What a Difference a Year Makes
Kamakura Troubled Company Index Decreases by 3.54% to 2.78%
Credit Quality Improves to the 100th Percentile
NEW YORK, July 1, 2021: Low interest rates, easy money and massive government spending have driven short-term default risk to a record low and stock prices to record highs while bond spreads collapse as investors are confident that inflation risks will not hurt the economic recovery. While short-term default risk continues to fall, the risk of rising rates and longer-term default pressure are increasing.
The Kamakura Troubled Company Index® indicated that credit quality improved in June, with a decline in default probabilities of 3.54% to 2.58%, compared to 6.32% on May 28. Volatility decreased, with default probabilities ranging from 6.74% on June 18 to 2.78% on June 30. 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 June, the percentage of companies with a default probability between 1% and 5% was 2.58%, a decrease of 2.98% over the previous month. The percentage with a default probability between 5% and 10% was 0.16%, a decrease of 0.41%. Those with a default probability between 10% and 20% amounted to 0.04% of the total, representing a decrease of 0.11%; and those with a default probability of over 20% amounted to 0.0%, a decrease of 0.04%.
Troubled Company Index – June 30, 2021
Among the 10 riskiest-rated firms listed in June, four each were in China and the U.S. and one each in France and Spain. The riskiest-rated firm was Codere S.A. (CDR:SM). Codere S.A. manages gaming machines, bingo halls, casinos, racetracks and sports betting locations in Latin America, Spain and Italy. There were 27 global defaults which includes 9 in the United States in the Kamakura coverage universe in the first half of 2021. This compares to 116 global defaults with 44 in the U.S. in the same period last year.
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 0.06% to 0.39%, while the 10-year rate increased by 5.75% to 17.33%. The increases in the long end of the curve were quite significant.
Expected Cumulative Default Rate – June 30, 2021
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
Short-term default risk has responded to the fiscal and monetary policies as well as the strong liquidity in the credit markets. This is evident by the dramatic reductions in short- term default probabilities as well as the year-over-year decline in the number of commercial defaults among rated companies. The broader global rollout of Covid-19 vaccines, progress in Europe’s economic recovery, and highly supportive fiscal and monetary policies reflect a reflationary and expansive environment. Most major economies are in an early to mid-phase recovery. Although, the post-pandemic manufacturing expansion in China may be slowing and the list of the riskiest rated companies showed a clear jump in risk among Chinese firms.
The U.S. economy and corporate earnings have rebounded from a massive contraction to boom-like conditions as the monetary and fiscal stimulus have been at record-breaking levels. If one looks at the U.S. GDP from the second quarter of 2020 to the first quarter of 2021, it has recovered the entire loss of the pandemic and remains on track for above average growth. Some are asking, are we in a bust-boom-bubble-bust scenario or will growth moderate to a more normalized environment as we progress through 2021 and into 2022?
This debate is very clear in the American housing market which is red-hot as the data released on June 29 showed house prices rising 14.6% year over year, the fastest in the history of the index. The Federal Reserve is buying $120 billion worth of assets each month with $40 billion of that being mortgage-backed securities. Public comments by Fed officials debate whether the purchases in the mortgage market are impacting the housing market. Eric Rosengren, the Boston Fed president, said in an interview with Financial Times that America could not afford a “boom-and-bust cycle” in the housing market. He was not alone in the sentiment that the Fed should scale back purchases in the mortgage market more quickly – this, being debated as a “two-speed taper”.
On the other side of the debate is the San Francisco Fed president Mary Daly who said, “My best-guess estimate is that we are having a de minimis effect on mortgage interest rates with our mortgage-backed securities purchases.” Add to the debate whether the inflationary pressures are transitory or risky, and one begins to see the traditional differences between the hawkish and dovish members of the Federal Open Market Committee become more pronounced. Further add the massive government spending, and then the risk of rising interest rates and twists in the interest curves become the biggest short-term risks.
These factors will and are playing out in the bond market ahead of the equity or bank loan markets. Kamakura’s CEO, Dr. van Deventer has a daily blog Corporate Bond Investor that examines attribution of the risks as they relate to changes in bond prices.
The following chart shows the one-month attribution as of June 30, 2021.
If we expect default risk to remain low and stable for the near term, then we must be very good at measuring and understanding the interest rate risk in our portfolio of assets. This is a very interesting time to be a portfolio manager as you must be nimble in action both for the short and long-term.
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 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.
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 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 $7.0 trillion. Current clients have a combined “total assets” or “assets under management” in excess of $28 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).
For more information, please contact:
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