The Kamakura troubled company index measures the percentage of more than 36,000 public firms in 61 countries that have annualized 1 month default risk over one percent. An increase in the index reflects declining credit quality while a decrease reflects improving credit quality. The default probabilities are produced by KRIS (Kamakura Risk Information Services) version 5.0 Jarrow-Chava reduced form default probability model, a formula that bases default predictions on a sophisticated combination of company-specific, market and macro-economic factors. The default probabilities are updated on a daily basis and have proven to be highly accurate in their predictive ability.
Probabilities of default rise and fall over a business cycle which allows a user to understand these peaks and troughs and to plan and react accordingly. More importantly KRIS provides a 120-month term structure of default which further allows a user to understand the riskiness of a counterparty compared to the business cycle. Further, the underlying factors impacting the default probabilities can be analyzed on an individual basis.
As one can see below the troubled company index was at a historic low on August 4, 2014 and has been showing a gradual risk with a spike earlier this summer. After an extended period of extremely benign credit conditions this spike is a warning to look more closely into your portfolio of counter party risk.
As of the end of August, the percentage of the global corporate universe with default probabilities between 1% and 5% was 6.91%, up 1.34% from the end of July; the percentage of the universe with default probabilities between 5% and 10% was 1.33%, up 0.36%; the percentage between 10% and 20% was 0.57%, up 0.23%; while the percentage of companies with default probabilities over 20% was 0.22%, up 0.11% from the previous month. The index is up 4.67% over the past year was at this level last in September 2011.
We will analyze these warning signs by focusing on those firms with the highest short term (1-month and 1-year) and longer term (5-year) default probabilities as well as those firms that have experienced the greatest increase in default risk over the same periods.
Ten Riskiest Firms as measured by 1-month KDP (Kamakura Default Probability)
Ten Firms with greatest increase in 1-month KDP over the past 90-days
In looking at both of these lists we see a diversity of countries and names although there is a concentration in natural resource companies. If we focus on the riskiest rated companies then the concentration becomes clearer with the focus on natural resource companies as well as the Greek banks.
Ten Riskiest Rated Firms as measured by 1-month KDP
Repeating this analysis for the firms with the highest 1-year and 5-year default risk begins to expand the picture of credit warning signs. In addition to natural resource companies and Greek banks we start seeing global logistics firms or more specifically international dry bulk shipping lines in the list of riskiest firms.
Ten Riskiest Firms as measured by 1-year KDP (Kamakura Default Probability)
Ten Riskiest Firms as measured by 5-year KDP (Kamakura Default Probability)
The final chart will focus on American Apparel Inc (NYSE:APP) as it represents the rated firm with the greatest 1-month default risk. The increase in default probabilities began to be apparent over 18-months ago and preceded formal ratings action. Diving deeper into the company-specific, market and macro factors that were drivers behind the increasing KDP for APP was a combination of financial and market measures, for example cash/market value of total assets and relative measures such as excess 1-year return.
In conclusion, default probabilities provide insight into both individual company risks as well as industry or country risks based on concentrations of firms with high absolute default probabilities or those experiencing rapid deterioration. Further insight can be gleaned from examining default probabilities over along the term structure. This provides a quick way to develop a watch list requiring further fundamental analysis to determine an appropriate action plan to guard against risk in a portfolio.
About Kamakura Corporation
Founded in 1990, Honolulu-based Kamakura Corporation is a leading provider of risk management information, processing and software. Kamakura was named to the World Finance 100 by the Editor and readers of World Finance magazine in 2012. In 2010, Kamakura was the only vendor to win 2 Credit Magazine innovation awards. Kamakura Risk Manager, first sold commercially in 1993 and now in version 8.1, is the first enterprise risk management system with 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 non-public 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 ranging in size from $1.5 billion to $1.6 trillion in assets. Kamakura’s risk management products are currently used in 43 countries, including the United States, Canada, Germany, the Netherlands, France, Austria, Switzerland, the United Kingdom, Russia, the Ukraine, Eastern Europe, the Middle East, Africa, South America, Australia, Japan, China, Korea, India and many other countries in Asia.
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