When You Come To A Fork In The Road, Take It
Kamakura Troubled Company Index Declines by 6.85% to 18.73%
Credit Quality Improves to 26th Percentile
NEW YORK, August 3, 2020: I cannot confirm whether the saying, “When you come to a fork in the road, take it” is a true Yogi-ism or a “pseudo-Yogi-ism”. Either way, it seems appropriate today, given the confusion surrounding the financial effects of the coronavirus and the growing disconnect between Main Street and Wall Street.
In the U.S., negotiations for coronavirus relief seem to be making progress, but at this writing, there is still deep division between the Democratic and the Republican vision of how relief should take shape. In the markets, The S&P 500, the Dow, and NASDAQ Composite all posted their fourth consecutive monthly gain. But on Main Street, a good friend of mine just had to shut all three of her restaurants for good to stem Covid-related losses.
The wider the fork between Wall Street and Main Street, the more important it is to look critically at the numbers. Globally, bank loss projections seem very consistent in pointing towards a lot more pain on the horizon.
The Kamakura Troubled Company Index® improved in July, with a decline of 6.85% over the month to 18.73% and ended the month at the 26th percentile. The index continued to be volatile, ranging during the month from 17.62% on July 29 to 24.61% on July 7. The index reflects the percentage of 40,500 public firms that have a default probability of over 1%. An increase in the index reflects declining credit quality, while a decrease reflects improving credit quality.
At the close of July, the percentage of companies with a default probability between 1% and 5% was 14.79%, a decrease of 4.48% over the month. The percentage with a default probability between 5% and 10% was 2.36%, a decrease of 1.0%. Those with a default probability between 10% and 20% amounted to 1.22% of the total, a decrease of 0.77%; and those with a default probability of over 20% amounted to 0.36%, a decrease of 0.60%.
Troubled Company Index – July 31, 2020
At 18.73%, the Troubled Company Index improved to the 26th percentile of historical credit quality as measured since 1990.
Among the 10 riskiest-rated firms listed in July, eight were in the U.S, with one each in Norway and Switzerland. The riskiest firm was Kongsberg Automotive of Norway, with a one-month default probability of 53.12%. Last month’s riskiest firm, Noble Corporation PLC, defaulted on July 17. For the second consecutive month, we had 19 defaults in our coverage universe. Energy and retail firms continued to lead the defaults.
Riskiest Rated Companies based on 1-month KDP
The Kamakura expected cumulative default curve for all rated companies worldwide narrowed, with the one-year expected default rate decreasing by 1.17% to 1.38%, while the 10-year rate narrowed by 3.38% to 14.81%. After four consecutive months, the 10-year cumulative default rate has come down below the peak during the credit crisis.
Expected Cumulative Default Rate – July 31, 2020
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
To prepare for this month’s commentary I did a quick read of the Financial Times, the Wall Street Journal, The Economist and a several other global publications. I was amazed by the conflicting headlines:
“US suffers worst month for Covid-19 cases”
“US junk bonds notch best month since 2011”
“US government debt surges”
“US dollar has worst month since 2010 in relentless sell-off”
The global financial crisis that followed by the Covid-19 pandemic has fundamentally changed how financial markets work. More specifically, intervention by central banks is now normal. How can you evaluate risk and reward when these interventions distort the pricing of risk in the markets?
The expansion of central bank purchases affects the pricing of government bonds, corporate bonds, equities, and other assets. But while central bank actions can drive interest rates to zero or even make them negative, they cannot force lenders to lend or high-quality borrowers to borrow. Where once companies were winners or losers and the market kept score, now bank and government interventions impact outcomes.
While there are many uncertainties ahead, I am confident that government intervention cannot and will not repeal the credit cycle, and we will see accelerating defaults. These can be hedged and managed if you use the proper tools.
My greater fear is that the central bank interventions will create bigger and bigger market and asset bubbles. And we know from experience what happens when these bubbles pop. Of course, you can’t fight central banks. But at Kamakura, we will continue to provide the most up- to- date and modern default measurements to help you navigate today’s uncertain conditions.
About the Troubled Company Index
The Kamakura Troubled Company Index® measures the percentage of 40,500 public firms in 76 countries that have an annualized one- month default risk of over one percent. The average index value since January 1990 is 14.53%. Since November 2015, the Kamakura index has used the annualized one-month default probability produced by the KRIS version 6.0 Jarrow-Chava reduced form default probability model, a formula that bases default predictions on a sophisticated combination of financial ratios, stock price history, and macro-economic factors.
The KRIS version 6.0 models were developed using a data base of more than 2.2 million observations and more than 2,600 corporate failures. A complete technical guide, including full model test results and parameters, is provided to subscribers. The KRIS service also includes a wide array of other default probability models that can be seamlessly loaded into Kamakura’s state-of-the-art enterprise risk management software engine, the Kamakura Risk Manager. Available models include the non-public-firm default model, the commercial real estate model, the U.S. bank model, and the sovereign model. Related data includes credit default swap trading volume by reference name, market implied credit spreads, and prices on all traded corporate bonds traded in the U.S. market. Macro factor parameter subscriptions include Heath, Jarrow, and Morton term structure models for government securities in the U.S., Germany, the UK, Canada, Spain, Sweden, Australia, Japan, Thailand, and Singapore. All parameters are derived in a no-arbitrage manner consistent with seminal papers by Heath, Jarrow, and Morton, as well as Amin and Jarrow. A KRIS Macro Factor Scenario Service subscription includes both riskneutral and “real world” empirical scenarios for interest rates and macro factors.
The version 6.0 model was estimated over the period from 1990 to May 2014 and includes the insights of the entirety of the recent credit crisis. The 76 countries currently covered by the index are: Argentina, Australia, Austria, Bahrain, Bangladesh, Belgium, Belize, Botswana, Brazil, Bulgaria, Canada, Chile, China, Colombia, Croatia, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Ghana, Greece, Hungary, Hong Kong, Iceland, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kenya, Kuwait, Luxembourg, Malaysia, Malta, Mauritius, Mexico, Nigeria, the Netherlands, New Zealand, Norway, Oman, Pakistan, Peru, the Philippines, Poland, Portugal, Qatar, Romania, Russia, Saudi Arabia, Serbia, Singapore, Slovakia, Slovenia, South Africa, South Korea, Spain, Sri Lanka, Sweden, Switzerland, Tanzania, Taiwan, Thailand, Turkey, the United Arab Emirates, Uganda, the UK, the U.S., Vietnam and Zimbabwe.
About Kamakura Corporation
Founded in 1990, Honolulu-based Kamakura Corporation is a leading provider of risk management information, processing, and software. Kamakura was recognized as a category leader in the Chartis Report, Technology Solutions for Credit Risk 2.0 2018. Kamakura was named to the World Finance 100 by the editor and readers of World Finance magazine in 2017, 2016 and 2012. In 2010, Kamakura was the only vendor to win two Credit Magazine innovation awards. Kamakura Risk Manager, first sold commercially in 1993 and now in version 10.1, is the first enterprise risk management system for users focused on credit risk, asset and liability management, market risk, stress testing, liquidity risk, counterparty credit risk, and capital allocation from a single software solution. The KRIS public firm default service was launched in 2002. The KRIS sovereign default service, the world’s first, was launched in 2008, and the KRIS nonpublic firm default service was offered beginning in 2011. Kamakura added its U.S. Bank default probability service in 2014.
Kamakura has served more than 330 clients with assets ranging in size from $1.5 billion to $3.0 trillion. Current clients have a combined “total assets” or “assets under management” in excess of $26 trillion. Its risk management products are currently used in 47 countries, including the United States, Canada, Germany, the Netherlands, France, Austria, Switzerland, the United Kingdom, Russia, Ukraine, South Africa, Australia, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Singapore, Sri Lanka, Taiwan, Thailand, Vietnam, and many other countries in Asia, Europe and the Middle East.
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