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Donald R. Van Deventer, Ph.D.

Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura.

# Comcast Corporation: A Bond Market View

04/16/2014 08:14 AM

Comcast Corporation (CMCSA) has a tender offer outstanding for Time Warner Cable (TWC) that is pending regulatory approval . The outcome of that transaction will have a significant impact on the risk and return to both common shareholders and bond holders. Still, in today’s analysis, we make no assumptions about the future and let the bond market facts lead us to the appropriate conclusions. Those facts presumably reflect a trade-weighted guess as to how the Time Warner Cable bid will end up. Today’s study incorporates Comcast Corporation bond price data as of April 14, 2014 to get an institutional, bond market view of the company.

We analyze the potential risk and return to bondholders of Comcast Corporation using 93 trades on 19 bond issues and a trading volume of $40 million in today’s analysis. Conclusion: We believe a majority of analysts would rank Comcast Corporation as “investment grade.” The outcome of the Time Warner Cable transaction is a major potential event and one that will trigger a re-examination of this conclusion. The bond market shows a credit spread to default probability ratio that is below average. While the ratios for Comcast Corporation were nowhere near as low as we saw yesterday for the bonds of Vodafone Group PLC (VOD), 204 bond issues traded on April 14 at a better return to risk ratio than the best bond issued by Comcast Corporation. The Analysis Institutional investors around the world are required to prove to their audit committees, senior management, and regulators that their investments are in fact “investment grade.” For many investors, “investment grade” is an internal definition; for many banks and insurance companies, “investment grade” is also defined by regulators. We consider whether or not a reasonable U.S. bank investor would judge Comcast Corporation to be “investment grade” under the June 13, 2012 rules mandated by the Dodd-Frank Act of 2010. The default probabilities used are described in detail in the daily default probability analysis posted by Kamakura Corporation. The full text of the Dodd-Frank legislation as it concerns the definition of “investment grade” is summarized at the end of our analysis of Citigroup (C) bonds published December 9, 2013. Assuming the recovery rate in the event of default would be the same on all bond issues of the same issuer, a sophisticated investor who has moved beyond legacy ratings seeks to maximize revenue per basis point of default risk from each incremental investment, subject to risk limits on macro-factor exposure on a fully default-adjusted basis. In this note, we also analyze the maturities where the credit spread/default probability ratio is highest for Comcast Corporation Term Structure of Default Probabilities Maximizing the ratio of credit spread to matched-maturity default probabilities requires that default probabilities be available at a wide range of maturities. The graph below shows the current default probabilities for Comcast Corporation ranging from one month to 10 years on an annualized basis. For maturities longer than ten years, we assume that the ten year default probability is a good estimate of default risk. The current annualized default probabilities range from 0.04% at one month to 0.02% at 1 year and 0.27% at ten years. Note that these default probabilities are a small fraction of the default risk we found in yesterday’s post on Vodafone Group PLC. Credit-Adjusted Dividend Yield We explained in a recent post on General Electric Company (GE) how default probabilities and the associated credit spreads for a bond issuer can be used to calculate the credit-adjusted dividend yield on a stock . That analysis makes use of a comparison between the yield on the issuer’s promise to pay$1 in the future versus the yield on a similar promise by the U.S. government to pay $1 at the same time. Using the maximum smoothness approach to both the U.S. Treasury curve and to Comcast Corporation credit spreads, we can generate the zero coupon bond yields on their promise to pay$1 in the future:

In tomorrow’s note, we present the credit-adjusted dividend yield on Comcast Corporation using this data.

Summary of Recent Bond Trading Activity
The National Association of Securities Dealers launched the TRACE (Trade Reporting and Compliance Engine) in July 2002 in order to increase price transparency in the U.S. corporate debt market. The system captures information on secondary market transactions in publicly traded securities (investment grade, high yield and convertible corporate debt) representing all over-the-counter market activity in these bonds. We used all of the 19 bond issues mentioned above in this analysis.

The graph below shows 6 different yield “curves” that are relevant to a risk and return analysis of Comcast Corporation bonds. These curves reflect the noise in the TRACE data, as some of the trades are small odd-lot trades. The lowest curve, in dark blue, is the yield to maturity on U.S. Treasury bonds (TLT)(TBT), interpolated from the Federal Reserve H15 statistical release for that day, which exactly matches the maturity of the traded bonds of Comcast Corporation. The next curve, in the lighter blue, shows the yields that would prevail if investors shared the default probability views outlined above, assumed that recovery in the event of default would be zero, and demanded no liquidity premium above and beyond the default-adjusted risk-free yield. The orange dots graph the lowest yields reported by TRACE on that day on Comcast Corporation bonds. The green dots display the trade-weighted average yield reported by TRACE on the same day. The red dots show the maximum yield in each of the Comcast Corporation issues recorded by TRACE. The black dots and connecting black line show the yield consistent with the best fitting trade-weighted credit spread explained below.

The data shows that the credit spreads widen fairly steadily as maturity lengthens, the typical pattern for a high quality bond issuer.

The high, low and average credit spreads at each maturity are graphed below for Comcast Corporation. We have done nothing to smooth the data reported by TRACE, which includes both large lot and small lot bond trades. For the reader’s convenience, we fitted a cubic polynomial (in black) that explains the trade-weighted average spread as a trade-weighted function of years to maturity.

Using default probabilities in addition to credit spreads, we can analyze the number of basis points of credit spread per basis point of default risk at each maturity. For Comcast Corporation, the credit spread to default probability ratio generally ranges from about 2.4 to 15 for maturities of 5 years and under. For the longer maturities, the credit spread to default probability ratio falls in a range from 2.4 to 5.1 times.

The credit spread to default probability ratios are shown in graphic form below for Comcast Corporation.

How do these reward to risk ratios compare with “normal” levels? The best way to answer that question precisely is to compare them to the credit spread to default probability ratios for all fixed rate non-call senior debt issues with trading volume of more than $5 million and a maturity of at least one year on April 14. The distribution of the credit spreads on the 288 traded bonds that met these criteria on April 14 is first plotted in this histogram: The median credit spread for all 288 trades was 0.826%. The average credit spread was 1.043%. The next graph shows the wide dispersion of the credit spread to default probability ratios on those 288 April 14 trades (only ratios of 40 or less are graphed): The median credit spread to default probability ratio on those 288 trades was 8.6 and the average credit spread to default probability ratio was 12.3. Comcast Corporation’s credit spread to default probability ratios ranked 205th, 237th, and 250thout of all 288 trades on April 14, 2014. Here are the 20 “best trades” done April 14, 2014 that had the highest ratios of credit spread to default probability, along with the same data for the most heavily traded bonds of Comcast Corporation. Credit Default Swap Analysis For the week ended April 4, 2014 (the most recent week for which data is available), the Depository Trust & Clearing Corporation reported there were 16 trades involving$221 million in notional principal on Comcast Corporation, ranking the firm the 155th most actively traded reference name. The weekly number of credit default swap trades on Comcast Corporation since the DTCC began publicizing weekly trade volume is shown here:

The notional principal of credit default swap trading on Comcast Corporation over the same period is shown in this graph:

Note that other legal entities in the Comcast Corporation organization have traded in the credit default swap market. Those entities are not reflected in the two previous graphs.

On a cumulative basis, the default probabilities for Comcast Corporation range from 0.02% at 1 year to 2.69% at 10 years. We give the relative rankings of the company’s default probabilities below.

Over the last decade, the 1 year and 5 year annualized default probabilities for Comcast Corporation have been moderately volatile, with the one year default probability exceeding 2.00% in 2008-2009. The annualized 5 year default probabilities exceeded 0.80% at the same time.

As explained earlier in this note, the firm’s default probabilities are estimated based on a rich combination of financial ratios, equity market inputs, and macro-economic factors. Over a long period of time, macro-economic factors drive the financial ratios and equity market inputs as well. If we link macro factors to the fitted default probabilities over time, we can derive the net impact of macro factors on the firm, including both their direct impact through the default probability formula and their indirect impact via changes in financial ratios and equity market inputs. The net impact of macro-economic factors driving the historical movements in the default probabilities of Comcast Corporation have been derived using historical data beginning in January 1990. A key assumption of such analysis, like any econometric time series study, is that the business risks of the firm being studied are relatively unchanged during this period. With that caveat, the historical analysis shows that Comcast Corporation default risk responds to changes in 11 risk factors among the 28 world-wide macro factors used by the Federal Reserve in its 2014 Comprehensive Capital Assessment and Review stress testing program, for which the results were announced in March. These macro factors explain 58.4% of the variation in the default probability of Comcast Corporation. The remaining variation is the estimated idiosyncratic credit risk of the firm.

Comcast Corporation can be compared with its peers in the same industry sector, as defined by Morgan Stanley (MS) and reported by Compustat. For the U.S. “consumer discretionary, media” sector, Comcast Corporation has the following percentile ranking for its default probabilities among its 124 peers at these maturities:

1 month      44th percentile
1 year         21st percentile
3 years       17th percentile
5 years       15th percentile
10 years     14th percentile

For the longer time horizons, Comcast Corporation default probabilities are in the safest quartile of all sector peer group firms.

Comparison with Legacy Ratings
Taking still another view, the actual and statistically predicted credit ratings for Comcast Corporation both show a rating in the middle of the “investment grade” territory. The statistically predicted rating is one notch below the legacy rating, those of Moody’s (MCO) and Standard & Poor’s (MHFI). The legacy credit ratings of Comcast Corporation have changed just twice in the last decade.

Conclusions
Before reaching a final conclusion about the “investment grade” status of Comcast Corporation, we look at more market data. First, we look at Comcast Corporation credit spreads versus credit spreads on every bond in the “technology, media, and telecommunications” sector that traded on April 14:

Comcast Corporation credit spreads were near the lower end of the range for the peer group. We now look at the matched maturity default probabilities on those traded bonds for both Comcast Corporation and the peer group:

Somewhat inconsistent with the percentile rankings above, the default probabilities for Comcast Corporation are on the higher end of the industry peer group. This is because the bonds trading most heavily are generally a much better group of credits than the industry in aggregate. We now turn to the legacy “investment grade” peers. First we compare traded credit spreads on April 14, 2014:

Again, Comcast Corporation credit spreads are solidly in the safest half of the investment grade peer group range. Investment grade default probabilities on a matched maturity basis for the bonds traded on April 14 are shown in this graph:

Again the default probabilities for Comcast Corporation rank on the high end of the traded investment grade peer group.

We believe a majority of analysts would rank Comcast Corporation as “investment grade.” The outcome of the Time Warner Cable transaction is a major potential event and one that will trigger a re-examination of this conclusion. The bond market shows a credit spread to default probability ratio that is below average. While the ratios for Comcast Corporation were nowhere near as low as we saw yesterday for the bonds of Vodafone Group PLC, 204 bond issues traded on April 14 at a better return to risk ratio than the best bond issued by Comcast Corporation.

Author’s Note
Regular readers of these notes are aware that we generally do not list the major news headlines relevant to the firm in question. We believe that other authors on SeekingAlpha, Yahoo, at The New York Times, The Financial Times, and the Wall Street Journal do a fine job of this. Our omission of those headlines is intentional. Similarly, to argue that a specific news event is more important than all other news events in the outlook for the firm is something we again believe is inappropriate for this author. Our focus is on current bond prices, credit spreads, and default probabilities, key statistics that we feel are critical for both fixed income and equity investors.

Donald R. Van Deventer, Ph.D.

Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura.