Another One Bites The Dust!

05/31/2016 02:10 AM

A Case Study of Empresas ICA SAB Using KRIS Default Probabilities
June 2, 2016

The objective of this write-up is to showcase how the Kamakura Risk Information Services (“KRIS”) default probabilities subscription service assists users to manage exposure ingress and egress based on Kamakura Default Probabilities (“KDP”) movements.

On December 18, 2015, Empresas ICA SAB (NASDAQ: ICA) (“Empresas”) filed for bankruptcy protection. Empresas Exploration & Production Corp and its units filed for protection from creditors in Mexico. Empresas ICA SAB skipped a debt payment due by the end of December as Mexico’s biggest construction company headed for the nation’s biggest default in at least two decades. The builder did not pay $31 million in interest on its $700 million in bonds maturing in 2024, and was using a 30-day grace period that ended December 29. The company was forced to halt payments on all of its $1.35 billion in overseas notes. ICA posted its biggest quarterly loss in 14 years as the government cut back infrastructure projects and the plunge in Mexico’s peso drove up the company’s leverage.

This document highlights how KRIS and related risk measures would have allowed investors to exit from a position in Empresas well before the default event of December 15.

The default probabilities produced by the KRIS service include both the best practice reduced form default probabilities and the older and less accurate Merton model default probabilities. In this note, we use the KRIS version 6.0 reduced form default probabilities, the newest and most accurate model in the KRIS default models framework.

The chart below shows the history of the 1-year (in blue) and 10-year (in red) default probabilities for Empresas:

In Kamakura Corporation’s popular troubled company index, a firm is considered “troubled” if its default probability exceeds one percent. The box on the left hand side of the graph above shows that the 1-year default probability of Empresas first exceeded 1.00% in September 2014, 1 years and 3 months before Empresas defaulted. For a fixed income investor, this is tremendous early warning, and highlights exit options well before a default event. One also immediately notices that the one-year KDPs of Empresas rose to 10% in March 2015 whilst the 10-year KDPs steadily showed an uptick hovering around 10%.

Another important metric in KRIS is the cumulative default probability of the company. On December 1, 2014, the cumulative 10-year default probability for Empresas was a very high 55%. This metric was a warning signal provided by KRIS a full twelve months before default.

A third analytic in the KRIS portfolio of outputs is the impact of macro factors on the company’s creditworthiness, and this represents a statistical relationship between key risk and macro factors and the performance of the company.

It can be seen clearly from the graphic above that low oil prices had a significant impact on Empresas’s probability of default and the spikes in KDPs were in line with falling oil prices.

The changing landscape had a direct and debilitating impact on Empresas Bond Spreads as well, as can be evidenced by the graph below, where the spreads moved from 8.31% in 2014, already very high, to almost 52%, just before default, and then market sentiment on recoveries were reflected in the bond prices falling to around USD 24.

This point is further accentuated by the following figure which outlines the bond price history for all Empresas outstanding bond issues. It is evident that at the time of default, all bond prices, irrespective of maturity, converge to the recovery estimate that the market expects.

Another indicator that is very valuable as an early warning signal is a comparison to the industry peer group, which in the case of Empresas is the Energy peer group. It can be seen clearly in the graph below that Empresas’s one-year default probability moved from close to the median level of the peer group to well above it in 2015. This is another warning, more than a year before default, to exit from any holdings of Empresas.

Finally, a critical indicator that is provided by KRIS is the linking of macro factors to default probability functions, and an analysis of Empresas shows that their KDPs are directly linked to the EUR/USD exchange rate, Oil prices, , Unemployment, and Case Schiller Index 1 year return. Since the performance of this organization was directly related to the falling construction prices, a drop in the Case Schiller 1 year return macro factor indicator essentially meant that the KDPs of Empresas moved in line these. The figure above identifies the various macro factors that drove the creditworthiness of Empresas, and the figure below identifies the relationship between Case Schiller 1 year return and Empresas KDPs.

The KRIS default probability models are benchmarked on more than two million observations of firms of all types. The total number of defaults used in the current version 6.0 models is more than 2,600. The unparalleled volume of data and the research insights of Kamakura’s Managing Director Prof. Robert Jarrow make the KRIS default probability service the most accurate early warning credit risk assessment indicator framework available. That is one of the reasons why Credit Magazine named both KRIS and the Kamakura Risk Manager Software package “Innovations of the Year”. For more information about KRIS default probabilities, please contact your Kamakura representative or e-mail Kamakura’s credit experts at

Copyright ©2016 Suresh Sankaran