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Corporate Credit Investing:
Market Overview and Risk Management
Michael Ning
November 2019
Not for Public Distribution
2
World Corporate Bond Map – Maturity/Currency
Bloomberg as Nov-1-2019
Maturity Total USD EUR CNY JPY GBP CAD INR KRW DKK AUD CHF
Total 41,911,827,055,153$ 17,081,281,962,552$ 10,536,622,241,729$ 6,383,051,855,801$ 1,003,117,561,496$ 1,356,216,237,716$ 580,762,211,315$ 551,324,703,597$ 495,013,538,326$ 475,237,171,928$ 448,673,687,247$ 433,468,901,503$
2019 1,552,335,034,596$ 289,281,228,291$ 438,283,692,986$ 623,234,692,105$ 27,156,054,624$ 37,263,906,209$ 8,276,634,617$ 13,293,285,840$ 16,239,104,353$ 13,959,833,542$ 7,936,459,647$
2020 6,993,485,761,388$ 1,960,145,471,447$ 2,050,223,637,785$ 1,872,149,153,541$ 149,933,245,984$ 113,063,411,056$ 69,131,958,881$ 96,391,202,813$ 120,286,322,171$ 69,199,177,804$ 83,118,410,124$ 42,948,904,170$
2021 4,760,066,111,937$ 1,758,171,921,887$ 1,175,209,978,121$ 852,587,654,157$ 114,846,752,858$ 111,749,666,857$ 69,185,334,578$ 75,607,725,222$ 110,577,898,154$ 55,859,991,301$ 70,382,486,169$ 44,427,309,730$
2022 4,578,514,318,604$ 1,815,049,109,815$ 1,090,927,072,852$ 711,773,178,396$ 110,848,761,496$ 131,609,580,037$ 58,375,873,668$ 71,829,072,302$ 88,734,817,168$ 60,811,032,031$ 70,059,387,178$ 43,211,342,667$
2023 3,664,470,328,402$ 1,473,638,779,103$ 1,018,701,474,325$ 467,899,034,478$ 83,933,347,369$ 98,279,423,232$ 56,172,180,762$ 40,831,805,800$ 43,544,687,457$ 44,462,840,139$ 51,624,069,884$ 45,850,413,192$
2024 3,793,136,973,319$ 1,480,922,882,805$ 960,113,519,303$ 498,384,167,492$ 99,974,506,509$ 75,686,936,455$ 57,347,801,203$ 38,042,480,383$ 38,048,037,169$ 20,061,616,796$ 49,345,594,707$ 50,868,469,690$
2025 2,432,013,388,673$ 1,131,361,364,913$ 725,076,307,616$ 200,986,574,180$ 43,667,434,357$ 65,107,079,949$ 32,960,862,370$ 35,210,478,117$ 10,456,972,759$ 4,692,658,040$ 20,843,703,298$ 39,177,405,618$
2026 2,276,175,865,142$ 1,063,408,465,250$ 657,615,417,908$ 186,020,367,193$ 59,894,939,611$ 72,066,478,422$ 22,004,496,908$ 31,134,940,526$ 11,446,417,911$ 3,579,206,247$ 19,337,187,829$ 27,530,240,961$
2027 1,713,643,387,643$ 818,541,697,186$ 459,749,083,219$ 148,133,060,235$ 40,433,903,241$ 39,547,557,477$ 17,543,164,841$ 27,027,270,580$ 3,974,633,214$ 3,978,477,993$ 15,373,925,069$ 26,689,093,106$
2028 1,333,033,588,578$ 615,065,299,903$ 343,735,445,601$ 109,375,341,017$ 40,055,836,789$ 45,533,681,405$ 17,527,258,187$ 31,746,046,596$ 7,138,261,307$ 7,640,254,861$ 16,382,161,772$ 20,093,979,540$
2029 1,179,453,619,905$ 543,108,628,749$ 293,077,378,533$ 104,108,729,436$ 35,221,041,265$ 46,496,166,964$ 21,867,727,750$ 29,299,436,708$ 8,505,988,280$ 6,415,981,656$ 11,164,939,354$ 14,651,008,855$
2030 406,755,655,722$ 182,104,633,059$ 136,077,068,391$ 8,550,831,700$ 9,198,197,963$ 20,257,675,449$ 5,276,881,636$ 3,504,723,362$ 1,315,571,998$ 2,180,457,140$ 1,367,582,748$ 11,439,307,504$
2031 313,086,484,320$ 90,520,879,440$ 120,394,954,899$ 19,777,647,140$ 6,529,007,312$ 33,484,274,516$ 4,097,666,003$ 9,877,498,111$ 1,720,545,728$ 693,034,287$ 1,043,394,620$ 8,121,381,850$
2032 225,140,411,205$ 71,788,981,431$ 67,984,990,339$ 7,293,002,650$ 6,302,272,387$ 24,236,832,195$ 5,773,634,429$ 2,957,971,028$ 1,062,551,513$ 3,022,139,047$ 1,420,406,885$ 5,140,697,907$
2033 242,014,781,154$ 84,194,417,872$ 85,040,229,163$ 7,649,096,900$ 5,329,641,937$ 20,115,959,264$ 5,570,940,770$ 4,549,470,345$ 1,059,314,114$ 3,145,247$ 1,930,077,203$ 3,734,215,790$
2034 224,398,858,778$ 90,189,753,654$ 58,231,114,588$ 15,575,949,800$ 5,893,087,275$ 21,583,553,928$ 3,474,760,396$ 7,906,671,976$ 574,149,564$ 1,943,137,078$ 2,308,489,645$ 4,157,535,894$
2035 241,076,669,374$ 125,783,688,391$ 41,177,329,171$ 7,455,993,000$ 2,355,936,143$ 22,906,181,165$ 6,102,390,252$ 1,863,116,721$ 727,558,193$ 4,187,779,425$ 1,135,072,168$ 3,664,225,192$
2036 220,760,050,517$ 125,135,063,655$ 39,731,043,904$ 4,134,081,000$ 8,028,397,920$ 25,304,502,000$ 4,360,702,956$ 1,042,966,447$ 366,009,144$ 436,816,374$ 1,001,828,222$ 1,407,722,026$
2037 276,980,059,804$ 154,478,482,936$ 48,108,297,244$ 7,931,117,520$ 27,619,846,732$ 5,453,763,558$ 1,761,013,010$ 738,276,023$ 10,921,194,858$ 99,935,033$ 2,610,903,593$
2038 255,019,873,664$ 139,365,301,415$ 40,547,928,423$ 20,279,560,600$ 8,626,293,311$ 19,776,015,414$ 3,609,427,693$ 890,296,571$ 1,117,191,169$ 7,222,089,993$ 633,722,173$ 1,543,412,375$
2039 264,265,538,401$ 143,908,674,746$ 42,659,305,519$ 24,120,784,000$ 7,055,230,483$ 23,735,615,872$ 7,708,994,782$ 1,996,195,594$ 1,346,512,774$ 332,991,484$ 1,822,349,638$ 1,873,228,314$
2040 174,452,105,855$ 94,150,716,918$ 24,985,458,223$ 3,723,750,000$ 1,051,111,829$ 20,838,904,780$ 5,403,740,838$ 629,842,148$ 49,511,983$ 16,942,624,670$ 406,313,293$ 1,965,844,210$
2041 143,131,387,688$ 88,654,517,018$ 17,476,736,742$ 4,506,666,878$ 13,901,325,256$ 8,950,441,332$ 603,255,557$ 37,510,757$ 1,519,005,588$ 61,108,313$ 1,584,446,977$
2042 219,953,890,793$ 164,012,757,568$ 18,069,608,438$ 48,922,340$ 21,342,253,979$ 9,652,641,437$ 155,895,546$ 109,153,540$ 683,672,003$ 814,648,329$
2043 201,742,070,082$ 150,242,433,786$ 16,846,992,458$ 684,602,493$ 17,159,855,966$ 6,104,834,769$ 49,785,643$ 3,621,766,617$ 6,469,514$ 897,738,088$ 1,102,446,433$
2044 224,180,731,159$ 170,841,197,200$ 19,665,506,553$ 322,275,216$ 10,499,734,433$ 9,990,882,712$ 12,951,910$ 878,531,178$ 5,724,891,900$ 399,152,338$ 1,551,534,276$
2045 268,166,831,725$ 225,652,953,869$ 21,598,861,439$ 1,717,520,236$ 7,728,111,800$ 5,539,254,585$ 344,097,759$ 1,981,599,170$ 785,810,592$ 703,131,750$
2046 270,750,345,203$ 226,681,318,860$ 15,151,328,388$ 1,472,285,000$ 5,608,050,194$ 9,009,180,983$ 6,127,936,552$ 496,210,804$ 1,350,226,876$ 741,119,082$ 420,399,123$ 569,498,339$
2047 357,481,767,098$ 248,883,193,593$ 27,179,204,178$ 5,471,507,537$ 17,149,299,942$ 7,852,689,473$ 205,170,386$ 2,344,163,231$ 43,251,467,316$ 821,815,078$ 150,490,500$
2048 301,179,735,730$ 244,392,388,360$ 25,063,857,157$ 220,539,808$ 3,683,574,100$ 9,820,798,108$ 5,597,188,914$ 1,021,587,229$ 1,158,243,771$ 515,755$ 1,560,150,143$ 838,279,320$
2049 255,144,676,498$ 206,159,517,389$ 19,465,056,853$ 72,795,880$ 5,739,264,709$ 8,877,399,916$ 8,450,762,202$ 55,232,599$ 2,725,135,095$ 1,445,610$ 1,488,791,023$ 142,913,400$
2050 178,974,535,206$ 57,593,279,047$ 13,807,444,468$ 5,818,720,817$ 2,451,611,247$ 34,476,800$ 97,098,969,047$ 125,263,750$
3
World Corporate Bond Map – Rating/Seniority
Bloomberg as Nov-1-2019
BBG Composite Rating Total Senior Debt Subordinated Debt Junior Debt <blank>
Total 41,911,827,055,153$ 38,373,178,720,454$ 2,208,460,511,334$ 1,213,920,647,050$ 116,267,176,315$
AAA 3,221,833,792,518$ 3,200,748,760,162$ 1,384,173,250$ 19,700,859,106$
AA+ 658,134,758,789$ 655,413,291,599$ 1,724,311,500$ 997,155,690$
AA 686,210,673,022$ 686,039,607,111$ 171,065,912$
AA- 1,320,244,482,196$ 1,287,411,616,482$ 26,568,826,000$ 571,000,000$ 5,693,039,714$
A+ 1,491,076,031,627$ 1,480,979,735,545$ 7,573,335,034$ 466,668,000$ 2,056,293,048$
A 2,469,868,111,956$ 2,378,127,949,781$ 57,774,894,726$ 16,379,957,090$ 17,585,310,360$
A- 2,421,747,880,226$ 2,170,075,051,346$ 220,892,012,524$ 30,680,310,250$ 100,506,106$
BBB+ 2,607,333,912,659$ 2,307,171,134,958$ 270,365,289,848$ 29,656,352,688$ 141,135,165$
BBB 2,566,729,691,643$ 2,316,365,380,170$ 168,282,598,776$ 81,837,579,072$ 244,133,624$
BBB- 1,901,706,872,551$ 1,630,241,535,626$ 86,726,897,191$ 183,672,128,104$ 1,066,311,631$
BB+ 789,923,535,564$ 561,094,120,657$ 77,411,306,997$ 151,296,899,942$ 121,207,967$
BB 539,153,021,198$ 393,456,210,306$ 13,783,548,400$ 131,913,262,492$
BB- 728,577,881,843$ 680,115,943,203$ 6,366,905,505$ 42,085,940,402$ 9,092,733$
B+ 403,247,770,576$ 352,655,710,600$ 33,207,487,076$ 17,384,572,900$
B 507,759,622,493$ 496,921,158,763$ 7,035,643,000$ 3,596,580,000$ 206,240,730$
B- 374,797,247,919$ 352,102,380,169$ 15,401,163,250$ 6,953,704,500$ 340,000,000$
CCC+ 263,561,851,148$ 245,462,640,648$ 18,099,210,500$
CCC 142,035,502,308$ 137,621,981,801$ 2,601,340,508$ 1,812,180,000$
CCC- 33,311,911,847$ 30,768,756,079$ 2,543,155,768$
CC+ 19,071,869,178$ 19,071,869,178$
CC 11,513,116,480$ 11,249,680,674$ 2,135,806$ 261,300,000$
CC- 283,311,881$ 154,663,000$ 128,648,881$
C+ 7,475,450,539$ 7,091,697,774$ 233,344,187$ 150,408,578$
C 5,959,730,439$ 5,615,835,185$ 343,895,254$
C- 404,043,956$ 387,836,491$ 16,207,465$
DDD+ 2,494,508,057$ 2,474,190,000$ 20,318,057$
DDD 4,115,237,385$ 4,049,132,385$ 66,105,000$
DD+ 5,186,806,178$ 5,135,996,902$ 50,809,276$
NR 4,954,428,586,867$ 4,483,787,178,901$ 273,003,314,552$ 163,546,045,556$ 34,092,047,857$
N.A. 13,773,639,842,109$ 12,471,387,674,958$ 917,353,103,861$ 351,928,097,915$ 32,970,965,376$
4
US Corporate Debt Is at a Fifty-Year High Ratio to GDP
5
Credit Default Swap - A Disappearing Market
BIS Globa l OTC der iva t ives market repor t Jun -2019
$-
$10,000,000,000
$20,000,000,000
$30,000,000,000
$40,000,000,000
$50,000,000,000
$60,000,000,000
$70,000,000,000
Notional Amounts Outstanding
6
High Yield Bond Default Rates
7
High Yield Bond Recovery Rates
8
BB Leads the Pack in Recent Years
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
Jan
-94
Au
g-9
4
Mar
-95
Oct
-95
May
-96
Dec
-96
Jul-
97
Feb
-98
Sep
-98
Ap
r-9
9
No
v-9
9
Jun
-00
Jan
-01
Au
g-0
1
Mar
-02
Oct
-02
May
-03
Dec
-03
Jul-
04
Feb
-05
Sep
-05
Ap
r-0
6
No
v-0
6
Jun
-07
Jan
-08
Au
g-0
8
Mar
-09
Oct
-09
May
-10
Dec
-10
Jul-
11
Feb
-12
Sep
-12
Ap
r-1
3
No
v-1
3
Jun
-14
Jan
-15
Au
g-1
5
Mar
-16
Oct
-16
May
-17
Dec
-17
Jul-
18
Feb
-19
Sep
-19
BBB/BB BB/B
Bloomberg as Nov-1-2019
Distressed debts
9
Oil Crash
recession
Migration of Market Tension
10
Source: Data represents B loomberg Barc lays US Corporate High Y ie ld Bond Index and MacKay Shie lds es t imates . Data as o f Septem ber 30,
2018. I l lus t ra t ion doesn ’ t represent a spec i f i c produc t or fund. For Ins t i tu t iona l Inves tor Use Only . Not fo r Pub l ic D is t r ibu t ion .
HY Issuers in the top quintile ranked by credit spread:
sector weights identify concentrated risk exposures
Weig
ht
Oil Crash
11
Asset Performance (12/31/1998-10/31/2019)
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
Retu
rn
Risk (Standard Deviation)
Efficient Frontier
S&P 500
REIT
Russell 1000
Small Stocks
Commodities
Non-US=EAFE
Cash
Bonds - Agg
Munis
US Corp HY
US Treasuries
US Corp IG
EM USD Bonds
Emerging Mkts
My Portfolio
US High Yield
US Investment Grade
12
Monthly Return Distribution (12/31/1998-10/31/2019)
Mean Standard Deviation Degrees of Freedom
US Investment Grade 0.47 1.52 30.00
US High Yield 0.59 2.57 34.00
13
Credit Risk and Credit-Related Risks Affecting Corporate Bonds
• Credit risk is the risk of loss resulting from the borrower (issuer of debt) failing to make full and timely payments of interest and/or principal.
• Credit risk has two components• Default risk, or Default probability: fails to meet its obligation to make full and timely payments of principal and interest, according
to the terms of the debt security, often expressed as (1 – Recovery rate)
• Loss severity, or Loss given default in the event of default: the portion of a bond’s value (including unpaid interest) an investor loses.
• Expected loss = Default probability × Loss severity given default
• Spread risk• Credit migration risk or Downgrade risk: the risk that a bond issuer’s creditworthiness deteriorates, or migrates lower, leading
investors to believe the risk of default is higher and thus causing the yield spreads on the issuer’s bonds to widen and the price of its bonds to fall.
• Market liquidity risk: the risk that the price at which investors can actually transact—buying or selling—may differ from the price indicated in the market.
• Why model Credit Risk? • Measure risk in portfolio of credit risky instruments
• Compute Regulatory Capital
• Compute Economic Capital
• Perform Risk Adjusted comparison of different portfolios
14
Fundamentals of Credit Risk Analysis • Business and Industry Analysis
• Industry Analysis including SWOT, critical success factors and Porter framework
• Operation/Business analysis
• Business risk versus financial risk
• The asset conversion cycle
• Environmental and Regulatory risk analysis
• Management Analysis
• Early Warning Signs
• Credit red flags
• Ratios and Credit Statistics• Advantages and Limitations of ratios
• Types of Ratios including: profitability, asset quality and efficiency, leverage and coverage
• Peer comparisons/Industry benchmarks
• Specialized industry ratios
• Seasonality
• Overall performance ratios: DuPont formula
• Cash Flow Analysis• Structure of the cash flow statement
• Sources and Uses
• Reconciliations including PP &E, Intangibles, Investments, Deferred Taxes, Long term debt, Minority interest and Equity
• Off Balance Sheet Items• Contingent liabilities
• Operating leases
• Debt of joint ventures and unconsolidated subsidiaries
• Guarantees
• Take-or-pay contracts and obligations under throughput and deficiency agreements
• Receivables that have been factored, transferred or securitized
• Contingent liabilities e.g. potential legal judgments or lawsuit settlements
15
Credit Risk Models
• Issuer-Level Credit Risk Models
• Market Implied Default Risk
• Merton’s Structural Model
• Extension to Merton’s Model (KMV Model)
• Ratings Based Model
• Multivariate Factor Models
• Portfolio Credit Risk
• Modeling joint default probabilities for groups of obligors with Copulas
• Reduced Form Model (Bernoulli Mixture Model etc)
16
Rating Agency and Credit Rating
• Role, Concepts and Process
• A rating agency is an organization which specializes in assessing the financial strength of a company or government
entities that uses the capital markets for financing.
• Credit rating provides a measure of a company solvency i.e. its ability to fulfill its financial obligations.
• Rating agencies use unique letter based code that shows the risk (high or low) of debt and the financial stability of the
issuer.
• Bloomberg default risk scale:
• The corporate credit markets are inefficient
• The credit ratings process employed by the main rating agencies is flawed. Their algorithms favor large enterprises with
long histories, and tends to punish issuers who are perceived as “small” or “new” and who issue debt tranches under $500
million. Not setting constraints based on size or history provides us with a much larger investment universe to seek
opportunities to capture excess returns.
• Many institutional investors are constrained by the ratings process, creating opportunities for active managers.
• Smaller issuers have offered higher return.
17
Bloomberg Credit Risk Model
• The default likelihood model is based on the Merton distance-to-default (DD) measure, along
with additional economically and statistically relevant factors, in particular for non-financial
firms, interest coverage, defined as Trailing 12-month Cash Flow from Operations
(CFO)/Trailing 12-month Interest Expense, significantly adds to the model performance.
• To ensure comparability across accounting/business models, reported financials are adjusted
for operating leases and pensions.
• Finally, firms are assigned a default risk measure as a high-level summary of their credit
health using an explicit mapping from default likelihood to default risk. The complete term
structure of default probability
18
Barclays Capital Global Risk Model - Notations
Portfol weights: 1 2[ , ,..., ]p p p p
Nw w w w
Asset covariance matrix: Asset
Factor covariance matrix: Factor
Specific (Idiosyncratic) covariance matrix:
Factor loadings (exposures): B
Default covariance matrix: 𝐷
Total Active Risk
𝜎𝑇𝑜𝑡𝑎𝑙 = 𝑤𝛴𝐴𝑠𝑠𝑒𝑡𝑤𝑇 +𝑤𝛺𝑤𝑇 +𝑤𝐷𝑤𝑇 = 𝑤𝐵𝛴𝐹𝑎𝑐𝑡𝑜𝑟 𝐵
𝑇𝑤𝑇 + 𝑤𝛺𝑤𝑇 +𝑤𝐷𝑤𝑇
Factor Risk
T T
Factor FactorwB B w
Specific (Idiosyncratic) Risk
T
specific w w
Default Risk
𝜎𝑑𝑒𝑓𝑎𝑢𝑙𝑡 = 𝑤𝐷𝑤𝑇
Credit Default Risk
Issuer Default Probability (%/month): 𝜌
Loss given default (%): 𝑙
Isolated default TEV:
𝜎𝐷𝑒𝑓𝑎𝑢𝑙𝑡 _𝑛 = 𝑤𝑛 𝜌𝑛𝐷𝑒𝑓𝑎𝑢𝑙𝑡
100𝑙𝑛 ∗ 100
19
Barclays Capital Global Risk Model – Corporate Credit Related Risk Factors
Base Spread
Industry & Sector
Country of Risk
Subordination
Distressed Specific
Par Rate Changes
Convexity
SpreadFactors
Curve Factors
Long-Duration Issue
High Yield Issue