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Markets continued to back off in September, with all three major U.S. indexes logging declines. Markets closed Friday with a government shutdown appearing imminent, though Congress passed a stopgap measure over the weekend to avert that possibility—at least for the next month and a half. Personal consumption expenditures (PCE) (excluding volatile food and energy prices) increased 3.9% on an annual basis in August. That marks the first time in over two years that it had fallen below 4%; yet still remains above the Fed target of 2%. Home affordability got tougher as home prices and mortgage interest rates continued to rise.  Global equity markets also backed off, on fears of rising interest rates and oil prices.

Global bond markets fell as investors fear continued price declines. Sentiment has shifted from anticipating rate cuts–or at least a stabilization of rates–to fears of additional increases, especially for longer maturities.  In the U.S. the 10-year rate was around 4.57%, a 16 year high. US Treasuries are on track to post a third consecutive year of negative returns, which has never happened in past 100 years. Figure 1 below shows the impact on the global 10-year government markets.


There were five defaults in our coverage universe during the month, with two in the U.S. and one each in China, Italy, and Malaysia.  Year to date we have seen 28 defaults, compared to 14 during the same period in 2022 in our coverage universe.


Figure 1: Quarterly Change in Government 10-year Bond YieldsFigure 1.jpg

Contemporaneous credit conditions accelerated their decline in September, with the Kamakura Troubled Company Index® closing the month at 9.53%, up 1.11% from the prior month. The index measures the percentage of 42,100 public firms worldwide with an annualized one-month default probability of over 1%. An increase in the index reflects declining credit quality, while a decrease reflects improving credit quality.

At the end of September, the percentage of companies with a default probability between 1% and 5% was 6.9%. The percentage with a default probability between 5% and 10% was 1.31%. Those with a default probability between 10% and 20% amounted to 0.91% of the total; those with a default probability of over 20% amounted to 0.41%.  Year-to-date short-term default probabilities ranged from a low of 7.22% on February 15 to a high of 9.75% on September 26.


Figure 2: Troubled Company Index® — September 29, 2023

Figure 2.jpg

At the end of September, the riskiest 1% of rated public firms within the coverage universe included 11 companies in the U.S.  The riskiest rated firm was Tupperware Brands Corporation (NYSE:TUP), with a one-month KDP of 59.69%, up 20.22% for the month. The second-riskiest firm was Rite Aid, which announced its intention to file for bankruptcy protection, though it had not yet done so at the end of month.


Table 1: Riskiest Rated Companies Based on 1-month KDP – September 29, 2023

Table 1: Riskiest Rated Companies Based on 1-month KDP – September 29, 2023Table 1: Riskiest Rated Companies Based on 1-month KDP – September 29, 2023


The term structure of default provides more insight into future movements than a point-in-time view.  The shape of the curve is insightful much in the same way that analysts use yield curve differentials to drive strategies.  In Figure 3, uncertainty about the future is clearly evident in the higher level of default risk at the four-year term structure.


Figure 3:  Expected Cumulative Default Rate – U.S. Market, 4-Year, September 29, 2023

Figure 3.jpg


The Kamakura Expected Cumulative Default Rate, the only daily index of credit quality of rated firms worldwide, shows the one-year rate up 0.14% at 0.84% with the 10-year rate up 0.91% at 9.7%.


Figure 4: Expected Cumulative Default Rate — September 29, 2023

Figure 4.jpg 


Stas Melnikov and Martin Zorn
SAS Institute Inc.


As rates remain high and risk going higher, banks will experience low or negative spreads on their securities portfolios.  Any hope that unrealized losses would reverse has faded.  The proportion of banks with spreads under 1% in their securities portfolios has increased dramatically.  The banks will also see continued pressure to raise deposit rates, which still trail the increases in the federal funds target rate. At the same time, U.S. bank deposits have posted the first YoY decrease in history[1].

One strategy that banks may be considering is using their excess capital to restructure their bond portfolios, enhancing the future return on capital.  To successfully employ this strategy, the institution must be confident that credit quality will remain strong. Higher interest costs will have negative impact on borrowers’ debt service coverage, but the bigger risk may be refinance and rollover risk.  Mergers and acquisition due diligence will require extensive stress testing of a target’s deposit portfolio.  Strong stress testing capabilities have never been more important for the sector in evaluating alternative strategies.


The macroeconomic environment appears stable on one hand, with many economies proving more resilient than expected.  However, concerns are mounting around interest rates, energy prices, and what the next central bank moves may be.  We have seen increased focus on the 10-year yield–with good cause, as you can see in Figure 5.


Figure 5: Market Yield on U.S. Treasuries at 10-year Constant MaturityFigure 5.jpg


Changes in the interest rate environment are one of the key macroeconomic drivers pushing up expected default rates in the intermediate term.  A key question will be whether corporate earnings or household income growth will be strong enough to cover the higher interest costs.  If not, the likely outcomes are reduced spending, increased defaults, or both.

The interaction of the macro factors is a key risk to test in this environment.  While companies and households have proven to be much more resilient than anticipated, the opportunity for investors is to identify the sectors or companies that can continue to navigate the uncertainty.  The risk is that investors or lenders may fooled by overly optimistic forecasts or model errors.

We continue to advocate for the use of advanced data and models, which help reduce unexplained components typically equated with idiosyncratic risk. Effective models also allow you to test the risk that a single event would create a contagion. In addition, they test model risk, which is becoming an increasingly valuable metric as AI models become more widely used.


About the Troubled Company Index
The Kamakura Troubled Company Index® measures the percentage of 42,100 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 14.24%.  Since July 2022, the Kamakura index has used the annualized one-month default probability produced by the KRIS version 7.0 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 7.0 models were developed using a data base of more than 4 million observations and more than 4,000 corporate failures. A complete technical guide, including full model test results and key 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, Kamakura Risk Manager. Available models include the non-public-firm default model, the U.S. bank model, and the sovereign model.  Related data includes 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 yields in Australia, Canada, France, Germany, Italy, Japan, Russia, Singapore, Spain, Sweden, Thailand, the United Kingdom, and the United States, plus a 13-country “World” model.  All parameters are derived in a no-arbitrage manner consistent with seminal papers by Heath, Jarrow, and Morton, as well as Amin and Jarrow.


The version 7.0 model was estimated over the period from 1990, through the Great Recession and ending in February 2022. 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.


Editorial contacts:

  • Martin Zorn – . 
    • Martin Zorn currently serves as a Managing Director, Risk Reseach and Quantitative Solutions for Risk Data and Analytics initives at SAS. In his role he oversees day-to-day operations serving risk management clients.
  • Stas Melnikov – . 
    • Stas Melnikov is Head of Risk Portfolio leading teams responsible for integrated balance sheet management solutions, risk data and analytics services and center for applied quantitative finance at SAS Institute. Stas’ work has been featured in numerous industry and investor presentations, including quantitative analyses used to express pre-Global Financial Crisis warnings about the mortgage and real estate markets


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