.

Return Dynamics of Distressed Bonds

This study adds to the small, but growing, body of research on active management of distressed debt. The analysis stratifies the distressed debt universe in various ways to test whether certain subgroups exhibit comparatively low risk or comparatively high returns, thereby representing superior investment opportunities. A small group of distressed bonds rated double-B do provide statistically lower default rates and higher bear market returns than single-B or triple-C issues. The authors also find no comparable advantages for bonds issued by public companies over bonds issued by private companies, which challenges the prevailing investor preference for public companies. And contrary to popular belief, agency ratings do appear to provide information content in the speculative grade market.

Small firms in the SSBF

This paper uses Survey of Small Business Finance data to better understand how the owners of small firms use decisions about legal organization, firm size, capital structure, and owner investment in the firm to manage firm risk. The main findings are: Firms with unlimited liability are smaller, both when measured by assets and number of employees, and tend to be less leveraged than those whose owners limit personal exposure to firm liabilities. Entrepreneurs tend to hold largely undiversified positions by investing heavily in their firms, and this does not differ appreciably by legal organization. The percentage of firms with limited liability has remained virtually constant through time, although within this group there is a trend toward hybrid legal organizations with beneficial tax treatment. We estimate return on assets and find that entrepreneurship is a very risky undertaking, with high upside gain. The possibility of high future returns helps explain the coexistence of a large percentage of firms with negative equity and low default rates. The shape of the return distribution and limited liability interact; the option to declare bankruptcy shields owners from personal loss in the lower tail of the distribution while preserving the potential for significant firm returns in the upper tail.

Dynamic incentive with nonfinancing threat and social sanction in rural credit markets

This paper analyzes an individual lending credit market in a rural society, where potential borrowers have a dynamic incentive of strategic default, and a benevolent lender gives them a credible threat to cut future credit when loands are not repaid. A crucial issue is that social sanction of default depends on the default rate in the society. Our analysis suggests that for a relatively small financing cost, a credit market exists where borrowers have little motivation to default voluntarily, associated with intense social sanctions. The results also reveal that a relatively large financing cost causes the credit market to collapse, since it raises motivation of default, associated with less intense social sanctions. These results could justify government support to reduce the lender’s financing cost. The model further illustrates the plausibility of two equilibria: a low default rate associated with a low lending rate and intense social sanctions, and a high default rate with a high lending rate and less intense social sanctions. This could explain the possibility that the default rate is different from village to village even though these societies seem to share an almost identical environment.

Maturity adjustments under asymptotic single risk factor models: a comparative analysis

Bank credit portfolios consist of instruments with different maturities. Both intuition and empirical evidence indicate that long-term credits are riskier than short-term credits. Consistent with these considerations, the Basel II maturity adjustment is a function of both maturity and default rate and is higher (in relative terms) for low default rate borrowers than for high default rate borrowers. This paper compares various methods to account for the maturity adjustment that fall within the framework of asymptotic single risk factor (ASRF) models. Section 2 reviews existing literature dealing with models of the maturity adjustment that fall within the scope of ASRF-type models. In particular, special attention is given to three approaches: (1) multi-period probability of default (PD) based on the theory of Merton (1974), (2) “annualized” PD using the theory of survival analysis and hazard rates and (3) default probability term structure derived from market credit spreads. Section 3 presents and analyzes the results obtained from simulating economic capital using both the Merton multi-period default approach and the “annualized” probability approach. As for the credit spread approach, instead of simulating portfolio economic capital, a case study on a single obligor is used to illustrate the concepts.

Make Poverty History

In the last two decades, many Micro Finance Organizations were able to reach significant number of poor, provide them credit at unsubsidized interest rates, and have relatively low default rates on these loans. Given the critical role of credit markets in economic development, this led to microfinance being seen as a panacea for poverty. In addition, microfinance has been seen as empowering since a large segment of microfinance clients are women. Of late however, the initial euphoria has given way to the recognition that credit is only one of the many services the poor need to increase their incomes, and increased income itself is not sufficient to eradicate poverty.

Negative equity and foreclosure: Theory and evidence

Recent declines in housing prices have focused attention on the relationship between negative housing equity and mortgage default. Theory implies that negative equity is a necessary condition for default, but not a sufficient one. This often-misunderstood result is clearly illustrated in a dataset of Massachusetts homeowners during the early 1990s; fewer than 10 percent of borrowers likely to have had negative equity at the end of 1991 experienced a foreclosure during the following three years. An econometric model of default estimated on two decades of Massachusetts housing data also predicts low default rates for current negative-equity borrowers. We develop a simple theoretical model to interpret these empirical findings and to assess potential foreclosure-reduction policies. Our results imply that lenders and policymakers face an information problem in trying to help borrowers with negative equity, because it is hard to determine which owners really need help in order to stay in their homes.

Treatment outcomes of patients placed on treatment under directly observed therapy short-course (DOTS)

Background:Tuberculosis continues to be a pressing health problem in India. The Revised National Tuberculosis Programme (RNTCP), an application of Directly Observed Treatment Short-course (DOTS) in India, launched in 1997 needs continuous evaluation.Objective:To study the outcomes of treatment among the patients put on DOTS under RNTCP in Chandigarh, UT.Material & Methods:A Longitudinal study was conducted during 2004-2005 in 13 Microscopic centres (MC's) spread over 2 Tuberculosis Units (TU's) under District Tuberculosis Centre (DTC) in Union Territory (UT), Chandigarh. A sample of 265 respondents, selected by two-stage stratified random sampling technique, was recruited in the study cohort. Data analysis was done using SPSS-10 statistical software package.Results:For Category I and Category II patients, the Success rate was 98.6% and 90.4% respectively. The overall default rate was 1.1% and failure rate was 2.6%. For re-treatment cases, failure rate was higher i.e. 5.8%. The sputum conversion rate among the new smear positive cases was 93.8% at 3 months of treatment. For the re-treatment cases, spu-tum conversion rate at 3 months was 94.1%.Conclusion:The study concludes that RNTCP is running successfully in UT Chandigarh, having high success rate and low default rate. The reasons for high failure rate should be explored in depth.

Morgan Stanley Roundtable on Managing Financial Trouble

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.

Beyond the Washington Consensus, Access to Finance, Microfinance, and International Banking Regulation

International banking regulation comprises, inter alia, transnational quasi-legal standards concerning the capital adequacy of internationally active banks, though their usage is normally much wider. These standards originate from the Basle Committee on banking supervision. The main rationale for their emergence has been the fashioning of national and transnational regulatory systems that are adept at preventing systemic crises and protect bank depositors from bank failures. This chapter suggests that, in addition to systemic stability and depositor protection, international capital adequacy standards may be utilized to facilitate access to finance. The degree of access to finance is a major criterion of financial sector development (FSD). FSD is generally viewed as an essential ingredient of sustained economic growth and thus a very effective means to foster development and fight poverty in developing countries. The first step in utilizing International capital adequacy standards to facilitate access to finance is through the assignment of lower capital requirements to private development finance loans under the Basle framework, in order to reflect their very low default rate. Relevant lending should be facilitated through the intermediation of centralized country schemes or specialized corporate vehicles that on-lend funds to the end lenders, regardless of whether these are mainstream financial institutions or microfinance Institutions. The suggested amendment of the Basle framework would give international banking institutions a clear incentive to be involved in the private development finance business and lend funds at lower interest rates.

Are Commercial Mortgage Defaults Affected by Tax Considerations?

We study whether tax considerations are an important determinant of commercial mortgage default. We also study whether large lenders are better informed, or better at interpreting information for lending purposes, and hence have lower foreclosure rates; whether lenders have more information on larger borrowers than smaller borrowers, and hence have lower foreclosure rates on larger loans; and whether commercial mortgage defaults are related to debt service coverage and loan-to-values, both initial and contemporaneous. The paper's main findings are fourfold. First, holding all else equal, there is evidence that tax considerations influence investors' decisions about when to put assets to lenders. The results are consistent with the argument of Constantinides (1984). Second, the evidence suggests that large lenders are especially knowledgeable about commercial mortgage borrowers and commercial property markets, in that they have lower foreclosure rates than smaller lenders. Third, on the question of whether lenders have more information on larger borrowers than smaller borrowers, we find that larger loans have, on average, lower default rates than smaller loans. Fourth, the findings suggest that lower default rates are associated with higher debt service coverage ratios, both initial and contemporaneous.

Highlights of Recent Trends in Financial Markets

After some significant corrections in the second half of May and in early June, major equity markets have resumed their growth, in some cases regaining levels reached before the May-June contraction. Against a backdrop of healthy corporate balance sheets, robust earnings growth and low default rates, investor sentiment has remained positive, as reflected in these equity market developments and compressed credit spreads. However, there are signs of increasing nevousness, which include the May/June market turbulence and somewhat increased levels of historical and implied volatility. The increased nervousness may reflect in part downward revisions to economic forecasts.

Can Microfinance Reduce Portfolio Volatility?

Microfinance is arguably one of the most effective techniques for poverty alleviation in developing countries. Although traditionally supported by nongovernmental organizations and socially-oriented investors, microfinance institutions (MFIs) have increasingly demonstrated their value on a stand-alone basis, typically exhibiting low default rates combined with attractive returns and growth, encouraging greater commercial involvement. This paper addresses a related issue - whether microfinance shows low correlation with international and domestic market performance measures. If so, it could form the empirical basis for MFI access to capital markets and performance-driven investors in their search for efficient portfolios. Our empirical tests do not show any exposure of microfinance institutions to global capital markets, but significant exposure regarding domestic GDP, suggesting that microfinance investments may have useful portfolio diversification value for international investors, not for domestic investors lacking significant country risk diversification options.

Corporate Bonds Underwritten by Commercial and Investment Banks: Analyzing the Default Risk

Starting in the early 1990s, banks began to slowly make their way into securities underwriting using their Section 20 subsidiaries. With the enactment of the Gram-Leach-Bliley Act of 1999, the long-standing restrictions between commercial- and investment-banking activities were formally removed. Banks have not wasted any time utilizing these new powers, making significant inroads in bond and equity underwriting over the last few years. In 2003, banks accounted for 53 percent of the IPO volume and 61 percent of corporate bond underwriting. The rapid ascendancy of many large banks in the underwriting league tables has renewed the debate concerning the gains (private information certification benefits) and costs (conflicts-of-interest costs) of combining commercial and investment banking. This paper examines these competing views on bank entry by analyzing the post-issue performance of corporate bond issues managed by investment and commercial banks during 1990-2003. We find that both commercial banks and investment banks underwrote the same quality of high-yield bonds. Investment-grade bonds underwritten by banks exhibited higher default rates than investment bank issues. Bank-advised unrated bonds had a lower default rate, suggesting that banks may be better at certifying unrated opaque firms where private information is more critical. Moreover, we find that the aftermarket performance of bonds was not adversely influenced by pre-existing syndicated loan relationships between bank underwriters and issuers.

Underground banking in Malaysia: a case study of ROSCAs

PurposeTo provide arguments in favour of legalising rotating savings and credit associations (ROSCAs) as they play an important role in savings and credit for women in Malaysia.Design/methodology/approachThe paper refers to previous studies on ROSCAs in Malaysia and extracts information that shows that ROSCAs are used mostly by women as a method of forced‐savings, credit and insurance against uncertainties. It suggests different methods that can be used to make ROSCAs more efficient. Finally, it provides suggestions for amendments to existing legislation which will not interfere with the social structure that supports ROSCAs, yet permit participants to sue defaulters.FindingsThe findings show that ROSCAs are widely practised in Malaysia especially in the rural and suburban areas. The participants are mostly women from middle income and low‐income groups who used it as a form of savings or credit. The benefits of permitting ROSCAs outweigh the risks. Legalising ROSCAs will not remove the benefits but will substantially reduce the risks.Originality/valueThis paper provides arguments to legalise ROSCAs in Malaysia and provides suggestions to ensure greater efficiency and a lower default rate. It also suggests amendments to the legislation to enable participants to take quick and cheap legal action against defaulters.

Default and recovery rates of Asia-Pacific corporate bond issuers, 1990–2003

This study investigates Asia-Pacific corporate bond rating transitions, defaults, and defaulted bond recoveries. As the size of the market continues to grow and mature, the speculative-grade part of the bond market has become a significant portion of the total bond market in the Asia-Pacific region. Despite this growth, Asia-Pacific issuers historically have had higher average ratings and lower default rates than the global sample. However, the speculative-grade Asia-Pacific issuers - excluding Japan - have higher default rates than their global counterparts. Most of the bond defaults happened during the Asian financial crisis of 1998-1999. Since the financial crisis the default rates have declined as companies have been able to repair their balance sheets. One exception to this pattern of higher default rates in the region is Japan, where there has been only one Moody's-rated default since 1990. Japan's relatively limited rated-bond default experience is attributable to its higher credit quality (bond market access has historically been very limited for speculative-grade issuers) and the general practice of its government and financial institutions to support companies facing financial distress. The recovery rates and annual credit losses for defaulted bonds in the region are comparable to those in Europe and North America.