Corporate credit conditions have a very significant equity market and bond market impact, but the most sensitive impacts come in the high yield arena. High yield exchange traded funds can react dramatically to changes in credit quality. Kamakura Corporation reported Thursday that corporate credit quality improved significantly from the 57th percentile in June (with 100 being best) to the 75th percentile in July. The percentile rankings are measured over the period from 1990 to the present. In this note, we highlight key excerpts from the Kamakura report.
The Kamakura percentile ranking calculation is based on the Kamakura troubled company index. The Kamakura troubled company index ended the month of July at 7.22%, a decrease of 1.29% since the end of June. The index reflects the percentage of the Kamakura 33,000 public firm universe that has a default probability over 1.00%. A decrease in the index reflects improving credit quality.
As of July 31st, the percentage of the global corporate universe with default probabilities between 1% and 5% was 5.96%, down 0.85% from last month. The percentage of the universe with default probabilities between 5% and 10% was 0.81%, down 0.29% from last month, while the percentage between 10% and 20% was 0.32%, down 0.09%. The percentage of companies with default probabilities over 20% was 0.13%, down 0.13% from last month. The index hit an intra-month high of 7.91% on July 2nd, while the intra-month low of 6.97% was on July 30th. Month over month improvements were evident along the entire distribution of the index.
The all-time high (the 0th percentile, at 27.41%) in the Kamakura troubled company index came in October 2001 in the wake of the crash of the high-tech sector. The all-time low in the index (the 100th percentile, 4.36%) was in December 2010. This graph shows the 1990-2013 history of the Kamakura troubled company index.
Eurobank Ergasias SA had the world's highest one-month default risk among rated companies, at 16.24%. Among the ten riskiest firms in July, six were European firms; two were from Brazil and one each from Argentina (although it trades on the NYSE) and China.
Martin Zorn, President and COO for Kamakura Corporation, said Thursday:
"Europe continued to be the primary area of credit worries again in July, with on-going problems in the banking and telecommunications sectors. We also saw emerging concerns in South America that at this point appear localized and policy related. July saw a busy economic calendar as well as the release of corporate earnings. In the US, the bankruptcy filing by the city of Detroit added headline risk and impacted investment funds flow and relative spreads. Employment and inflation expectations will continue to drive US interest rates and the corresponding impact on leveraged balance sheets. We expect these trends to continue and recommend focus on those companies with higher than average default probabilities."
The Kamakura troubled company index measures the percentage of more than 33,000 public firms in 37-45 countries that have annualized 1 month default risk over one percent. The average index value since January 1990 is 11.98%. Since November 2010, the Kamakura index has used the annualized one month default probability produced by the KRIS version 5.0 Jarrow-Chava reduced form default probability model, a formula that bases default predictions on a sophisticated combination of financial ratios, stock price history, and macroeconomic factors. The version 5.0 model was estimated over the period from 1990 to 2008, and includes the insights of the worst part of the recent credit crisis. The countries currently covered by the index include Australia, Austria, Bahrain, Belgium, Brazil, Canada, China, Denmark, Egypt, Finland, France, Germany, Greece, Hong Kong, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kuwait, Luxemburg, Malaysia, Mexico, the Netherlands, New Zealand, Norway, Oman, Poland, Portugal, Qatar, Russia, Saudi Arabia, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, United Arab Emirates, United Kingdom, the United States, and Vietnam.