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August 10, 2023

Yellow Corporation: 10 Months of Red Flags

by Adam Baron.

In past few days, you may have seen a flurry of news articles about the high-profile bankruptcy of Yellow Corporation (YELL.O). While this media attention is very recent, our StarMine credit risk models have been detecting significant trouble for more than 10 months. The StarMine Combined Credit Risk quantitative model significantly downgraded Yellow to an implied rating of CCC in early November 2022, well ahead of the humans at ratings agencies.

Exhibit 1: StarMine Combined Credit Risk Model

Source: StarMine

The StarMine Combined Credit Risk model is an optimal combination of our three credit risk models (Structural, SmartRatios, Text Mining), which each monitor different phenomena to detect an impending credit default. While a strongly bearish view from one individual credit risk model might be enough to influence the overall combined score, further downgrades from the other models can help strengthen that conviction.

The StarMine Structural Credit Risk model is a proprietary extension of the Merton default model, essentially treating the company’s equity as a call option on its assets. For Yellow, this was the first model to hit CCC territory, in mid-October 2022. It is typically our most responsive credit model. The Leverage component had already been ranked the lowest possible for quite some time, but it was the precipitous fall of the Asset Drift component that led to the downgrade. The Asset Drift represents the non-random change in asset value forecasts over time; that calculation is powered by our proprietary StarMine Value Momentum model.

Exhibit 2: StarMine Structural Credit Risk Model

Source: StarMine

You’ll notice that the Region Rank, on a 1-100 scale, has been quite low all along. A common use case for these credit risk models is filtering out high risk securities from your portfolio to avoid unpleasant surprises. We’ve optimized all our credit risk models to capture the majority of credit defaults or bankruptcies in the bottom quintile. Hence, we often recommend excluding securities ranked 1-20.

Following that advice, Yellow would have already been avoided at this time. The Model Implied Rating, derived from each model’s Probability of Default, does help further differentiate these problematic companies in the Bottom 20% to help us understand when even bigger trouble is brewing. The Implied Rating is a letter score that a rating agency would be expected to assign to a company with a similar Probability of Default.

The StarMine SmartRatios Credit Risk model utilizes common financial ratios, but with the special sauce of also including forward-looking StarMine SmartEstimates®. StarMine SmartEstimates improve upon the consensus estimates in that more weight is given to sell-side analysts with a better track record of accurately predicting financials with the timeliest estimates. This credit model was the next to downgrade Yellow to CCC, in January 2023. Leverage shows up as being quite bad for some time and its final deterioration led to the downgrade, though the low ranks for Interest Coverage, Liquidity and Profitability also contributed to the low credit rating.

Exhibit 3: StarMine SmartRatios Credit Risk Model

Source: StarMine

The StarMine Text Mining Credit Risk model runs natural language processing and machine learning on the text of News, Transcripts, Financial Filings and Broker Research to detect phrases that are correlated with a future default or bankruptcy.  This adds nice diversification to the other models, which focus on market activity and financial ratios.  This model was the last to downgrade to CCC, but was still ahead of the actual bankruptcy event on August 7. Ultimately, it was the News Component which caused the downgrade. However, earlier warning signs existed in the Transcripts and Broker Research components, as seen by their very low ranks. Specifically, it was the discussion around the category of Income that seemed most troubling in the text.

Exhibit 4: StarMine Text Mining Credit Risk Model

Source: StarMine

It’s always sad to see a once-successful company declare bankruptcy, especially one that has been part of the American business landscape for over 100 years. Yet defaults and bankruptcies can happen among your portfolio holdings, so it’s wise to try to protect yourself. The diverse suite of StarMine credit risk models is based on several different hypotheses, analyzing various phenomena utilizing multiple content sets. The StarMine Combined Credit Risk model is a great place to start  monitoring signs of financial distress, though drilling down into each credit model and their components can help paint a more comprehensive picture of what’s going on within a company in the credit risk landscape.

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