Moody’s Analytics Credit Transition Model: Frequently Asked

Questions
1. What is Moody's Analytics Credit Transition Model?
The Credit Transition Model is an issuer-level model of rating transitions and default rates. The model separately
identifies the probability of an issuer upgrading, downgrading, remaining at the same rating, and defaulting. It
conditions on issuer-related rating facts and the future path of two economic drivers: the unemployment rate and
the high yield spreads. Key inputs include:

»» Issuer-specific factors observable today: the current rating, whether the issuer was upgraded or downgraded
into its current rating, rating momentum, how long the issuer has maintained its current rating, how long the
issuer has consecutively maintained any credit rating, and the issuer’s current outlook or watchlist status
»» U.S. Unemployment Rate: used as a measure of macroeconomic health and helps summarize recent economic
history, and there is strong correlation between the aggregate default rate and changes in unemployment
»» High-yield spreads: used as a summary statistic of the market’s perception of credit quality and hence credit
availability. As such, it is a key driver in rating transitions and defaults.

2. What are each of the issuer-specific factors meant to represent?

»» Current Rating: Current level of credit-worthiness.
»» Rating History: The longer a rating has been in a given category, the more likely it is to make a transition.
»» Age (how long the issuer has continuously maintained any Moody's rating): This serves to capture the
seasoning effect, or the well- documented influence of the age of a bond on default rates, as first discovered in
Altman, E. I., 1989. "Measuring Corporate Bond Mortality and Performance," Journal of Finance 44: 909-22.
»» Outlook/ Watchlist Status: Offers additional information regarding the near-term prospects of an issuer.
»» Rating Momentum: if an issuer was last downgraded/upgraded the issuer has a higher probability of moving in
the same direction versus other issuers
Moody’s Analytics Credit Transition Model: Frequently Asked Questions

3. What is the output of Moody’s Credit Transition Model?

The output of the model includes a forecasted transition matrix and default rate across the entire credit rating scale
for individual issuers. The issuer level matrices are then aggregated to produce outputs such as rating migration
matrices, marginal default rates, cumulative default rates, default forecasts, and default distributions in easy to use
graphics and tables. Drill-down and hover functionality allows you to see added detail on each output. This outpost
can be customized under the “Custom Scenarios” tab. Forecast can be made for up to 20 quarters in the future, and
customized economic scenarios can be input into the model.

4. If two companies have the same rating and are run through the same macroeconomic environment, will the
results be the same?
No. The two companies would also need to have the same outlook / watchlist status and the same rating history in
terms of when they were upgraded and downgraded and how long they stayed in a given rating category. They would
also need to be in the same broad industry category (financials, industrials, utilities) and the same broad regional
category (e.g. North America, Europe).

5. What is a Watchlist/Outlook Assignment?

In many cases, rated corporate entities carry a Moody’s Outlook. This Outlook – which is usually Stable but may be
Negative or Positive – represents the analyst’s view as to the likely future prospects of the issuer’s credit condition. In
some cases, when Moody’s believes that a rating change is likely, an issuer will be placed on a Watchlist for either an
Upgrade or a Downgrade.

6. What is the methodology for creating the high-yield spread forecast?

The historical data on the high-yield spread came from Lehman Brothers. The historical value of the spread was
regressed on an intercept, the spread of the Baa over the 10-year Treasury rate, an eight-quarter moving average of
the year-ago percent change in corporate profits, and a 12-quarter moving average of interest payments as a share of
corporate profits. A Baa spread measures corporate credit conditions. The profit variable measures recent corporate
conditions. The interest variable measures the ability of firms to meet their interest payments. All of the variables have
the expected sign and are statistically significant. The R2 is 0.96, meaning that the equation explains about 96% of the
variation in the spread.
The other corporate credit spreads are forecasted using similar regressions, with the forecast for each bond based on
the spread of the next higher-rated bond. For example, the spread for the Baa is based on the spread for the A bond.

7. My firm’s economist produces forecast based on calendar quarters. Can I input this forecast into CTM?
You can input your calendar quarter based forecast directly into the “Custom Scenario” tool in CTM. CTM disaggregates
calendar quarters into months and combines the forecast appropriately across the non-calendar quarterly forecast.

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Moody’s Analytics Credit Transition Model: Frequently Asked Questions

8. What do each of the settings on the Forecast charts signify?

The various filter parameters allow you to customize your results :

»» "From” and “To” fields to specify the quarters the model is forecasting. The “From”
field always starts from the current calendar quarter although ratings are as of the last
business day to forecast accurate results.
»» The Economy.com Scenario filter selects from Baseline, Upside: High growth,
Downside: mild recession, Downside: Moderate recession, Downside: severe recession
scenarios and displays results on the charts.
»» The Region/Country dropdown has three options to choose from Americas, Europe/M.
East/Africa and Asia as well as countries. These are the effective domains e.g. If a
company incorporated in the Cayman Islands, but does most of their business in the
United States, they would be classified as U.S. We cover 100+ countries under CTM.
The number of countries you select is shown in parentheses.
»» Industry dropdown has Moody’s 11,Moody’s 35,Broad, Specific, Broad SIC, Specific SIC
code and under each of these categories we have the respective Industry segments
mapped, by default Moody’s 35 is selected. The number of industries you select is
shown in parentheses. (e.g. “(35)”).
»» Ratings dropdown has “All ratings” selected by default but users can also select from
Letter/ Alpha numeric/Investment grade/Speculative grade.
»» Probability of Withdrawal filter enables the user to select either of the two options to
“Exclude” or “Include” the probabilities of WR’s from the respective CTM forecasts.

By default withdrawals are excluded from the forecasts. This option is not available in the custom forecast area. Users
can put in combinations of the above parameters and return customized result subsets.

9. Can we see the results of all Macroeconomic factors at once?

Yes; to see the results of all five Moody’s Economy.com scenarios at once, select all five scenarios on the left navigation
pane on the Default Rate chart.

10. Do we have the ability to customize withdrawals on the custom scenarios?

We do not have the ability to exclude / include withdrawals from the custom scenarios currently. By default they are
excluded.

11. How are the Moody’s Industry codes mapped in the CTM?
The industries, known as Moody’s 35, are created and maintained by Moody’s Investor Service’s Credit Strategy and
Standards (CSS). These 35 industry categories are comprised of industry groupings loosely based on the industries
shown in the company page on moodys.com. Please click here for a description of Moody’s 35 codes.

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Moody’s Analytics Credit Transition Model: Frequently Asked Questions

12. Why do only some names show up when I import my portfolio into the Credit Transition Model?
The universe of names in the Credit Transition Model is slightly different from the Moody’s Rated universe of names.
For example, Structured Finance entities municipals, and project finance are not be included in the Credit Transition
Model universe. Additionally, for an issuer to show up in the CTM, it must carry a Moody’s Senior Unsecured Rating.
Only companies included in CTM will be counted and included in your portfolio and results.

About Moody’s Analytics

Moody’s Analytics, a unit of Moody’s Corporation, helps capital markets and credit risk management
professionals worldwide respond to an evolving marketplace with confidence. The company offers
unique tools and best practices for measuring and managing risk through expertise and experience in
credit analysis, economic research and financial risk management. By offering leading-edge software
and advisory services, as well as the proprietary credit research produced by Moody’s Investors Service,
Moody’s Analytics integrates and customizes its offerings to address specific business challenges.

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