We'll See: Kamakura Troubled Company Index Increases By 1.08% To 15.06%
Bonds, Portfolio Strategy, Banks, risk management
Seeking Alpha Analyst Since 2009
Donald R. van Deventer is a Managing Director in the Center for Applied Quantitative Finance at SAS Institute, Inc. Prior to the acquisition of Kamakura Corporation by SAS on June 24, 2022, Dr. van Deventer was the Chairman and Chief Executive Officer of Kamakura Corporation. He founded the Kamakura Corporation in April, 1990. The second edition of his book, Advanced Financial Risk Management (with Kenji Imai and Mark Mesler) was published in 2013. Dr. van Deventer was senior vice president in the investment banking department of Lehman Brothers (then Shearson Lehman Hutton) from 1987 to 1990. During that time, he was responsible for 27 major client relationships including Sony, Canon, Fujitsu, NTT, Tokyo Electric Power Co., and most of Japan's leading banks. From 1982 to 1987, Dr. van Deventer was the treasurer for First Interstate Bancorp in Los Angeles. In this capacity he was responsible for all bond financing requirements, the company’s commercial paper program, and a multi-billion dollar derivatives hedging program for the company. Dr. van Deventer was a Vice President in the risk management department of Security Pacific National Bank from 1977 to 1982. Dr. van Deventer holds a Ph.D. in Business Economics, a joint degree of the Harvard University Department of Economics and the Harvard Graduate School of Business Administration. He was appointed to the Harvard University Graduate School Alumni Association Council in 1999 and served through 2021. Dr. van Deventer was Chairman of the Council for four years from 2012 to 2016. From 2005 through 2009, he served as one of two appointed directors of the Harvard Alumni Association representing the Graduate School of Arts and Sciences. Dr. van Deventer also holds a degree in mathematics and economics from Occidental College, where he graduated second in his class, summa cum laude, and Phi Beta Kappa. Dr. van Deventer speaks Japanese and English.
- This note was authored by Martin Zorn, President and Chief Operating Officer of Kamakura Corporation.
- During the month of December, the Kamakura Troubled Company Index shows that worldwide corporate credit quality declined to the 35th percentile of the period 1990-2020, with 100 indicating best conditions.
- There were 5 defaults in the Kamakura coverage universe, with 3 in the U.S. and one each in France and Great Britain.
NEW YORK, January 4, 2021: There is a Zen story of a farmer who worked his crops for many years. One day his horse ran away. Upon hearing the news, neighbors came to visit. “Such bad luck” they said. “We’ll see,” replied the farmer. The next morning the horse returned, bringing with it three wild horses. “How amazing,” exclaimed the neighbors. “We’ll see,” replied the farmer. The following day, the farmer’s son tried to ride one of the wild horses, but was thrown and broke his leg. The neighbors came to offer sympathy. “We’ll see,” answered the farmer. The day after that, military officials came to the village to draft young men into the army. Seeing that the farmer’s son had a broken leg, they passed him by. The neighbors once again congratulated the farmer. Said the farmer, “We’ll see.”
The markets ended 2020 with a bang. There were gains across all of the indices, with the Dow up 6.5%, the NASDAQ up 43.2% and the NYSE FANG up 102.7%. IPOs boomed, and so did their valuations. Airbnb, for example, was valued at more than Marriott International, Hilton Worldwide Holdings, Inc., and Hyatt combined. Gold closed up 24% and China’s stock market was up 27%. Britain finally exited the EU. And of course, coronavirus stimulus packages were introduced globally.
Given the fact that markets generally reflect future expectations, should we be upbeat?
The Kamakura Troubled Company Index® indicated that credit quality declined in December, with an increase 1.08% over the month to 15.06% and an increase over the year of 2.16%. It ended the month at the 35th percentile. The index continued to be volatile, ranging from 13.6% on December 8 to 16.21% on December 21. For the year, the index ranged from a low of 10.35% on January 20 to a high of 35.3% on March 23. The index reflects the percentage of 40,500 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 December, the percentage of companies with a default probability between 1% and 5% was 12.31%, an increase of 0.81% over the previous month. The percentage with a default probability between 5% and 10% was 1.79%, an increase of 0.17%. Those with a default probability between 10% and 20% amounted to 0.73% of the total, an increase of 0.05%; and those with a default probability of over 20% amounted to 0.23%, an increase of 0.05%.
Troubled Company Index – December 31, 2020
At 15.06%, the Troubled Company Index declined to the 35th percentile of historical credit quality as measured since 1990.
Among the 10 riskiest-rated firms listed in December, nine were in the U.S., with one in Japan. The riskiest-rated firm remained Highpoint Resources (NYSE:HPR), an energy exploration and production firm. There were five defaults in the Kamakura coverage universe, with three in the U.S and one each in France and Great Britain. For the year, there were 77 defaults in the US, with two thirds coming from the energy and consumer discretionary sectors.
Riskiest Rated Companies based on 1-month KDP
2020 US Defaults by Sector
The Kamakura expected cumulative default curve for all rated companies worldwide widened, with the one-year expected default rate increasing by 0.06% to 0.86%, while the 10-year rate increased by 0.68% to 15.38%.
Expected Cumulative Default Rate – December 31, 2020
By Martin Zorn, President and Chief Operating Officer, Kamakura Corporation
The markets rallied over the year, responding to low interest rates, government stimulus, optimism around the Covid-19 vaccine rollouts, and market intervention by the central banks around the globe. Federal Reserve President Jerome Powell called for more stimulus, as did his peers at other banks.
But, despite the positive market news, not all sectors benefited. Restaurants, theaters and many small businesses are struggling for survival. The KBW Bank Index dropped 14.2% over the year. It is worth asking whether the banks’ view of future losses is more realistic than the capital markets’ view, especially considering that debt issuance expanded dramatically during the year. Particularly worrisome is corporate debt, which expanded much faster than the earnings needed to support the increased leverage.
Is the market rally real, or is it simply a reaction to massive government intervention into the markets, distorting price discovery and investment fundamentals? Central banks seem to believe that the solution for too much debt is … more debt. But interventions always have unintended consequences, and current fiscal and monetary policy should put investors and lenders on guard, despite the old adages “Do not fight the tape” and its corollary, “Do not fight the Fed.” The present global situation calls for caution and extreme nimbleness on the part of portfolio managers.
As we enter the new year full of hope that 2021 will be very different from its predecessor, we need to ask more questions than ever about the risks that lie like icebergs just beneath the surface. Are our risk tools adequate? Are we using our financial X-rays and MRIs to identify risks that can be disruptive and dangerous for our portfolios?
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 14.55%. 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 10.0.5, 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. Current clients have a combined “total assets” or “assets under management” in excess of $26 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:
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Web site: www.kamakuraco.com
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