No Free Lunch

02/01/2022 06:46 PM

No Free Lunch
Kamakura Troubled Company Increases by 1.30% to 5.70%
Credit Quality Weakens to the 94th Percentile

NEW YORK, February 2, 2022: The year has started with an ominous increase in global uncertainty. Rising geopolitical tensions, Covid variants, labor shortages, continued supply chain disruptions, inflationary pressure, market volatility and a change in the interest rate regime by the Federal Reserve and other central banks are just a few of the issues markets are facing. In this environment, the risk of error increases for portfolio managers and business decision makers, as well as for government policy makers. The withdrawal of monetary policy accommodation will be a key test for the markets in the months ahead.

The Kamakura Troubled Company Index® indicates that credit quality remained low by historical measures but increased in January to 5.70%, compared to 4.40% last month. Volatility increased for the second consecutive month, with default probabilities ranging from 3.98% on January 12 to 7.19% on January 26. Over the past year, the index has declined by 13.97%. The low was set on August 12, at 2.06%. An increase in the index reflects declining credit quality, while a decrease reflects improving credit quality.

At the close of January, the percentage of companies with a default probability between 1% and 5% was 4.94%, an increase of 1.04% from the previous month. The percentage with a default probability between 5% and 10% was 0.58%, an increase of 0.17%. Those with a default probability between 10% and 20% amounted to 0.15% of the total, representing an increase of 0.07%; and those with a default probability of over 20% amounted to 0.03%, an increase of 0.02% over the prior month. This level shows that worldwide corporate credit quality is at the 94th percentile for the period of 1990 to 2021, with 100 indicating “best conditions.”

Figure 1: Troubled Company Index — January 31, 2022

Among the 20 riskiest-rated firms listed in January, eight were in China, with seven in the U.S., two in Mexico, and one each in Great Britain, Ireland and Norway. The riskiest-rated firm was Petroleum Geo-Services, PGS ASA of Norway (OSE:PGS) with a one-month KDP of 24.26%, up 21.45% from the previous month.  Last month’s riskiest firm, ION Geophysical Corp (NYSE:ION), defaulted on January 4. Ion was the only default in the Kamakura coverage universe.

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

The Kamakura Expected Cumulative Default Rate, the only daily index of credit quality for rated firms worldwide, shows the one-year rate up 0.30% at 1.56%, and the 10-year rate flat at 19.16%.

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

By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
As noted in the introduction, we started the new year with an increase in the number of known risks. The Federal Reserve’s message on unwinding quantitative easing has been muddled at best, contributing to the uncertainty. We already know the Fed erred in its early estimation that inflation was “transitory.” And since Jerome Powell has been chair, the market has come to expect the “Powell Put,” hoping that if asset prices fall precipitously, the Fed will come to the rescue. But we also know that “hope” is not a strategy.

Capitalism encourages investment with the expectation of profit. It also produces failures. The key to capitalism’s success is market participants’ willingness to forgo immediate gratification to obtain greater future reward. At its most simplistic, it is the story of the fisherman who foregoes several days of fishing with a line and hook in order to build a net.

Today’s politicians – and the policy makers who follow their lead — promise immediate results while deferring the costs of paying for them. Covid-related programs are an example. Obviously, the pandemic required a policy response, but the monetary and fiscal policies the government adopted, while they prevented catastrophic outcomes, were extremely broad and expansive. We do not yet know all of their deferred effects, but inflation is one that is already raising its ugly head. Will an acceleration in future defaults be a second byproduct?

Our expected cumulative default table suggests an answer, clearly showing an acceleration in expected defaults between years 3 and 5. Hence there is no free lunch.  One could almost wonder whether politicians who said “Go big!” were referring to the size of the stimulus or the size of the next credit downturn.

As we have said before, the role of risk management is to anticipate what may happen and be prepared to respond quickly to a dynamic environment. The current environment provides an opportunity for well-informed risk managers to be the stars of their organizations.

The best indicator of default risk is the bond markets. I closely follow our CEO Dr. Donald van Deventer’s daily blog Corporate Bond Investor  in this regard to examine the daily attribution of risks as they relate to changes in bond prices. Table 2 below shows the one-month attribution as of January 31, 2022.

Table 2: Bond Performance Attribution – January 31, 2021

Dr. van Deventer’s analysis provides insights into whether price changes are driven by systemic risks (as measured by Treasury-related changes) or company-specific risks (as measured by credit-related changes). The bond market has a strong track record for providing insights about future economic growth.

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 14.32%.  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 $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 (
Kamakura President, Martin Zorn (
Kamakura’s official twitter account (

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