Kamakura: Strong Quarter for Risky Assets

04/01/2019 02:58 PM

Kamakura: Strong Quarter for Risky Assets

Kamakura Troubled Company Index Declines by 5.84% for the Quarter

NEW YORK, April 1, 2019: The Kamakura Troubled Company Index® ended March at 10.78%, a decrease of 0.46% from the end of February. So far this year the index has improved 5.84%. The index reflects the percentage of 39,000 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 March, the percentage of companies with a default probability between 1% and 5% was 8.76%—a decrease of 0.23% from the end of February. The percentage with a default probability between 5% and 10% was 1.34%, a decrease of 0.15%. Those with a default probability between 10% and 20% amounted to 0.52% of the total, down 0.06%, and those with a default probability of over 20% amounted to 0.16%, down 0.02% from a month earlier.

Volatility moderated further during the month, with the index ranging from 11.67% on March 25 to 10.35% on March 18.

At 10.78%, the troubled company index now sits at the 54th percentile of historical credit quality as measured since 1990. Among the 10 riskiest-rated firms listed in March, five are in the U.S., with one each in Australia, Canada, Great Britain, Hong Kong and Spain. Debenhams PLC (DEB:LN) remained the riskiest-rated company in our universe, with a one-year KDP of 57.40, up 3.97 from last month. During the month there were three defaults in our coverage universe, all in the U.S.

The following chart shows the list of rated firms that had the largest increases in their one-year Kamakura default probability over the quarter.

The Kamakura expected cumulative default curve for all rated companies worldwide showed increases at both the short and the long end, with the one-year expected default rate increasing by 0.03% to 1.17% and the 10-year rate increasing by 0.24% to 13.66%.

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

The first quarter produced very strong returns for assets in most categories, including equities, investment grade credit, high yield debt, emerging market dollar bonds, and commodities. The improvement in the Troubled Company Index® reflects strong market conditions and positive financial results.

The critical question at this point is determining which forward-looking metrics should guide exposure and segment allocation. Clearly, companies that registered large quarterly increases in their one-year KDP during an environment of strong market performance should be placed on a watch list for reduced exposure. The increase in the 10-year cumulative default curve is another forward-looking metric that deserves analysis.

According to Bloomberg, total assets in money market funds remain at $3 trillion, reflecting strong liquidity and uncertainty with respect to taking on longer-term risk. In addition, the 3-month to 10-year yield curve has inverted for the first time since 2007, and the German Bund went negative for the first time since 2016. All of these are red flags indicating that investors need to stay vigilant and focus on forward-looking perspectives.

In Europe, Italy is in recession and France and Germany have both registered weakness—primarily export-driven—in their latest economic reports. Unlike the U.S. Federal Reserve, which recently signaled a pause in its interest rate policy, the European Central Bank may not have the tools to respond to a more significant economic downturn. Uncertainty surrounding Brexit is also a concern. Nevertheless, we believe the weakness in China is a much bigger problem for Europe’s exporters than Brexit.

The long-term default outlook for both sector and company analysis is the most prudent measure for fixed income managers in assessing sector allocation and determining whether a buy, hold, or sell strategy is most appropriate. The term structure approach, which includes using the Kamakura Expected Cumulative Default Rate, is also an important tool for lenders in assessing exposure levels at the company or sector level, as well as for structuring appropriate covenants to manage risks.

About the Troubled Company Index
The Kamakura troubled company index (Reg. U.S. Pat) measures the percentage of 39,000 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 14.38%. 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 10.0.3, 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 $3.0 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.

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For more information, please contact:
Kamakura Corporation
2222 Kalakaua Avenue, Suite 1400, Honolulu, Hawaii 96815
Telephone: 1-808-791-9888
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