Z-Score History & Credit Market Outlook

Transcription

1 Z-Score History & Credit Market Outlook Dr. Edward Altman NYU Stern School of Business CT TMA New Haven, CT September 26,

2 Scoring Systems Qualitative (Subjective) 1800s Univariate (Accounting/Market Measures) Rating Agency (e.g. Moody s (1909), S&P (1916) and Corporate (e.g., DuPont) Systems (early 1900s) Multivariate (Accounting/Market Measures) Late 1960s (Z-Score) - Present Discriminant, Logit, Probit Models (Linear, Quadratic) Non-Linear and Black-Bo Models (e.g., Recursive Partitioning Neural Networks, 1990s) Discriminant and Logit Models in Use for Consumer Models - Fair Isaacs (FICO Scores) Manufacturing Firms (1968) Z-Scores Etensions and Innovations for Specific Industries and Countries (1970s Present) ZETA Score Industrials (1977) Private Firm Models (e.g., Z -Score (1983), Z -Score (1995)) EM Score Emerging Markets (1995) Bank Specialized Systems (1990s) SMEs (2000s) Option/Contingent Claims Models (1970s Present) Risk of Ruin (Wilco, 1973) KMVs Credit Monitor Model (1993) Etensions of Merton (1974) Structural Framework 2

3 Scoring Systems (continued) Artificial Intelligence Systems (1990s Present) Epert Systems Neural Networks Machine Learning Blended Ratio/Market Value Models Altman Z-Score (Fundamental Ratios and Market Values) 1968 Bond Score (Credit Sights, 2000; RiskCalc Moody s, 2000) Hazard (Shumway), 2001) Kamakura s Reduced Form, Term Structure Model (2002) Z-Metrics (Altman, et al, Risk Metrics, 2010) Re-introduction of Qualitative Factors/FinTech Stand-alone Metrics, e.g., Invoices, Payment History Multiple Factors Data Mining (Big Data Payments, Governance, time spent on individual firm reports [e.g., CreditRiskMonitor s revised FRISK Scores, 2017], etc.) Enhanced Blended Models (2000s) 3

4 Major Agencies Bond Rating Categories Moody's S&P/Fitch Aaa AAA Aa1 AA+ Aa2 AA Aa3 AA- A1 A+ A2 A A3 A- Baa1 BBB+ Baa2 Investment BBB Baa3 Grade BBB- Ba1 High Yield BB+ Ba2 ("Junk") BB Ba3 BB- B1 B+ B2 B B3 B- Caa1 CCC+ Caa CCC Caa3 CCC- Ca CC C C D 4

5 Problems With Traditional Financial Ratio Analysis 1 Univariate Technique 1-at-a-time 2 No Bottom Line 3 Subjective Weightings 4 Ambiguous 5 Misleading 5

6 Forecasting Distress With Discriminant Analysis Linear Form Z = a a a a n n Z = Discriminant Score (Z Score) a 1 1 a n = Discriminant Coefficients (Weights) n = Discriminant Variables (e.g. Ratios) Eample EBIT TA EQUITY/DEBT 6

7 Z-Score Component Definitions and Weightings Variable Definition Weighting Factor X 1 Working Capital 1.2 Total Assets X 2 Retained Earnings 1.4 Total Assets X 3 EBIT 3.3 Total Assets X 4 Market Value of Equity 0.6 Book Value of Total Liabilities X 5 Sales 1.0 Total Assets 7

8 Zones of Discrimination: Original Z - Score Model (1968) Z > Safe Zone 1.8 < Z < Grey Zone Z < Distress Zone 8

9 Time Series Impact On Corporate Z-Scores Credit Risk Migration - Greater Use of Leverage - Impact of HY Bond & LL Markets - Global Competition - More and Larger Bankruptcies Increased Type II Error 9

10 Estimating Probability of Default (PD) and Probability of Loss Given Defaults (LGD) Method #1 Credit scores on new or eisting debt Bond rating equivalents on new issues (Mortality) or eisting issues (Rating Agency Cumulative Defaults) Utilizing mortality or cumulative default rates to estimate marginal and cumulative defaults Estimating Default Recoveries and Probability of Loss Method #2 or Credit scores on new or eisting debt Direct estimation of the probability of default Based on PDs, assign a rating 10

11 Median Z-Score by S&P Bond Rating for U.S. Manufacturing Firms: Rating 2013 (No.) AAA/AA 4.13 (15) * 4.80* A 4.00 (64) BBB 3.01 (131) BB 2.69 (119) B 1.66 (80) CCC/CC 0.23 (3) D 0.01 (33) *AAA Only. Sources: Compustat Database, mainly S&P 500 firms, compilation by NYU Salomon Center, Stern School of Business. 11

12 Mortality Rates by Original Rating All Rated Corporate Bonds* Years After Issuance AAA Marginal 0.00% 0.00% 0.00% 0.00% 0.01% 0.02% 0.01% 0.00% 0.00% 0.00% Cumulative 0.00% 0.00% 0.00% 0.00% 0.01% 0.03% 0.04% 0.04% 0.04% 0.04% AA Marginal 0.00% 0.00% 0.20% 0.06% 0.02% 0.01% 0.01% 0.01% 0.02% 0.01% Cumulative 0.00% 0.00% 0.20% 0.26% 0.28% 0.29% 0.30% 0.31% 0.33% 0.34% A Marginal 0.01% 0.03% 0.11% 0.12% 0.09% 0.05% 0.02% 0.24% 0.07% 0.04% Cumulative 0.01% 0.04% 0.15% 0.27% 0.36% 0.41% 0.43% 0.67% 0.74% 0.78% BBB Marginal 0.32% 2.34% 1.24% 0.98% 0.49% 0.22% 0.25% 0.16% 0.17% 0.33% Cumulative 0.32% 2.65% 3.86% 4.80% 5.27% 5.48% 5.71% 5.86% 6.02% 6.33% BB Marginal 0.92% 2.04% 3.85% 1.95% 2.42% 1.56% 1.44% 1.10% 1.41% 3.11% Cumulative 0.92% 2.94% 6.68% 8.50% 10.71% 12.11% 13.37% 14.32% 15.53% 18.16% B Marginal 2.86% 7.67% 7.78% 7.75% 5.74% 4.46% 3.60% 2.05% 1.73% 0.75% Cumulative 2.86% 10.31% 17.29% 23.70% 28.08% 31.29% 33.76% 35.12% 36.24% 36.72% CCC Marginal 8.11% 12.40% 17.75% 16.25% 4.90% 11.62% 5.40% 4.75% 0.64% 4.26% Cumulative 8.11% 19.50% 33.79% 44.55% 47.27% 53.40% 55.91% 58.01% 58.28% 60.05% *Rated by S&P at Issuance Based on 3,280 issues Source: Standard & Poor's (New York) and Author's Compilation 12

13 Mortality Losses by Original Rating All Rated Corporate Bonds* Years After Issuance AAA Marginal 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.01% 0.00% 0.00% 0.00% Cumulative 0.00% 0.00% 0.00% 0.00% 0.01% 0.02% 0.03% 0.03% 0.03% 0.03% AA Marginal 0.00% 0.00% 0.03% 0.02% 0.01% 0.01% 0.00% 0.01% 0.01% 0.01% Cumulative 0.00% 0.00% 0.03% 0.05% 0.06% 0.07% 0.07% 0.08% 0.09% 0.10% A Marginal 0.00% 0.01% 0.04% 0.05% 0.05% 0.04% 0.02% 0.02% 0.05% 0.03% Cumulative 0.00% 0.01% 0.05% 0.10% 0.15% 0.19% 0.21% 0.23% 0.28% 0.31% BBB Marginal 0.23% 1.53% 0.70% 0.58% 0.26% 0.16% 0.10% 0.09% 0.10% 0.18% Cumulative 0.23% 1.76% 2.44% 3.01% 3.26% 3.42% 3.51% 3.60% 3.70% 3.87% BB Marginal 0.55% 1.18% 2.30% 1.11% 1.38% 0.74% 0.78% 0.48% 0.73% 1.09% Cumulative 0.55% 1.72% 3.98% 5.05% 6.36% 7.05% 7.78% 8.22% 8.89% 9.88% B Marginal 1.92% 5.38% 5.32% 5.20% 3.79% 2.45% 2.34% 1.13% 0.91% 0.53% Cumulative 1.92% 7.20% 12.13% 16.70% 19.86% 21.82% 23.65% 24.52% 25.20% 25.60% CCC Marginal 5.37% 8.68% 12.49% 11.45% 3.42% 8.61% 2.32% 3.34% 0.40% 2.72% Cumulative 5.37% 13.58% 24.38% 33.04% 35.33% 40.89% 42.27% 44.19% 44.42% 45.93% *Rated by S&P at Issuance Based on 2,714 issues Source: Standard & Poor's (New York) and Author's Compilation 13

14 Classification & Prediction Accuracy Z Score (1968) Failure Model* Year Prior Original Holdout Predictive Predictive Predictive To Failure Sample (33) Sample (25) Sample (86) Sample (110) Sample (120) 1 94% (88%) 96% (72%) 82% (75%) 85% (78%) 94% (84%) 2 72% 80% 68% 75% 74% 3 48% % % *Using 2.67 as cutoff score (1.81 cutoff accuracy in parenthesis) 14

15 Z Score Trend - LTV Corp Z Score BB+ Safe Zone Grey Zone Distress Zone BBB- B- B- CCC+ CCC+ D Year Bankrupt July 86 15

16 IBM Corporation Z Score ( ) Z Score Safe Zone Grey Zone Consolidated Co. Operating Co. BBB Year BB July 1993: Downgrade AA- to A B 1/93: Downgrade AAA to AA- 16

17 Z-Score Model Applied to General Motors (Consolidated Data): Bond Rating Equivalents and Scores from Z-Scores BRE 12/31/ B- 12/31/ B 12/31/ B 12/31/ B 12/31/ B 12/31/ B 12/31/ B 12/31/ CCC 03/31/09 (1.12) D 12/31/08 (0.63) D 12/31/ CCC+ 12/31/ B- 12/31/ CCC+ Note: Consolidated Annual Results. Data Source: S&P Capital IQ, Bloomberg., Edgar 17

18 Z-Score Model Applied to GM (Consolidated Data): Bond Rating Equivalents and Scores from Z- Score: General Motors Co Z-Score 1.50 CCC B- CCC+ CCC B B Full Emergence from Bankruptcy 3/31/11 B B B Upgrade to BBBby S&P 9/25/14 B B Dec-05 Dec-06 Dec-07 D Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Emergence, New Co. Only, from Ch. 11 Filing Bankruptcy, 7/13/09 6/01/09 Dec-14 Dec-15 Dec D Z-Score 18

19 Applying the Z Score Models to Recent Energy & Mining Company Bankruptcies /15/2017 Z-Score Z' -Score BREs t-1* t-2** t-1* t-2** # % # % # % # % A BBB+ BBB BBB- BB+ 1 2% BB 0 0% BB- 3 5% B+ 1 2% 1 2% B 2 6% 3 5% 13 24% B- 3 5% 6 11% CCC+ 1 2% 8 15% CCC 5 16% 12 39% 2 4% 8 15% CCC- 4 7% 9 16% D 26 84% 17 55% 41 75% 6 11% Total % % % % * One or Two Quarters before Filing ** Five or Si Quarters before Filing Source: S&P Capital IQ 19

20 Additional Altman Z-Score Models: Private Firm Model (1968) Non-U.S., Emerging Markets Models for Non Financial Industrial Firms (1995) e.g. Latin America (1977, 1995), China (2010), etc. Sovereign Risk Bottom-Up Model (2010) SME Models for the U.S. (2007) & Europe e.g. Italian Minibonds (2016), U.K. (2017), Spain (?) 20

21 Z Score Private Firm Model Z =.717X X X X X 5 X 1 = Current Assets - Current Liabilities Total Assets X 2 = Retained Earnings Total Assets X 3 = Earnings Before Interest and Taes Total Assets X 4 = Book Value of Equity Total Liabilities X 5 = Sales Total Assets 21

22 Z Score Model for Manufacturers, Non-Manufacturer Industrials; Developed and Emerging Market Credits (1995) Z = X X X X 4 X 1 = Current Assets - Current Liabilities Total Assets X 2 = Retained Earnings Total Assets X 3 = Earnings Before Interest and Taes Total Assets X 4 = Book Value of Equity Total Liabilities 22

23 US Bond Rating Equivalents Based on Z -Score Model Z = X X X X 4 Rating Median 1996 Z -Score a Median 2006 Z -Score a Median 2013 Z -Score a AAA/AA (8) 7.51 (14) 8.80 (15) AA/AA (33) 7.78 (20) 8.40 (17) A (24) 7.76 (26) 8.22 (23) A 6.65 (42) 7.53 (61) 6.94 (48) A (38) 7.10 (65) 6.12 (52) BBB (38) 6.47 (74) 5.80 (70) BBB 5.85 (59) 6.41 (99) 5.75 (127) BBB (52) 6.36 (76) 5.70 (96) BB (34) 6.25 (68) 5.65 (71) BB 4.95 (25) 6.17 (114) 5.52 (100) BB (65) 5.65 (173) 5.07 (121) B (78) 5.05 (164) 4.81 (93) B 4.15 (115) 4.29 (139) 4.03 (100) B (95) 3.68 (62) 3.74 (37) CCC (23) 2.98 (16) 2.84 (13) CCC 2.50 (10) 2.20 (8) 2.57(3) CCC (6) 1.62 (-) b 1.72 (-) b CC/D 0 (14) 0.84 (120) 0.05 (94) c a Sample Size in Parantheses. b Interpolated between CCC and CC/D. c Based on 94 Chapter 11 bankruptcy filings, Sources: Compustat, Company Filings and S&P. 23

24 Z and Z -Score Models Applied to Sears, Roebuck & Co.: Bond Rating Equivalents and Scores from Z and Z - Score: Sears, Roebuck & Co CCC B+ CCC B B D Z-Score Z"-Score 24

25 Current Conditions and Outlook in Global Credit Markets 25 25

26 Benign Credit Cycle? Is It Over? Length of Benign Credit Cycles: Is the Current Cycle Over? No. Default Rates (no) Default Forecast (no) Recovery Rates (no) Yields (no) Liquidity (no) 26

27 Size of the US High-Yield Bond Market (Mid-year US$ billions) $1,800 $1,600 $1,622 $1,400 $1,200 $ (Billions) $1,000 $800 $600 $400 $200 $ Source: NYU Salomon Center estimates using Credit Suisse, S&P and Citi data. 27

28 Historical H.Y. Bond Default Rates Straight Bonds Only Ecluding Defaulted Issues From Par Value Outstanding, (US$ millions), (9/18) Year Par Value Outstanding a ($) Par Value Defaults ($) Default Rates (%) 2017 (9/18) 1,622,365 21, ,656,176 68, ,595,839 45, ,496,814 31, ,392,212 14, ,212,362 19, ,354,649 17, ,221,569 13, ,152, , ,091,000 50, ,075,400 5, ,600 7, ,073,000 36, ,100 11, ,000 38, ,000 96, ,000 63, ,200 30, ,400 23, ,500 7, ,400 4, ,000 3, ,000 4, ,000 3, ,907 2, ,000 5, ,600 18, ,000 18, a Weighted by par value of amount outstanding for each year. Year Par Value Outstanding* ($) Par Value Defaults ($) Default Rates (%) ,258 8, ,187 3, ,557 7, , , , , , , , , , , , , , , , , Arithmetic Average Default Rate (%) Standard Deviation (%) 1971 to to to Weighted Average Default Rate (%)* 1971 to to to Median Annual Default Rate (%) 1971 to Source: NYU Salomon Center and Citigroup/Credit Suisse estimates 28

29 Default Rates on High-Yield Bonds Quarterly Default Rate and Four-Quarter Moving Average (9/18) 6.0% 16.0% 5.0% 14.0% 12.0% Quarterly Default Rate 4.0% 3.0% 2.0% 10.0% 8.0% 6.0% 4.0% 4 - Quarter Moving Average 1.0% 2.0% 0.0% 0.0% Quarterly Moving Source: Author s Compilations 29

30 Filings for Chapter 11 Number of Filings and Pre-petition Liabilities of Filing Companies (9/18) Pre- Petition Liabilities, in $ billions (left ais) Median Liabilities Number of Filings (right ais) Median No. of Filings. $ $ Billion $700 $600 $500 $400 $300 $200 $ (9/18) 77 filings and liabilities of $111.6 billion 2017 (9/18) 63 filings and liabilities of $81.1 billion $ (9/18) Note: Minimum $100 million in liabilities Source: NYU Salomon Center Bankruptcy Filings Database Mean : 75 filings Median : 57 filings 30

31 YTM & Option-Adjusted Spreads Between High Yield Markets & U.S. Treasury Notes June 01, 2007 September 18, 2017 Yield Spread (YTMS) OAS Average YTMS ( ) Average OAS ( ) 12/16/08 (YTMS = 2,046bp, OAS = 2,144bp) 2,200 2,000 1,800 1,600 1,400 1,200 1, YTMS = 539bp, OAS = 544bp Sources: Citigroup Yieldbook Inde Data and Bank of America Merrill Lynch. 31 7/19/2017 4/5/ /19/2016 9/5/2016 5/23/2016 2/8/ /22/2015 7/9/2015 3/26/ /9/2014 5/13/2014 1/28/ /11/2013 6/28/2013 3/15/ /28/2012 8/15/2012 5/2/2012 1/18/ /3/2011 6/20/2011 3/7/ /22/2010 8/9/2010 4/26/2010 1/11/2010 9/24/2009 6/11/2009 2/26/ /11/2008 7/29/2008 4/15/ /31/2007 9/14/2007 6/1/ /26/2014 9/18/17 (YTMS = 397p, OAS = 368bp) 6/12/07 (YTMS = 260bp, OAS = 249bp)

32 Comparative Health of High-Yield Firms (2007 vs. 2012/2014/3Q 2016) 32

33 Comparing Financial Strength of High-Yield Bond Issuers in 2007& 2012/2014/3Q 2016 Number of Firms Z-Score Z -Score (3Q) Year Average Z-Score/ (BRE)* Median Z-Score/ (BRE)* Average Z -Score/ (BRE)* Median Z -Score/ (BRE)* (B+) 1.84 (B+) 4.68 (B+) 4.82 (B+) (B) 1.73 (B) 4.54 (B) 4.63 (B) (B+) 1.85 (B+) 4.66 (B+) 4.74 (B+) 2016 (3Q) 1.97 (B+) 1.70 (B) 4.44 (B) 4.63 (B) *Bond Rating Equivalent Source: Authors calculations, data from Altman and Hotchkiss (2006) and S&P Capital IQ/Compustat. 33

34 Financial Distress (Z-Score) Prediction Applications Eternal (To The Firm) Analytics Internal (To The Firm) & Research Analytics Lenders (e.g., Pricing, Basel Capital Allocation) To File or Not (e.g., General Motors) Bond Investors (e.g., Quality Junk Portfolio Comparative Risk Profiles Over Time Long/Short Investment Strategy on Stocks (e.g. Baskets of Strong Balance Sheet Companies & Indees, e.g. STOXX, Goldman, Nomura) Industrial Sector Assessment (e.g., Energy) Sovereign Default Risk Assessment Security Analysts & Rating Agencies Purchasers, Suppliers Assessment Regulators & Government Agencies Accounts Receivables Management Auditors (Audit Risk Model) Going Concern Researchers Scholarly Studies Advisors (e.g., Assessing Client s Health) Chapter 22 Assessment M&A (e.g., Bottom Fishing) Managers Managing a Financial Turnaround

35 MANAGING A FINANCIAL TURNAROUND: APPLICATIONS OF THE Z-SCORE MODEL THE GTI CASE 35

36 Objectives To demonstrate that specific management tools which work are available in crisis situations To illustrate that predictive models can be turned inside out and used as internal management tools to, in effect, reverse their predictions To illustrate an interactive, as opposed to a passive, approach to financial decision making 36

37 Z-Score Component Definitions Variable Definition Weighting Factor X 1 X 2 X 3 X 4 X 5 Working Capital Total Assets Retained Earnings Total Assets EBIT Total Assets Market Value of Equity Book Value of Total Liabilities Sales Total Assets

38 Z-Score Distressed Firm Predictor: Application to GTI Corporation ( ) Z-Score EPS = $0.09 EPS = $0.52 Safe Zone EPS = $ Grey Zone EPS = ($1.27) Distress Zone 38

39 Management Tools Used Altman s Distressed Firm Predictor (Z-Score) Function / Location Matri Financial Statements Planning Systems Trend Charts 39

40 Managerial & Financial Restructuring Actions and Impact on Z-Score Strategy Reason Impact Consolidated Locations Eliminate Underutilized Assets Z-Score Drop Losing Product Lines Eliminate Unprofitable Underutilized Assets Z-Score Reduce Debt Using Funds Received from Sale of Assets Reduce Liabilities and Total Assets Z-Score 40

41 Z-Score Distressed Firm Predictor Application to GTI Corporation ( ) Z-Score 9.0 $ $0.70 $ EPS = $ $0.52 $0.19 $0.28 $0.15 ($0.29) ($1.27) Safe Zone Grey Zone Distress Zone 41