Kamakura: Corporate Debt Market Improves
Kamakura Troubled Company Index Rises to 50th Percentile
NEW YORK, March 4, 2018: The Troubled Company Index® ended February at 11.24%, a decrease of 0.63% from the end of January. So far this year the index has improved 3.19%. The index reflects the percentage of 39,000 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 February, the percentage of companies with a default probability between 1% and 5% was 8.99%—a decrease of 0.52% from the end of January. The percentage with a default probability between 5% and 10% was 1.49%, a decrease of 0.08%. Those with a default probability between 10% and 20% amounted to 0.58% of the total, down 0.01%, and those with a default probability of over 20% amounted to 0.18%, down 0.02% from a month earlier.
Volatility remained moderate, with the index ranging from 12.49% on February 11 to 11.15% on February 22.
At 11.24%, the troubled company index now sits at the 50th percentile of historical credit quality as measured since 1990. Among the 10 riskiest-rated firms listed in February, six are in the U.S., with one each in Australia, Great Britain, Hong Kong and Spain. Debenhams PLC (DEB:LN) remained the riskiest-rated company in our universe, with a one-month KDP of 41.15 and a one-year KDP of 53.43%. The one-month default probability increased from last month even as the one-year KDP showed a slight improvement. During the month there were eight defaults in our coverage universe, with six in the U.S. and one each in Hong Kong and Ireland.
In addition to revealing the absolute level of default probability, the KDP term structure provides point in time as well as through the cycle insight to evaluate quantitative risk.
The term structure of the ten riskiest global firms can be seen below.
The Kamakura expected cumulative default curve for all rated companies worldwide showed decreases at both the short and the long end, with the one-year expected default rate declining by 0.02% to 1.14% and the 10-year rate declining by 0.166% to 13.42%.
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
The Troubled Company Index® provides quantitative evidence that the corporate debt market is improving. U.S corporate and high-yield debt have both produced positive gains in the year to date. Corporate leverage last year surpassed even the highest level it ever reached (during the credit crisis) but has since fallen from those peaks. A continued deleveraging trend, along with earnings growth is fundamentally good for loans and bonds. As all observers would agree, we are in the later stages of this cycle, so it is positive to see corporate deleveraging occurring in anticipation of an economic slowdown, rather than as a reaction to it.
In analyzing the drivers of the improvement in the one-month and one-year Kamakura default probabilities, we can see several variables have been driving much of the improvement for the past few months across our coverage universe: net income to market total assets, market leverage, and a reduction in company volatility. February was a heavy month for financial reporting and improved financial conditions are clearly evident in our risk measures.
When you combine this with dovish comments from the Federal Reserve on interest rates and the benign volatility levels measured by the VIX, it is clear that market and financial drivers suggest a moderating level of credit risk compared to where we were in the fourth quarter. This can also be seen from the improvements in the Kamakura Cumulative Default Curve at both the short and long end.
This more benign environment may give central banks a window in which to unwind their extraordinary balance sheets in a way that poses less risk for the general economy. We would recommend that they follow the lead of corporations in deleveraging their balance sheets. For portfolio managers, the focus should remain on idiosyncratic risk, as the list of riskiest companies shows that there are quite a number of risky firms in the universe.
About the Troubled Company Index
The Kamakura troubled company index (Reg. U.S. Pat) measures the percentage of 39,000 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 14.38%. 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 risk-neutral 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 69 countries currently covered by the index are: Argentina, Australia, Austria, Bahrain, Bangladesh, Belgium, Belize, Brazil, Bulgaria, Canada, Chile, China, Colombia, Croatia, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, Hong Kong, Iceland, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kuwait, Luxembourg, Malaysia, Malta, 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, Taiwan, Thailand, Turkey, the United Arab Emirates, the UK, the U.S., and Vietnam.
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 10.0.3, 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 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 with assets ranging in size from $1.5 billion to $3.0 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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