NEW YORK, November 2, 2020: As October comes to an end and some countries celebrate Halloween, return-seeking investors are so confounded by recent events and feel they are riding blind. It reminds me of a verse from Edgar Allan Poe’s poem “Eldorado”:
Over the mountains
Of the moon,
Down the valley of the shadow,
“Ride, boldly ride,”
The shade replied,–
“If you seek for Eldorado!”
The month ended with a rebound in Covid-19 cases in the U.S. and Europe. Washington remained in gridlock amid election uncertainties and even threats of possible civil unrest.
Still, much of the news was positive. While global markets ended the month lower, commodities were mixed, with retail sales driving global trade. In fact, global trade volumes rose, ending the month only 3% below where they were in December. U.S. employment was stronger than forecast, and global GDP numbers were impressive. Defaults moderated, large banks reported lower loan loss provisions, and investors seemed excited to buy speculative-grade debt. To seek alpha in this environment one must definitely “ride, boldly, ride.”
The Kamakura Troubled Company Index® indicated that credit quality declined in October, with an increase of 3.92% over the month to 18.55%. It ended the month at the 26th percentile. The index continued to be volatile, ranging from 14.61 on October 1 to 18.55% at month’s end. 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 October, the percentage of companies with a default probability between 1% and 5% was 14.79%, an increase of 2.74% over the previous month. The percentage with a default probability between 5% and 10% was 2.33%, an increase of 0.58%. Those with a default probability between 10% and 20% amounted to 1.11% of the total, an increase of 0.47%; and those with a default probability of over 20% amounted to 0.32%, an increase of 0.13%.
Troubled Company Index – October 30, 2020
At 18.55%, the Troubled Company Index declined to the 26h percentile of historical credit quality as measured since 1990.
Among the 10 riskiest-rated firms listed in October, eight were in the U.S., with one each in Norway and Switzerland. The riskiest-rated firm was Highpoint Resources (NYSE:HPR), an energy exploration and production firm. The firm is expected to announce its third quarter earnings on November 6. We had eight defaults in our coverage universe, with five in the U.S, two in India and one in Ireland.
Riskiest Rated Companies based on 1-month KDP
The Kamakura expected cumulative default curve for all rated companies worldwide widened, with the one-year expected default rate increasing by 0.26% to 1.11%, while the 10-year rate increased by 0.67% to 12.49%. Extrapolating the one-year expected defaults out to year two we see that the forward default curve is predicting a slight annualized increase in defaults to 1.12% before declining indicating that defaults are likely to be elevated for the next two years.
Expected Cumulative Default Rate – October 30, 2020
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
We ended October with mixed signals in the market and a great deal of uncertainty. The increase in Covid-19 cases across the U.S. and Europe and the reinstatement of lockdowns has created uneasiness about future economic prospects. Europe saw stronger growth in the third quarter, but mounting business restrictions increase the risk of a fourth quarter contraction.
In this environment, investors are faced with a quandary in trying to gauge risk and evaluate lending opportunities. U.S. election uncertainty only intensifies their doubts, which could remain for weeks in the event of a contested outcome.
The good news is that corporate defaults have slowed, and third quarter loan loss data indicate that banks have a more positive view of future credit losses as well. At least so far, it appears that central bank actions and government policies have contained default fallout from the pandemic. Still, the expected cumulative defaults caution us that it is too early to declare victory. The capital markets have remained strong, as has investor interest in speculative-grade debt. According to a recent Wall Street Journal article, companies have issued more than $120 billion in speculative-grade bonds in the U.S. since the start of August, and more than $320 billion since the start of the year, surpassing all previous full- year totals.
John Maynard Keynes is said to have responded to a critic by stating, “When the facts change, I change my mind. What do you do, sir?” It is clear that the pandemic’s effects on credit and default are still evolving, and we will continue to provide the most accurate and timely analytics available to help you navigate this default cycle as new facts emerge.
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 14.55%. 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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