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Credit Analysis
50 Years Of Altman Z-score, And PD Model Fundamentals – Case Study General Motors

Jun. 11 2018 — The year 2018 marks the 50th anniversary of the Altman Z-score, which was designed to gauge credit strength of publicly traded manufacturing corporates. Until this day, the model has been used by financial practitioners to obtain a condensed picture of the financial strength of a company, and serves as a benchmark for credit risk assessment models.

As a part of providing data and tools for a comprehensive analysis of credit risk, S&P Global Market Intelligence has developed a family of PD Model Fundamentals (PDFN). The PDFN is a statistical model that produces probability of default (PD) values over a one- to more than thirty-year horizon for public and private banks and corporations of any size. The model maps the PD values to credit scores1 (i.e. ‘bbb’), based on historical observed default rates (ODRs) extracted from S&P Global Ratings’ database (available on CreditPro® ) PDFN also offers a global coverage of over 250 countries and more than 20 segments, regions, and industries.

PDFN incorporates both financial risk and business risk to generate the overall PD value. This innovative approach captures, in a statistical PD model, important credit risk drivers as identified by S&P Global Ratings’ extensive experience in corporate credit assessments, and provides users with a well-rounded measure of credit risk, where different sources can be easily identified.

We apply the credit assessment metrics to analyze one of the most publicized bankruptcy events in the last decade, the case of General Motors (General Motors Company, formerly General Motors Corporation). In Figure 1 we present the historical evolution of credit risk for General Motors (GM) from January 2005 to May 2018, accompanied by bankruptcy related Key Developments. We compare assessed credit score by PDFN, Altman Z-score, and corresponding S&P Global Ratings Issuer Credit Rating.

At the beginning of 2005, PDFN indicates a credit risk score of ‘bbb-‘, while the S&P Global Ratings Issuer Credit Rating is ‘BBB-‘. The credit risk score indicates that General Motors had adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments. Likewise, the Z-score indicates a rather problematic financial situation, placing General Motors in distressed zone category.

In the following months, the credit quality of General Motors rapidly deteriorated. PDFN signals highly increased probability of financial distress already at the beginning of 2007, more than two years in advance. The implied ‘ccc’ credit score suggests high vulnerability to adverse business, financial, or economic conditions with at least a one-in-two likelihood of default. A few months before default, PDFN indicates a credit score of ‘cc’, thus expecting default to be highly likely. Similarly, the S&P Global Ratings Issuer Credit Ratings shows decaying credit quality, albeit the credit rating changes are more sporadic and have larger increments. The Z-score starts to show a significant deterioration of credit quality one year prior to default, but with a notable lag in comparison with PDFN.

After completion of the post-bankruptcy reorganization, creditworthiness of General Motors improved, and PDFN indicates a fairly stable credit risk profile with an implied score of ‘bbb’. In comparison, S&P Global Ratings Issuer Credit Rating initially shows a greater conservatism in light of the reorganization processes. Since then, the credit rating has improved steadily, converging with PDFN estimate. Z-score shows a somewhat steady estimate of credit risk, with a slight deterioration in the recent years.

Figure 1: Historical evolution of credit risk for General Motors (GM)

The shaded area denotes the period of reorganization between the bankruptcy announcement and reemergence of General Motors (GM) as a public company on the New York Stock Exchange (NYSE). Dashed vertical lines denote bankruptcy related Key Development (see corresponding numbers for details). The Z-score scale has been selected to match the credit score level at the beginning of the period.

Source: S&P Global Market Intelligence (as of May 30th, 2018). For illustrative purposes only.

General Motors (GM) – Key Developments:
(1) Nov 8, 2008: GM heads towards bankruptcy
(2) Dec 31, 2008: GM expects to receive $13.40 billion in funding from U.S. Department of The Treasury.
(3) Feb 14, 2009: GM contemplates bankruptcy
(4) Jun 1, 2009: GM filed for bankruptcy
(5) Nov 17, 2010: GM has completed an IPO and starts trading on NYSE

PDFN incorporates both financial and business risk dimensions to generate an overall PD value as well as an assessment of each individual dimension (financial and business risk). It also comes equipped with a useful analytic tool, the contribution analysis, which allows users to identify drivers of risk, in absolute or relative terms, to define potential paths to creditworthiness improvement or deterioration.

Figure 2 presents the current credit risk profile of General Motors as provided by the PDFN based on last twelve months of data. The contribution analysis indicates that overall business risk is strong, but the company’s financial position is aggressive and is currently the main driver of overall PD estimate. A deep dive analysis shows a weak total equity position which in addition to profitability (EBIT/Total Assets) and efficiency (EBIT/Revenues), resulting in limited financial flexibility (Retained Earnings/Total Assets), represent the risk factors with the largest driver for the assigned credit risk score for General Motors.

Figure 2: Credit risk profile of General Motors (GM)

Source: S&P Global Market Intelligence (as of May 30th, 2018). For illustrative purposes only.

This case study exemplifies the value of PD Model Fundamentals, in providing predictive insights into companies’ creditworthiness and dynamic estimates of PD value and mapped credit score. Our model was trained and calibrated on default flags and is able to signal deterioration of credit quality well in advance of the actual bankruptcy event. The combination of both financial risk and business risk enables a comprehensive overview of a company's creditworthiness, while also providing an in-depth review of a company's credit risk profile to identify and distinguish the main sources of risk. S&P Global Market Intelligence leverages leading experience in developing PD models to achieve a high level of accuracy and a robust out-of-sample model performance. The integration of PDFN into the S&P Capital IQ platform allows users to access a global pre-scored database with more than 45,000 public companies and almost 700,000 private companies, obtain PD values for single or multiple companies, and perform a scenario analysis.

1 S&P Global Ratings does not participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD credit model scores from the uppercase credit ratings issued by S&P Global Ratings.

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