Moody's: Low sovereign default rate reflects buoyant economic conditions in 2006

By Angela McDaniels

Seattle, June 12 - Moody's Investors Service said that of 103 rated sovereigns, Belize was the only one to default in 2006 and is only the third country to have defaulted in the past four years. The Dominican Republic defaulted in 2005 and Uruguay defaulted in 2003.

"The low default volume is consistent with strong global economic conditions and ample liquidity," Andrea Zazzarelli, Moody's associate analyst director of default research, said in an agency report.

"Reflecting this benign default environment, sovereign bond spreads continued to tighten in 2006. Last year, 19 sovereign issuers were upgraded against only two downgrades."

The agency said that most of the 19 upgraded issuers belonged to three main groups: oil-exporting countries, European Union membership seekers and new joiners, and a trio of strong Latin American performers.

In addition to analyzing sovereign defaults since 1983, Moody's report compared and contrasted the default, migration and recovery rates of sovereigns and corporates, and ratings accuracy measures.

Sovereign default rates have been, on average, lower than those for their corporate counterparts, but the agency said the differences in default rates are not likely significant because default risk is highly correlated across emerging market sovereigns and the overall size of the sovereign sample is small.

Moody's also found that rating changes, on average, have been less frequent for sovereign issuers than for corporate issuers. This greater average stability of sovereign ratings reflects an overwhelmingly lower historical probability of being downgraded within a 12-month period relative to corporate issuers, according to the report.

The two highest recovery rates in the agency's sample follow the Belize and Dominican Republic defaults in 2006 and 2005, respectively, when corporate recovery rates were generally high and corporate default rates were low.

"Issuer-weighted recovery rates for defaulted sovereign bonds have historically been higher than those for their corporate counterparts. Since sovereign default rates have also been lower, sovereign bonds have generally experienced lower credit loss rates than similarly rated corporate bonds," Zazzarelli said in the report.

He also pointed out that the value-weighted recovery rate estimate is significantly lower than the issuer-weighted recovery rate due to the large defaults of Argentina and Russia, which garnered low recovery rates.

Moody's noted that the recovery rate on the defaulted bonds of Belize was 76% and that the recovery rate on Belize's bonds was substantially higher than the historical average recovery rate on sovereign bonds, which is 55% on an issuer-weighted basis and 29% on a volume-weighted basis.

In terms of accuracy, the report said sovereign ratings have historically proven to be more accurate than corporate ratings as predictors of relative default risk. All sovereign defaulters have had ratings of Ba2 or less within one year prior to default.

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