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# There Is a Market for That

08/02/2021 12:01 AM

#### Kamakura Troubled Company Index Increases by 0.25% to 3.03% Credit Quality Remains at the 100th Percentile

NEW YORK, August 2, 2021: In 2009, Apple began a television campaign called “There’s an app for that” — a slogan that became so successful, the company acquired a trademark to capitalize on it.

Although portfolio managers may not be able to create trademarks, they do have an unusual window of opportunity before them. With both short-term default rates and interest rates at record lows, it’s possible to refinance almost anything to one’s advantage. Even used cars can make you money. In this month’s credit report, we will consider some of the ways to capitalize on the current economic environment.

The Kamakura Troubled Company Index® indicated that credit quality remained benign in July, with the index at 3.03% — compared to 2.78% at the end of June. Volatility decreased further, with default probabilities ranging from 3.91% on July 19 to 2.59% on July 5 representing a new period low for the index. 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 July, the percentage of companies with a default probability between 1% and 5% was 2.79%, an increase of 0.21% over the previous month. The percentage with a default probability between 5% and 10% was 0.19%, an increase of 0.03%. Those with a default probability between 10% and 20% amounted to 0.05% of the total, representing an increase of 0.01%; and those with a default probability of over 20% amounted to 0.0%, the same as the prior month.

This level shows that worldwide corporate credit quality is at the 100th percentile of the period 1990 to 2021, with 100 indicating “best conditions.” The record low in the index, the 100th percentile, was 2.59%, set on July 5, 2021. The all-time high in the index was 46.26%, recorded on December 26, 2008.

Troubled Company Index — July 31, 2021

We have expanded the riskiest-rated firms to 20. Among the 20 riskiest-rated firms listed in July, ten were in China, six were in the U.S. and one was in Argentina, Brazil, France and Spain respectively. The riskiest-rated firm remained Codere S.A. (CDR:SM), a company that manages gaming machines, bingo halls, casinos, racetracks and sports betting locations in Latin America, Spain and Italy. There was only one global default in the Kamakura-coverage universe, which occurred in China.

Riskiest Rated Companies Based on 1-month KDP

The Kamakura Expected Cumulative Default Rate, the only daily index of credit quality of rated-firms worldwide, shows the one-year rate up 0.10% at 0.49%, and the 10-year rate down 1.83% at 15.50%. By comparison, the 10-year rate in September 2008 (the month that Lehman, AIG, FNMA, FHLMC and Washington Mutual failed) was 13.33%.

Expected Cumulative Default Rate — July 30, 2021

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

Last month, the S&P 500 Index posted its sixth straight monthly gain. And on Friday, the Core Personal Consumption Index rose 3.5% — better than market participants expected. Also last week, the Federal Reserve said it will keep its benchmark rate near zero, despite signs that inflationary pressure continues to heat up; The IMF warned that inflation risk may be more than transitory. Against this backdrop as well as concerns about how economic recovery will be impacted by the spreading Delta variant, market volatility showed signs of increasing.

Defaults in China are reshaping its credit markets as we have seen a record pace of onshore and offshore failures. So far, real estate firms have made up about 30% of the defaults. These statistics are clearly placing pressure on the Chinese market and influencing fiscal incentives going forward.

But overall, the outlook is strongly positive for both spreads and defaults. This was evident from the latest quarterly survey from the International Association of Credit Portfolio Managers (IACPM).

In the U.S., one can suspect that the Federal Reserve will use the uptick in the Delta variant, along with the most recent inflation numbers, to delay tapering.

For borrowers, the current climate extends the window to refinance debt in one of the most accommodative markets in recent memory. The opportunity to further reduce interest expenses and increase liquidity is very attractive. Possibly, the only oversupply problem right now is in the U.S. IPO market. This also means portfolio managers should look carefully at names in their portfolio that have long-term risk and take advantage of the opportunity to trade out of them at potentially good prices.

These factors will continue to play out in the bond market ahead of the equity or bank loan markets. Kamakura CEO Dr. Donald van Deventer addresses the current situation in his daily blog, Corporate Bond Investor, which examines attribution of risks as they relate to changes in bond prices.

The table below shows the one-month attribution as of July 30, 2021.

By taking advantage of the current low and stable default risk — and knowing which sectors or firms to avoid due to above-average risk profiles — you can now attractively position your portfolio for the long term.

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 14.46%.  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 10.1, 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)