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Corporate Default Risk Falls

07/01/2019 02:11 PM

Corporate Default Risk Falls
Kamakura Troubled Company Index Decreases by 0.34% to 12.03%

NEW YORK, July 1, 2019: The Kamakura Troubled Company Index® ended June at 12.03%, a decrease of 0.34% from the prior month. 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 June, the percentage of companies with a default probability between 1% and 5% was 9.66, a decrease of 0.32% from the prior month. The percentage with a default probability between 5% and 10% was 1.57%, a decrease of 0.02%. Those with a default probability between 10% and 20% amounted to 0.80% of the total, the same as last month; and those with a default probability of over 20% amounted to 0.21%, again, the same as the prior month.

The index ranged from 12.99% on June 3 to 11.71% on June 19. Volatility declined. For the year, the index has ranged from 14.95% on January 3 to 10.11 on April 22. For the year to date the index is down 199 basis points.

At 12.03%, the troubled company index now sits at the 47th percentile of historical credit quality as measured since 1990. Among the 10 riskiest-rated firms listed in June, seven are in the U.S., with one each in Belgium, Great Britain and Spain. During the month there were three defaults in our coverage universe, with two in the US and one in Brazil.

Halcon Resources (HK:NYSE) became the riskiest-rated firm, with a one-year of KDP of 53.10%, up 32.29% from the prior month. The firm was notified by the NYSE of noncompliance with its standard listing criteria, based on its average daily stock price. That factor naturally weighed negatively on the company, On the other hand, Halcon finally named a new CEO, filling a vacancy that has been open since February. The appointment may add at least a small measure of stability to the company.

The Kamakura expected cumulative default curve for all rated companies worldwide widened as the one-year expected default rate decreased by 0.17% to 1.26%, while the 10-year rate increased by 0.22% to 14.6%.

Commentary
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation

The decline in risk revealed by the Troubled Company Index® reflects the markets’ optimism and search for gains. In the U.S., markets rebounded in June, although the gains were driven by a handful of stocks. It currently appears that the market is pricing in the Federal Reserve’s continued use of monetary policy as a put for the equity markets. European stocks were higher ahead of the G-20 meetings, which are raising hopes of a trade settlement between China and the U.S. Asian markets were more guarded and edged downward. Bond yields continued to drop based on long- term economic concerns. At the same time, investors appeared to be willing to take risks to obtain positive yields in the high-grade space. This was especially evident in Austria, which sold its second tranche of “century bonds.”

The Expected Cumulative Default Rate continues to point towards an increase in defaults in 2020. While he level of expected defaults one year out moderated from last month, elevated default levels are expected to remain for a longer period of time. Using the Expected Cumulative Curve, we can extract these one-year-forward expected defaults and see their evolution of over the past two months:

Forward One-Year Cumulative Default Rate
May 2019     1.43%     June 2019     1.26%
May 2020     1.86%     June 2020     1.70%
May 2021     1.30%     June 2021     1.35%
May 2022     1.21%     June 2022     1.28%

Using another view, we can disaggregate the 1-year expected cumulative default rate by sector. While that rate came down by 17 basis points generally, we also see that it surged for both the energy and consumer discretionary goods sectors.

Studying the movement in default probabilities by sector, country, and counterparty provides insight into the risks late in the credit cycle. We will be publishing more research on this topic soon.

About the Troubled Company Index
The Kamakura Troubled Company Index® 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 14.35%. 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 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.

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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