An August To Remember
Kamakura Troubled Company Index Declines by 3.68% to 15.05%
Credit Quality Improves to 35th Percentile
NEW YORK, September 1, 2020: Despite the steamy weather outside, the August performance of financial markets made us recall the iconic Lexus commercial, “A December to Remember.” You cannot watch television in December without seeing the cars decked out with red bows and the jubilant faces of loved ones when they are surprised with their new vehicles.
Similarly, the markets this August continued to amaze and surprise everyone, even as bankruptcies reached record levels. As of mid-August, a record 45 companies with assets of more than $1billion had filed for bankruptcy, according to an August 21 article in the Financial Times. According to the article, this compares to 38 for the same period during the 2008-2009 financial crisis. Nevertheless, the Dow and S&P 500 had their best August in 36 years, and the NASDAQ set yet another record. In other words, economic performance on Wall Street and on Main Street significantly diverge, a situation we will continue to analyze at length.
The Kamakura Troubled Company Index® improved in August, with a decline of 3.68% over the month to 15.05%, and it ended the month at the 35th percentile. The index continued to be volatile, ranging during the month from 18.7% on August 3 to 13.27% on August 17. 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 August, the percentage of companies with a default probability between 1% and 5% was 13.05%, a decrease of 1.74% over the month. The percentage with a default probability between 5% and 10% was 1.02%, a decrease of 1.34%. Those with a default probability between 10% and 20% amounted to 0.74% of the total, a decrease of 0.48%; and those with a default probability of over 20% amounted to 0.24%, a decrease of 0.12%.
Troubled Company Index – August 31, 2020
At 15.05%, the Troubled Company Index improved to the 35th percentile of historical credit quality as measured since 1990.
Among the 10 riskiest-rated firms listed in August, eight were in the U.S, with one each in Norway and Switzerland. The riskiest firm remained Kongsberg Automotive of Norway, with a one-month default probability of 37.90%. We had 7 defaults in our coverage universe with six in the U.S and one in Mexico. Energy and retail firms continued to lead the defaults. We have seen 32 energy defaults and 44 retail firms default year to date.
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 0.45% to 0.93%, while the 10-year rate narrowed by 2.95% to 11.86%.
Expected Cumulative Default Rate – August 31, 2020
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
The equity and bond markets continue to perform amazingly well, but defaults and economic stress continue, especially for small businesses. Central banks have stepped in to provide market liquidity, allowing the capital markets to continue to function and keeping global economies afloat. We are certainly appreciative of these efforts.
However, all actions also produce reactions, and often include unintended consequences. One of these in this case is the compression of spreads for strong and weak firms alike. This puts pressure on portfolio managers to use the best tools available to identify risk.
Earnings expectations have turned positive for the future, but at the same time, the real yield on U.S. corporate bonds turned negative. While this reflects the liquidity provided by central bank actions, it also pushes more money into the equity markets.
A very interesting and timely study, the Federal Reserve’s “Reports to Congress Pursuant to Section 13(3) of the Federal Reserve Act in response to Covid-19,” provides transparency into the central bank’s actions. In particular, I point readers towards the section on the Secondary Market Corporate Credit Facility. The transaction-specific disclosures here provide insight into the Fed’s purchases. Its current level of buying drives rates down and compresses spreads, resulting in less differentiation by credit quality. At the same time, the Federal Reserve July Senior Loan Officer Opinion on Bank Lending Practices report shows that lending standards have tightened for both business and commercial real estate lending. Anecdotal evidence suggests the current tightening of underwriting standards is a global phenomenon
With defaults running higher than they did during the 2007-2008 credit crisis, this is an opportunity for portfolio and risk managers to excel by applying appropriate forward-looking analytics.
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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