The Silver Skates Of Default
Kamakura Troubled Company Index Declines by 6.13% to 25.58%
Credit Quality Improves to 13th Percentile
NEW YORK, July 1, 2020: In 1865 American author Mary Mapes Dodge published “Hans Brinker; or the Silver Skates: A Story of Life in Holland.” The story, which introduced the sport of Dutch speed skating to Americans, also contained a memorable subplot about a boy who put his finger in a leaking dike, preventing a disastrous flood. It’s a good story, but in reality, dikes with structural flaws do not leak. Instead, whole sections collapse at once.
In 2020, many wonder whether central banks and the governments supporting them will be able to stop the leak in the dike of insolvency, like the legendary Hans Brinker, or whether they must face a new reality as the dike breaks and the wave of defaults becomes unstoppable. At this point in the cycle, defaults have primarily come from companies that were overleveraged especially in industries that were already under stress and had declining sales or margins or were reliant on loose underwriting to roll over debt. As we look forward, the question will be whether collateral damage of the pandemic will cause insolvency for companies that were not considered at risk six months ago. Low rates have driven many investors to seek yield in companies that were considered prudent risks at the time, but whether they will remain so in today’s uncertain environment is difficult to say.
The Kamakura Troubled Company Index® improved in June, with the decline of 6.13% to 25.58% compared to May 29 and ended the month at the 13th percentile. The index continued to be highly volatile, ranging during the month from 25.58% to 31.94%. 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 June, the percentage of companies with a default probability between 1% and 5% was 19.27%, a decrease of 3.16% over the month. The percentage with a default probability between 5% and 10% was 3.36%, a decrease of 1.61%. Those with a default probability between 10% and 20% amounted to 1.99% of the total, a decrease of 0.74%; and those with a default probability of over 20% amounted to 0.96%, a decrease of 0.62%.
Troubled Company Index – June 30, 2020
At 25.58%, the Troubled Company Index improved to the 13th percentile of historical credit quality as measured since 1990.
Among the 10 riskiest-rated firms listed in June, seven were in the U.S, with one each in Australia, Great Britain, and Norway. The riskiest firm remained Noble Corporation PLC with a one-month KDP of 66.85%, down 18.20% over the past month. We had 19 defaults in our coverage universe over the past month, bringing our three-month running total to 50. Eleven were in the U.S., with two in China and one each in Australia, Chile, Germany, South Korea, Thailand, and the UK. While defaults remained concentrated in energy-related firms, we are starting to see the default contagion spread to other sectors.
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 1.21% to 2.55%, while the 10-year rate narrowed by 5.96% to 18.19%. This is the fourth consecutive month that the expected 10-year cumulative default rate has been higher than the prior peak during the credit crisis.
Expected Cumulative Default Rate – June 30, 2020
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
This quarter featured a duel between Wall Street and Main Street. The Dow had its best quarter since 1987, the S&P 500 had its best quarter since 1998, the NASDAQ had its best quarter since 1999, and gold closed at over $1,800 per ounce. On the other hand, we saw 50 global defaults-- the highest in one quarter since the Great Recession. New Covid-19 cases reached over 43,000 in the U.S., 38,000 in Brazil, and 18,000 in India. Global Covid-19 deaths topped 500,000 on June 28. I cannot remember a time when there was a bigger divide between the markets and the day-to-day experience on Main street. It recalls the wisdom of Ben Graham: In the short run the market is a voting machine, but in the long run it is a weighing machine.
The Kamakura Troubled Company Index® certainly paints a different picture than the equity indices. The Federal Reserve’s announcement on June 25 of the results of its stress test and additional coronavirus-related sensitivity tests provided assurance of the strength of the banking sector, though it also announced the need for the sector to maintain capital levels. The accelerating rate of defaults provides more than ample concern about the ability of banks and investors to absorb the losses. The following table shows the year- to- date defaults in the U.S. We will release a global snapshot shortly.
As the quarter ends, we will be analyzing the default data on a country and sector basis and will release additional commentary over the next few weeks.
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 14.52%. 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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