Kamakura Reports Continued Improvement In Corporate Credit Quality In April

by: Donald van Deventer


The Kamakura Troubled Company Index measures the percentage of firms with annualized monthly default probabilities over 1%, which Kamakura defines as "troubled."

The index improved in April, dropping 0.30% to 7.77%.

Worldwide corporate credit quality is now at the 84th percentile of the period 1990-2017, with 100 indicating "best" credit conditions.

Kamakura Troubled Company Index Decreases 0.30% to 7.77%

Kamakura Corporation reported Monday that the Kamakura troubled company index ended April at 7.77%, a decrease of 0.30% from the prior month. The index reflects the percentage of the Kamakura 38,000 public firm universe that has a default probability over 1.00%. An increase in the index reflects declining credit quality while a decrease reflects improving credit quality.

As of the end of April, the percentage of the global corporate universe with default probabilities between 1% and 5% was 6.32%, a decrease of 0.26% from the prior month; the percentage of the universe with default probabilities between 5% and 10% was 1.03%, a decrease of 0.03% from the prior month; the percentage between 10% and 20% was 0.35%, down 0.01%; while the percentage of companies with default probabilities over 20% was 0.07%, the same as the previous month. The index ranged from 7.74% on April 27 to 8.21% on April 3. Volatility continued to be very low on a relative basis.

At 7.77%, the troubled company index was at the 84th percentile of historical credit quality (with 100 being best all time) over the period from January 1990 to the present. Among the ten riskiest rated firms in April, five were from the United States, two from Great Britain and one each from Canada, Japan and Spain. During the month, there were 29 defaults in the coverage universe. Johnston Press PLC (LON: JPR) became the riskiest rated firm with a one-year KDP of 32.65%, up 23.07% from the past month.

Martin Zorn, President and Chief Operating Officer for Kamakura Corporation, said Monday,

Last month we introduced the Expected Cumulative Default Rate over the 1 to 10 year time horizon. You can see below that the expected defaults in the 5 to 7 year time horizon remain elevated above the levels that existed prior to the credit crisis. This term remains the most popular for investors so it should be a call for vigilance and deeper analytical analysis. I am currently reading Michael Lewis' "The Undoing Project" which brought to mind the first time I read the work of Amos Tversky and Daniel Kahneman - "Judgment Under Uncertainty: Heuristics and Biases". Prior to reading their work I had successfully used rules of thumb as a lender as I had not yet learned the meaning of 'heuristics.' I was served well by these rules like 'never be the first lender on a golf course' but by the time you were the third lender they probably got the cost structure right. During this time I was also very interested in Ed Thorp's 'Beat the Dealer' which taught me to combine probability theory with money management. This brings me back to the condition of the debt markets today. We have had low interest rates with a benign default environment for a number of years. The impact of recent experience on judgment is a well-studied heuristic and bias that leads to errors and reinforces the need to use quantitative analysis. In expanding our analysis of default probabilities to the term structure we see new and troubling analysis. If we examine the cumulative term structure we see that Sears Holding (NASDAQ:SHLD) is the fourth riskiest company based on the cumulative default probability at five years. If we go a step further and look at the traded price for bonds maturing after five years we find convergence in the bond prices. I refer you the work done by Dr. van Deventer and Suresh Sankaran on April 25, 2016 on Fair Value and Expected Credit Loss Estimation: An Accuracy Comparison of Bond Price versus Spread Analysis Using Lehman Data. Quantitative analysis provides the portfolio manager with the early mover advantage that can result in market outperformance."

The Kamakura troubled company index measures the percentage of 38,000 public firms in 68 countries that have annualized 1-month default risk over one percent. The average index value since January 1990 is 14.71%. Beginning in 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 is provided to subscribers which includes full model test results and parameters. 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 Kamakura Risk Manager. Models available 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 United States market. Macro factor parameter subscriptions include Heath, Jarrow and Morton term structure models for government securities in the United States, Germany, the United Kingdom, Canada, Spain, Sweden, Australia, Japan, Thailand and Singapore. All parameters are derived in a no arbitrage manner consistent with the seminal papers by Heath, Jarrow and Morton and 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, which includes the insights of the entirety of the recent credit crisis. The 68 countries currently covered by the index are Argentina, Australia, Austria, Bahrain, Bangladesh, Belgium, Brazil, Bulgaria, Canada, Chile, China, Colombia, Croatia, Cyprus, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, Hong Kong, Iceland, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kuwait, Luxembourg, Malaysia, Malta, 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, Taiwan, Thailand, Turkey, the United Arab Emirates, the United Kingdom, the United States, and Viet Nam.

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