Credit Risk Rebound or a Bump on a Downhill Slide?

06/01/2022 08:31 AM

Credit Risk Rebound or a Bump on a Downhill Slide?
Kamakura Troubled Company Decreases by 1.37% to 7.02%
Credit Quality Improves to the 88th Percentile

NEW YORK, June 2, 2022: Volatility in inflation, interest rates, and Eastern Europe has roiled financial markets and the credit risk expectations of market participants.  The doom and gloom that prevailed in April was partially lifted in May, which saw Treasury yields fall on six of the last eight trading days in the month.

The Kamakura Troubled Company Index® shows that short term default risk in May recovered half of April’s deterioration. Corporate credit quality improved 11 points to the 88th percentile of the period from 1990 to the present.  The 100th percentile indicates the best credit conditions during that period. The Kamakura Troubled Company Index closed in May at 7.02%, compared to 8.39% in April and 5.08% in March. The index measures the percentage of 41,200 public firms worldwide with an annualized one-month default probability over 1%. An increase in the index reflects declining credit quality, while a decrease reflects improving credit quality.

At the close of May, the percentage of companies with a default probability between 1% and 5% was 5.85%, a decrease of 1.04% from the previous month. The percentage with a default probability between 5% and 10% was 0.78%, a decrease of 0.25%. Those with a default probability between 10% and 20% amounted to 0.32% of the total, representing a decrease of 0.03%. Companies with a default probability of over 20% amounted to 0.07%, a decrease of 0.05% over the prior month.

Figure 1: Troubled Company Index — May 31, 2022

Among the 20 riskiest-rated firms at the end of May, 14 were in the United States. The riskiest-rated firm was Exela Technologies, with a one-month KDP of 50.22%, up 17.28% from the previous month.  Sunac China Holdings Ltd. was the only default in the Kamakura coverage universe in May.

Table 1: Riskiest-Rated Companies Based on 1-Month KDP – May 31, 2022

The Kamakura Expected Cumulative Default Rate, the only daily index of credit quality of rated firms worldwide, shows the one-year rate up 0.04% at 2.07% and the 10-year rate down 0.94% at 16.80%.

Figure 2: Expected Cumulative Default Rate — May 31, 2022

Commentary
By Donald R. van Deventer, Founder, Kamakura Corporation

Just two months ago, the 2-year/10-year Treasury spread turned negative for a few business days before returning to its normal upward slope.  Is the inverted yield curve a reliable predictor of future recessions?  Most statisticians would say the sample size (the number of recessions) is too small to answer that question with high confidence.  Kamakura’s weekly simulation of U.S. Treasury yields shows that the probability of an inverted yield curve peaks at 33.6% in the 3-month period ending in May 2023.

Figure 3: Probability of an Inverted Treasury Curve — May 27, 2022

One forecast that is rock-solid is that both the Federal Reserve Board’s members and a large number of interest rate risk managers are going through “on the job training” as this note is written. That spells potential danger for credit risk managers.

About the Troubled Company Index
The Kamakura Troubled Company Index® measures the percentage of 41,200 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 14.22%.  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. Beginning next month, the index will be based on the newly released version 7.0 Jarrow-Chava model.

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. The forthcoming version of KRIS default probabilities uses more than 4.3 million observations and more than 4,200 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., Canada, France, Germany, Italy, Spain, Sweden, the United Kingdom, 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 through the Great Financial Crisis and includes the insights of the entirety of that era. 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 $10.0 trillion.  Current clients have a combined “total assets” or “assets under management” in excess of $38 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:
Kamakura Corporation
2222 Kalakaua Avenue, Suite 1400, Honolulu, Hawaii 96815
Telephone: 1-808-791-9888
Facsimile: 1-808-791-9898
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