NEW YORK, October 1, 2020: Most of us have read the opening of Charles Dickens’ classic novel, “A Tale of Two Cities”:
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.”
Though we are hardly undergoing the throes of the French Revolution, today’s financial turmoil sometimes seems almost Dickensian in its extremes. While the markets snapped a five-month winning streak, they still posted a gain for the quarter. The U.S. private sector created 749,000 jobs in September according to ADP data. Housing remains robust across the globe. Gold rose another 4%, while oil prices slumped.
One theory is that large cities are in a recession, while strength remains in less crowded and contagious corners. Large companies appear to be doing well even as smaller firms go bust in record numbers. There is a huge gap between how banks perceive the health of their borrowers and how the capital markets perceive risk based on spreads. We will dig into these dichotomies in this release.
The Kamakura Troubled Company Index® increased 1.00% in September to 14.63%, and it ended the month at the 36th percentile. The index continued to be volatile, ranging during the month from 18.14% on September 3 to 13.72% on September 18. The index reflects the percentage of 40,500 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 September, the percentage of companies with a default probability between 1% and 5% was 12.05%, an increase of 0.96% compared to the previous month. The percentage with a default probability between 5% and 10% was 1.75%, an increase of 0.01%. Those with a default probability between 10% and 20% amounted to 0.64% of the total, an increase of 0.04%; and those with a default probability of over 20% amounted to 0.19%, a decrease of 0.01%.
Troubled Company Index – September 30, 2020
At 14.63%, the Troubled Company Index declined to the 36th percentile of historical credit quality as measured since 1990.
Among the 10 riskiest-rated firms listed in September, seven were in the U.S, with one each in Ireland, Norway and Switzerland. The riskiest firm was Transocean Ltd. (NASDAQ:RIG) with a one- month KDP of 43.55 up 12.16%. We had 9 defaults in our coverage universe with six in the U.S and one in Mexico. Energy and retail firms continued to lead the defaults.
Riskiest Rated Companies based on 1-month KDP
The Kamakura expected cumulative default curve for all rated companies worldwide narrowed, with the one-year expected default rate decreasing by 0.08% to 0.85%, while the 10-year rate narrowed by 0.04% to 11.82%.
Expected Cumulative Default Rate – October 30, 2020
By Martin Zorn, President, and Chief Operating Officer, Kamakura Corporation
The month and quarter closed with contrasting signals. Markets rebounded from their lows, closing up for the quarter but down for the month. Home prices rose globally and manufacturing rebounded. Global markets were generally strong, though volatility in the dollar increased. The first U.S. presidential debate was widely perceived as a “train wreck,” and the upcoming presidential election has been priced as the worst event risk in VIX history.
The big drivers of these divergent signals are the impacts of fiscal policy and the intervention of central banks. An estimated $20 trillion of global stimulus has been pumped into the global financial system. One result is that in the second quarter, disposable income in the G7 group was $100 billion higher than it was before the pandemic, even as jobs disappeared, according to a report in The Economist. Add to that the bond buying by central banks and you can quickly see that these are not normal times. Stimulus talks in the U.S. could spell relief or disaster for the airlines, while the Federal Reserve stands in the wings as a backstop to the markets.
The chart below, compiled from data extracted from the St. Louis Federal Reserve, clearly displays today’s dichotomies by comparing loan provisions to corporate spreads.
Fiscal and monetary government actions have created a bifurcated market. For companies that can access the capital markets, it is the best of times, while firms dependent upon bank lending or cash flow fear the worst. Urgent questions remain unanswered: How long can government handouts continue? Who will get hurt the most when the music finally stops? In the meantime, ultralow interest rates mean savers and pensioners are subsidizing borrowers. Managing money in this volatile environment requires robust stress testing. Portfolio managers and traders must obtain a firm grasp of all the risk factors so that they can act quickly and decisively when they need to.
About the Troubled Company Index
The Kamakura Troubled Company Index® measures the percentage of 40,500 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 14.53%. 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 riskneutral 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.
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 10.1, 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 nonpublic 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. Current clients have a combined “total assets” or “assets under management” in excess of $26 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.
To follow risk commentary by Kamakura on a daily basis, please follow:
Kamakura CEO Dr. Donald van Deventer (www.twitter.com/dvandeventer)
Kamakura President Martin Zorn (www.twitter.com/riskmgrhi)
Kamakura’s official twitter account (www.twitter.com/KamakuraCo).
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