Blue Fire AI’s Credit Stress Measure (CSM) is an indexed measure (0 to 100) of the credit stress in a specific company—the higher the index, the weaker the company. It represents a forward looking 12-month view of credit stress and can be used to fully complement any equity or cross capital structure view of a company.

Understanding a company’s ability to service its debt obligations is a strong measure of financial health. There is an established transmission mechanism between the performance of the equity price and the credit stress measure, which provides key insights for trading and investment decisions. The credit stress measure is constructed by looking at the risk that the company will be unable (or unwilling) to repay its debt in full or on time. It is calculated by evaluating characteristics such as inadequate cash flow to service debt, declining revenues or operating margins, high leverage, declining or marginal liquidity, and the inability to successfully implement a business plan.

Using short clustering data to evaluate equity price weakness can be combined with a credit stress measure to see when weakness in equity or credit markets will transmit into weakness in asset prices. This can give actionable signals of more structural breakdown in equity prices as operational weakness of a company starts to become systemic across the capital structure.

Use Cases: How the Combination of S3 Data and CSM Has Enhanced Risk-Adjusted Returns

Below are some situations where combining S3 crowding data and the Credit Stress Measure could have helped increase returns and avoid large drawdowns:

Crowding in Shorts followed by steadily increasing Credit Stress Measure

Transocean LTD

A strong crowding signal at almost 30 (Oct 1st, 2018) nicely marks the highest stock price of 13.98 which continues to plummet to 1.04 over a period of 18 months, while Credit Stress Measure steadily increases from 30 to 50.

Crowding in Shorts followed by steadily increasing Credit Stress Measure

TCL Corp-A

Two strong crowding signals ~ 25 within a couple of weeks (Jan 20th, 2021 & Feb 8th, 2021) marks the start of an equity price collapse from 10.09 to 5.11, while Credit Stress Measure steadily increases from 7.8 to 15.

Elevated Mid Rates for borrows in an environment of continued and increasing Credit Stress Measure

Casino Guichard Perrachon

While there was no indication of crowding in shorts, the mid-rate witnesses a spike from 7.36% to peak at 28.86% from Jun to Oct 2019 signaling serious market risk concerns. While mid rates normalize back down to 2% by July 2020, Credit Stress Measure steadily increases from 20 in Jun 2019 to 44 in Mar 2022. This coincides in a collapse of the stock price from EUR 48.96 to EUR 15.8.

Normalized Mid Rates and stable low Credit Stress Measure help avoid overreaction to Short Crowding

Sparebanken Vest

Despite multiple short crowding indications, the mid rate stays stable around 2.0%, while Credit Stress Measure steadily decreases from 13 to 2.7. This coincides in a stock price rally that doubles the price from 50 NOK to 102 NOK.