Toward A Bottom-Up Approach in Assessing Sovereign Default Risk

Transcription

1 Toward A Bottom-Up Approach in Assessing Sovereign Default Risk Dr. Edward I. Altman Stern School of Business New York University Keynote Lecture Risk Day Conference MacQuarie University Sydney, Australia March 22, 2013

2 Measuring and Assessing Sovereign Risk (Outline for Discussion) Current Conditions in Credit Markets Some Recent Sovereign Crises Mexico (1994,1995) Asia 1997 Europe Traditional Indicators of Risk Macroeconomic Related Variables Traditional Models Statistical and Aggregative Techniques Newer Market Based Techniques and Measures Contingent Claims Structural Approach Credit Default Swaps (CDS) Implied Probability of Defaults (PDs) Corporate Statistical PD Measures to Assess Sovereign Health The Z-Metrics Approach A Bottom-Up analysis 2

3 6/1/2007 7/27/2007 9/21/ /16/2007 1/15/2008 3/11/2008 5/6/2008 7/1/2008 8/26/ /21/ /16/2008 2/12/2009 4/9/2009 6/4/2009 7/30/2009 9/24/ /19/2009 1/18/2010 3/15/2010 5/10/2010 7/5/2010 8/30/ /25/ /20/2010 2/14/2011 4/11/2011 6/6/2011 8/1/2011 9/26/ /21/2011 1/18/2012 3/14/2012 5/9/2012 7/4/2012 8/29/ /24/ /19/2012 2/15/2013 YTM & Option-Adjusted Spreads Between High Yield Markets & U.S. Treasury Notes June 01, 2007 March 08, ,700 Yield Spread (YTMS) OAS Average YTMS ( ) Average OAS ( ) 12/16/08 (YTMS = 2,046bp, OAS = 2,144bp) 2,200 1,700 1, YTMS = 546bp, OAS = 549bp 200 6/12/07 (YTMS = 260bp, OAS = 249bp) 3/08/13 (YTMS = 450bp, OAS = 476bp) Sources: Citigroup Yieldbook Index Data and Bank of America Merrill Lynch. 3

4 6/1/2007 7/27/2007 9/21/ /16/2007 1/15/2008 3/11/2008 5/6/2008 7/1/2008 8/26/ /21/ /16/2008 2/12/2009 4/9/2009 6/4/2009 7/30/2009 9/24/ /19/2009 1/18/2010 3/15/2010 5/10/2010 7/5/2010 8/30/ /25/ /20/2010 2/14/2011 4/11/2011 6/6/2011 8/1/2011 9/26/ /21/2011 1/18/2012 3/14/2012 5/9/2012 7/4/2012 8/29/ /24/ /19/2012 2/15/2013 June 01, 2007 March 08, % High Yield Bonds - Yield to Maturity High 12/12/08 (YTM = 23.03%) 20% 15% 10% 3/08/13 (YTM = 6.55%) 5% Low 1/25/13 (YTM = 6.48%) 0% Sources: Citigroup Yieldbook Index Data 4

5 Major Risks Going Forward (For 2013) Global Economy Slowdown Primarily U.S. (Double-Dip?): Impact on Default & Recovery Rates, Credit Availability & Credit Quality China Europe Sovereign Debt Crisis Europe Calm in Late ; Elections Instability? Looming Corporate Defaults Despite Low (2012) Default Rate? Survival of the Euro? Fed Balance Sheet, Money Supply and Inflation LBO and Covenant-Lite Risk Role of Collateral in the Global Financial System Contagion Between Markets Debt and Equity Political Paralysis Deficit/Debt Crises U.S. Municipal Bond & Federal Government Default Risk Uncertainties (non-quantifiable) 5

6 Measuring and Assessing Sovereign Risk (Outline for Discussion) Traditional Indicators of Risk Macroeconomic Related Variables Traditional Models Statistical and Aggregative Techniques Newer Market Based Techniques and Measures Contingent Claims Structural Approach Credit Default Swaps (CDS) Implied Probability of Defaults (PDs) 6

7 A NOVEL APPROACH TO ASSESSING SOVEREIGN DEBT RISK 7

8 4-Jan-09 4-Mar-09 4-May-09 4-Jul-09 4-Sep-09 4-Nov-09 4-Jan-10 4-Mar-10 4-May-10 4-Jul-10 4-Sep-10 4-Nov-10 4-Jan-11 4-Mar-11 4-May-11 4-Jul-11 4-Sep-11 4-Nov-11 4-Jan-12 4-Mar-12 4-May-12 4-Jul-12 4-Sep-12 4-Nov-12 4-Jan-13 4-Mar-13 Default Probability (As %) Five Year Implied Probabilities of Default (PD) From Capital Market CDS Spreads* Jan March 08, Greece (9/16/11) Portugal Italy Spain Ireland Spain Italy Greece Portugal Ireland * Assuming a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e (-5*s/(1-R)). Source: Bloomberg 8

9 European (PIIGS) Government Benchmark Yields and Spreads March 08, 2013 Country 5-Year Price 5-Year Yield % 5-Year Spread to Germany 10-Year Price 10-Year Yield % 10-Year Spread to Germany Germany n/a n/a Greece n/a n/a n/a Ireland n/a n/a n/a Italy * 3.07 Portugal Spain * 3.23 *10-Year Yield as of July 16, 2012 was 6.10% for Italy and 6.77% for Spain. Source: Bloomberg 9

10 Greek CDS Default (March 2012) Greece invokes collective action clause triggering default designation from I.S.D.A. Net exposure for CDS insurers = 3.5 Billion Auction determined recovery rate = 21.5% Net loss = 78.5% - premium earned 10

11 Debt as a Percentage of G.D.P. European Countries, 2011 (3Q) 47% 37% 6% 49% 45% 105% 38% 85% 65% 99% 82% 19% 56% 40% 42% 72% 85% 44% 83% 33% 120% 15% 66% 159% 70% 68% Source: Eurostat 11

12 Ratings Sovereign Ratings Actions (Moody s) Present Greece A1 A2 A3 Ba1 B1 Caa1 Ca C Downgraded to SD by S&P, Dec

13 Ratings Sovereign Ratings Actions (Moody s) Present Portugal Aa2 A1 A3 Baa1 Ba2 Ba3 13

14 Ratings Sovereign Ratings Actions (Moody s) Present Ireland AAA Aa1 Aa2 Baa1 Baa3 Ba1 14

15 Sovereign Ratings Actions (Moody s) Present Spain Ratings AAA Aa1 Aa2 A1 A3 Baa3 15

16 Sovereign Ratings Actions (Moody s) Present Italy Aa2 A2 A3 Baa2 Ratings 16

17 Objectives of Our Z-Metrics Model To construct an accurate, logical, and robust credit-scoring model To assign a probability of default (PD) and Z-Metrics unique credit rating over one-year and five-year horizons to non-financial firms To provide both best estimate as well as stressed PDs and ratings To create models for: Large publicly-held firms in the U.S. and Canada ( U.S. Model ) Large, privately-held firms in the U.S. and Canada Small, publicly-held firms in the U.S. and Canada Large and small firms outside the U.S. and Canada We expect that our U.S. model will be applicable to ex-u.s. firms 17

18 Model Characteristics Based on over 1,000 U.S./Canadian defaulted (credit-event) non-financial firms and a control sample (~15:1) of non-defaulting observations Credit-event date is default or bankruptcy date whichever occurs first Credit-event sample reduced to 638 firms in public firm sample and 802 in private firm sample after removing those with insufficient data Sample period , out-of-sample tests based on two 10-year samples and 2009 credit-event firms 18

19 Model Characteristics (continued) Over 260,000 quarterly & annual observations used to construct model Macroeconomic factors included to capture time-series variation of default probabilities For stressed ratings and PDs, two critical measures are examined: Share price and earnings Final public model has 12 fundamental and market variables, including both static and trend measures plus two macroeconomic variables 19

20 Variables Assessed Over 50 fundamental financial statement variables covering such performance characteristics as solvency, leverage, size, profitability, interest coverage, liquidity, asset quality, investment, dividend payout, and financing results Analyzed trends in many of the fundamental variables Included equity market price and return variables and their relative volatility patterns: typically used in structural, distance-to-default measures Examined distribution of variable values: transformed variables to capture nature of distribution and to reduce influence of outliers Supplemented fundamentals and market data with macroeconomic measures to adjust for macro stresses on the world s economies 20

21 Logit Model Estimation Standard logit regression functional form CS i,t = α + ΣβX i,t + ε i,t CS i,t = Z-Metrics credit score of company i at time t β = variable parameters (or weights) X i,t = set of fundamental, market based and macroeconomic variables for firm/quarter observations ε i,t = error terms (assumed to be identically and independently distributed) CS i,t is transformed into a probability of default by PD i, t 1 1 e CS i, t 21

22 Type I and Type II Error Rates for Agency ratings, Z-Metrics and Z -score Agency Equivalent (AE) Ratings ( ): One Year Prediction Horizon for Public Firms type I error rate (defaulters classified as non-defaulters / total defaulters) 1 AE rating: Z" score 0.8 Agency rating type I error rate AE rating: Z-Metrics public one year type II error rate (non defaulters classified as defaulters/total non defaulters) CCC/CC/C B- B B+ BB BB+ BBBrating class (cutoff score = score at upper boundary of rating class N) BB- type II error rate CCC/CC/C B- B B+ BB- BB AE rating: Z" score Agency rating AE rating: Z-Metrics public one year BB+ BBB- BBB BBB+ A- A A+ AA- AA AA/AAA rating class N (cutoff score = score at upper boundary of rating class N) 22

23 Financial Health of the Corporate, Non-Financial Sector: Selected European Countries and Australia/U.S.A. in (6/30) Country Z-Metrics PD Estimates * : Five-Year Public Model Listed Companies (2011) (Z-Metrics PD Estimates - Median) Median PD 6/30/12 Y/E 2011 Y/E 2010 Y/E 2009 Y/E 2008 Sweden % 2.7% 2.6% 3.1% 6.7% U.K % 4.6% 3.7% 4.5% 7.3% Ireland % 3.0% 1.8% 3.0% 7.9% Netherlands % 3.1% 2.5% 2.7% 5.0% Germany % 4.6% 3.9% 4.5% 7.6% France % 6.6% 4.0% 4.6% 7.2% Spain % 10.6% 7.1% 5.9% 8.6% Italy % 11.9% 7.7% 7.7% 11.3% Portugal % 15.1% 9.9% 8.2% 16.6% Greece % 26.7% 18.7% 11.9% 16.7% Australia % 3.2% 2.4% 3.3% 6.3% U.S.A % 4.8% 3.8% 3.3% 4.5% * Since the Z-Metrics Model is not practically available for most analysts, we could substitute the Z -Score method (available from <altmanzscoreplus.com>). Sources: RiskMetrics Group (MSCI), Markit, Compustat. 23

24 Financial Health of the Corporate, Non-Financial Sector: Selected European Countries and Australia/U.S.A.in (6/30) Country (Z-Metrics PD Estimates 75 th Percentile) Z-Metrics PD Estimates * : Five-Year Public Model Listed Companies (2011) 75th Percentile PD 6/30/12 Y/E 2011 Y/E 2010 Y/E 2009 Y/E 2008 Sweden % 9.6% 6.8% 8.0% 13.5% U.K % 9.7% 5.7% 9.3% 16.6% Netherlands % 8.7% 5.7% 6.7% 15.7% Ireland % 6.3% 8.6% 11.0% 27.5% Germany % 11.2% 9.7% 11.9% 22.2% France % 14.8% 8.5% 10.3% 19.2% Spain % 20.1% 13.2% 12.7% 18.4% Italy % 26.4% 14.1% 18.1% 27.1% Portugal % 24.9% 20.1% 12.3% 26.6% Greece % 50.5% 40.1% 27.6% 31.0% Australia % 11.0% 6.2% 7.8% 16.3% U.S.A % 11.7% 8.0% 11.5% 19.5% * Since the Z-Metrics Model is not practically available for most analysts, we could substitute the Z -Score method (available from <altmanzscoreplus.com>). Sources: RiskMetrics Group (MSCI), Markit, Compustat. 24

25 Five Year Implied Probabilities of Default (PD) From 75 th Percentile Non-Financial Corporate PD* (6/30) Greece, 47.0 Portugal, 32.3 Italy, 25.4 Spain, 25.0 France, 11.0 Germany, 10.8 Ireland, 7.3 *Based on Z-Metrics Model Calculation 25

26 Financial Health of the Corporate, Non-Financial Sector: Selected European Countries and U.S.A. in (Implied PDs from CDS Spreads) Five-Year Implied PD Listed From CDS Spread Companies * Country (2010) Netherlands % 2.03% 2.83% 6.06% U.S.A % 3.28% 4.47% Sweden % 2.25% 4.60% 6.33% U.K % 4.73% 6.52% 8.13% France % 4.51% 3.75% 4.05% Germany % 2.50% 2.67% 3.66% Italy % 18.02% 8.66% 11.20% Spain % 25.27% 8.82% 8.07% Portugal % 34.05% 7.32% 7.39% Greece % ** 59.14% 20.88% 13.22% * Assuming a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e (-5*s/(1-R)).**As of 9/16/2011. Sources: RiskMetrics Group (MSCI), Markit, Compustat. 26

27 Weighted Average Median 5-Year PD for Listed Non-Financial 1 and Banking Firms 2 (Europe & US): 2010 Non-Financial Firms Banking Firms Country PD (%) Weight PD (%) Weight Weighted Average (%) Rank CDS Spread PD (%) Rank Netherlands Sweden U.K Germany France U.S.A Spain Italy Portugal Greece Based on Z-Metrics Default Probability Model. 2 Based on Altman-Rijken Model (Preliminary) 27

28 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD Greece, % 80.00% Default Probability (As %) 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q th Percentile CDS 28

29 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD Portugal, % 60.00% Default Probability (As %) 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q /16/ th Percentile CDS 29

30 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD Ireland, Default Probability (As %) 50.00% 45.00% 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q /16/ th Percentile CDS 30

31 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD Spain, % 35.00% Default Probability (As %) 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q /16/ th Percentile CDS 31

32 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD Italy, % 35.00% Default Probability (As %) 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q /16/ th Percentile CDS 32

33 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD Germany, % Default Probability (As %) 20.00% 15.00% 10.00% 5.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q /16/ th Percentile CDS 33

34 Five Year Implied Probabilities of Default (PD) From Sovereign CDS Spreads vs 75 th Percentile Corporate PD France, % Default Probability (As %) 20.00% 15.00% 10.00% 5.00% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q /16/ th Percentile CDS 34

35 Measures of Sovereign Financial Health: Selected Asian Countries Median 5-Year PD* Financial Crisis of the late 1990 s to 2012 (1H) 45% 40% 35% 1996 KOR THA % 25% 20% 15% 10% 5% 0% (1H) Indonesia Japan S. Korea Malaysia Thailand JAP 4.51 IDN 4.08 MYS (1H) KOR 9.89 IDN 4.55 JAP 4.44 MYS 3.23 THA 1.88 * Based on Z-Metrics Model Calculation 35

36 Measures of Sovereign Financial Health: Selected Asian Countries 75 th Percentile 5-Year PD* Financial Crisis of the late 1990 s to 2012 (1H) 70% 60% 50% 40% 30% 20% 10% 0% (1H) 1996 KOR THA IDN 7.09 JAP 5.81 MYS (1H) KOR MYS 9.32 IDN 8.77 Indonesia Japan S. Korea Malaysia Thailand JAP 8.68 THA 6.51 * Based on Z-Metrics Model Calculation 36

37 Measures of Sovereign Financial Health: BRICHS Countries Median 5-Year PD* Financial Crisis of the late 1990 s to 2012 (1H) % 14% 12% 10% 8% 6% 4% 2% 0% (1H) Brazil China Hong Kong India Russia Singapore SGP 3.99 HKG 2.30 BRA 2.62 ( 98) CHN ( 98) IND 9.93 ( 97) RUS 8.44 ( 00) 2012 (1H) BRA 7.76 CHN 4.72 HKG 4.51 RUS 4.25 IND 4.24 * Based on Z-Metrics Model Calculation SGP

38 Measures of Sovereign Financial Health: BRICHS Countries 75 th Percentile 5-Year PD* Financial Crisis of the late 1990 s to 2012 (1H) % 35% 30% 25% 20% 15% 10% 5% 0% (1H) Brazil China Hong Kong India Russia Singapore HKG 8.45 SGP 7.65 BRA 7.61 ( 98) CHN ( 98) IND ( 97) RUS ( 00) 2012 (1H) BRA HKG SGP IND CHN 9.70 * Based on Z-Metrics Model Calculation RUS