An increased risk of credit-related exposures and the contagion effect of the recent global financial crisis have led to stringent regulations and the need for accurate credit risk models. Under the Basel III Accord, adequate stress testing models are required to have a strong capital base and to cover the unexpected losses for a range of risks. In this paper, a simulation-based methodology is proposed for the estimation of stressed through-the-cycle transition probabilities to provide a practical technique in stress testing. Unlike the traditional asset-correlation-based models, this study considers time-varying correlations between the rating migrations. An extended loss function, which is sensitive to the portfolio credit qualities and credit spreads, is applied to improve the estimation power of the transition probabilities. The model targets accuracy of credit loss estimations, and it is analyzed under different portfolio structures. The derived transition probability matrixes are downgrade oriented and capture the stress conditions.