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    A Tale of Two Memes: How Gamestop and AMC Impacted the Credit Market

    Hello everyone! This will be the first post in a blog series focusing on applications of quantitative credit data to broader market trends. Having recently joined Moody’s Analytics, this blog will be structured akin to the journey of a learner – along the way, I want to share insights as I discover them, and how to best utilize a world of rich consumer, economic, and corporate credit data to paint a fuller picture of what’s going on. As someone fascinated by the mechanics of the options markets, meme stocks, and stock market bubbles, it seemed fitting to begin this journey there.

    Retail trading is a front-and-center issue in many market participants’ minds, having grown dramatically in recent years due to the emergence of low-or-zero transaction fee retail brokerages like Robinhood. While initially the phenomenon was confined to small, highly concentrated niches, it is indisputable that retail traders have become a substantial force. This influence can be felt market-wide, as potentially one of the drivers of the equity options markets boom post-COVID. However, nowhere can it be felt more strongly than in the new 2021 asset class, “meme stocks”.

    Many still view the trend (and its major epicenters, Gamestop Corporation and AMC Entertainment Holdings Inc.) as temporary price dislocations in the equity markets, driven partly by dedicated online communities like WallStreetBets and by the hedging of equity options market makers. Conversely, both meme favorites have demonstrated a stubborn resilience, with equity prices for both remaining markedly elevated since the first signs of the squeeze. This begs the question – what, if anything, materially changed for both companies?

    A classic short squeeze (as many viewed the initial January 2021 squeeze) does not tend to drag on for months after an initial rapid price increase. Comparing recent price action to the 2008 Porsche-Volkswagen short squeeze or the more recent March 2020 squeeze of Blue Apron, usual short squeeze, we see a stark difference in duration. While in all cases we observe substantial declines in short interest post-squeeze, the Blue Apron and Volkswagen culminating events were brief (lasting days) rather than a protracted battle lasting multiple months. It is hard to explain the current situation as a simple short squeeze.

    Looking at the credit data, we can see a different perspective. For both AMC and Gamestop, the presence of a price-insensitive, loyal shareholder base fundamentally changed the solvency and credit outlook of both firms by allowing them to draw capital from increased equity pricing and sustained interest. This capital injection led to creation of fundamental value, improving debt structure, creditworthiness, and reducing default risk dramatically. While many discount these squeezes as one-off events, I argue that the advent of retail trading and social media-driven investing creates a novel factor in understanding future credit risk, especially in the context of heavily shorted and indebted companies (which tend to be retail favorites). This can be used by both short sellers and yield-seeking investors to better model risk and find asymmetric return opportunities.

    Equity and Defaults

    It is well-known that the market capitalization of a firm must reflect implicitly the likelihood that a firm will default in the future. During a default, shareholder equity becomes worthless (although in some cases after reorganization shareholders can negotiate some positive value in the recapitalization). In 1974, Robert Merton provided the key realization that due to limited liability, if a firm is underwater on debt, shareholders can choose to simply liquidate the firm rather than pay back debt. From that perspective, the equity value of a firm can be viewed as a call option on the firm’s assets, with the option for the shareholders to liquidate if debt exceeds asset value (the option expires out-of-the-money) or not liquidate (the option expires in-the-money and is exercised).

    This core thesis underpins how to quantitatively model defaults, best summarized as an Expected Default Frequency (EDF). Prior research using the EDF9 Model (derived from the Merton model) has supported the tacit link between equity valuation and default frequency, with significant excess returns noted for firms with lower probabilities of default than riskier firms.

    From this, we can observe that equity markets, despite potentially uninformed or faddish trading, over the medium-term should reflect credit market information. All things otherwise held similar, the greater liquidity and smaller notional size involved in equity markets implies greater investor accessibility, and investors can often express their credit outlooks more rapidly and easily via equity versus credit. An extreme example of this should occur for companies near to a credit event – as a company approaches default or bankruptcy, it should see precipitous declines in stock price, with the converse (e.g. a rescue package or cancellation of debt) also holding true.

    Interestingly, the relationship between EDF and equity returns tends to be smile-shaped: poor equity performers have higher credit risk, but firms with highly positive equity performance also exhibit heightened default risk, likely correlating with increased use of debt leverage.

    However, this relationship is not unidirectional, as we can see strongly for both AMC and Gamestop. For both meme stocks, the rapid increase in equity price and interest allowed them to raise substantial capital via offerings, materially impacting their ability to service debt and avoid insolvency. Although pre-squeeze most investors discounted both firms as eventual casualties of the macro changes driven by the COVID-19 pandemic, using EDF data, we can see both companies underwent dramatic shifts in credit risk.


    Per our EDF model, the 1-year forward chance of default for Gamestop Corporation peaked around May 2020 at nearly 20% (nearly 1200% higher than in 2018). While since then the default point (the time-weighted value of Gamestop’s outstanding debts) remained largely constant, as asset value increased during the squeeze its market leverage (asset value versus default point) markedly decreased while asset volatility (the volatility of the dollar value of Gamestop’s assets) increased.

    Investors, customers, and employees all buy in to your reputation—risking that over a supplier with poor ESG credentials could cost you all three.

    Reputation is hard to win, and even harder to measure. But we all know when we’ve lost it—and social media is quick to spread the news of any scandal. Today, one key measure of reputation is ESG: your record on environmental and social impact, and on governance. And, in a hyper-connected world, it’s not only your own ESG credentials you need to worry about, but those of everyone you deal with.

    EverEdge, an intangible-asset valuation organization, estimates that assets such as reputation account for more than 87% of a business’s value, and a World Economic Forum study reported that reputation alone accounts for 25% of a company’s market value.

    Reputational damage can arise from many areas, and ESG risk in the supply chain is one major potential source, with little visibility. Effectively assessing and managing operational risk using ESG metrics helps organizations to become resilient and sustainable, enhancing their reputation and helping them to retain investors, customers, employees—and suppliers.

    Monitoring ESG risk in your supply chain makes your organization more attractive. Younger generations are increasingly concerned about corporations’ ethics; according to healthcare provider Bupa, 64% of respondents aged 18–22 say it’s important that employers act on environmental issues. Stakeholders view companies that have strong ESG commitments more favorably, and sustainable investing is rising rapidly in popularity. Assessing your risk exposure also helps you to avoid potentially costly regulatory infringements.

    There are challenges in accurately determining your organization’s ESG-related vulnerabilities, but also benefits to adopting a proactive stance. Read on to learn about:
    • Why avoiding regulatory infringements is so important.
    • The benefits of creating a positive environmental and societal impact.
    • How your ESG risk management program can help you retain investors, customers, and employees.
    • How monitoring ESG can reduce costs for your organization.

    Organized crime is large scale and sophisticated; comprehensive due diligence is essential.

    According to the UN, the amount of money laundered worldwide is equivalent to 2–5% of global GDP per year (around $800 billion–$2 trillion). The scale of organized crime is huge, and criminals have quickly adapted to and are thriving in the conditions created by COVID-19, including supply chain upheaval.

    Criminals often use legitimate businesses to hide the proceeds of fincrime. In its 'EU Serious and Organised Crime Threat Assessment' for 2021, Europol reported that 80% of criminal networks active in the EU use legal business structures for their illegal operations. A comprehensive compliance program is essential to rooting out such activities in your supply chain.

    “Criminal networks are sophisticated,” says Bill Hauserman, Head of Financial Crime Due Diligence at Moody’s Analytics. “It’s critical that companies take the due diligence process seriously, so that they’re not funding terrorism or human trafficking.”

    Being unaware of fincrime within your operations can result in hefty penalties. At the end of 2021, a leading bank was fined £64 million by the UK’s Financial Conduct Authority for failures in its automated anti-money laundering system between 2010 and 2018.

    “Using technology to monitor for ESG-related risk in the supply chain can bring fairness and transparency to the decision-making process,” says Alex Zuck, Managing Director, Product Strategy for KYC at Moody’s Analytics.
    How is your supply chain affecting society?
    According to the latest International Labor Organization data, an estimated 40.3 million people worldwide were in modern slavery in 2016. Even if you believe there are no slaves in the country where your business is headquartered, there could be connections with slavery in your global supply chain. According to the Global Slavery Index produced by human rights group Walk Free, laptops and garments are among the five products most at risk of modern slavery that are imported into the G20. “Human trafficking, human rights and all the other issues that come under ‘social’, such as pay equality, these affect your reputation—and that’s what people remember,” says Hauserman.

    Of course, unethical working practices can still take place in richer nations. In 2020, headlines abounded about a UK-based fast-fashion retailer regarding employment practices in some of its factories in the north of the country. The news had significant reputational and financial consequences for the company, with £1 billion wiped off its value in the immediate aftermath of the reports. In November 2021, its share price had fallen 44.3% since January of the same year.

    “Companies can take action against modern slavery, but first they need to find out where in their supply chains slavery risk is highest,” explains Dr Alexander Trautrims, Associate Professor in Supply Chain and Operations Management at the University of Nottingham Rights Lab. Different solutions are appropriate in different situations, he says. “You might want to change the way you place orders, or instead of spot buying decide to develop longer-term relationships. You have to go in, see where risks are and engage with the situation.”

    Read more about fincrime in the supply chain.

    Do you know your suppliers’ exposure to environmental and climate change risk?

    It’s important to monitor two main strands of supply chain environmental risk. The first relates to whether your suppliers are truly committed to sustainability and if they are acting to minimize and ultimately eradicate environmentally unfriendly practices. The second concerns how vulnerable your suppliers are to environmental disaster or climate change.
    A sustainable business model?
    Whether or not a supplier is committed to environmental targets can directly affect your organization and its reputation. Scope 3 emissions include indirect emissions from a company’s supply chain—so relying on suppliers with inadequate sustainability plans could increase your carbon footprint.

    “We’re able to help companies with their responsible-sourcing strategy and sustainable frameworks,” explains Carolina Azar, Senior Director, Product Strategy at Moody’s Analytics. “We can provide an integrated view of all the different kinds of risk organizations face, from financial and credit to climate and environmental. When you’re going into business with an entity, we can give you a clear view of their ESG situation.” This knowledge, she says, means organizations are better equipped to make decisions.

    For instance, can you guarantee that your suppliers are sourcing materials sustainably? Requiring environmental certifications can ensure certain standards are reached—signaling your commitment to sustainability and helping to create a stronger future for your company. By finding alternatives to carbon-intensive materials, you are not contributing to the depletion of scarce resources, and your organization will grow in resilience.
    Is your supply chain diversified enough?
    Assessing your suppliers’ vulnerabilities to natural disaster and climate change is a vital part of mitigating your supply chain ESG risk. “How is that supplier going to react to a negative situation impairment?” asks Bill Hauserman, Head of Financial Crime Due Diligence at Moody’s Analytics. “It could be weather, it could be a tsunami like the one that just hit Tonga.” In 2018, following a drought, parts of the Rhine were at extremely low levels, meaning larger ships could no longer navigate the river. German chemical producer BASF had to halt production because it could not receive the necessary raw materials, and this negatively affected its 2018 earnings.

    “The experience of COVID-19 brought into sharp relief the importance of being able to quickly pivot to alternative suppliers,” adds Azar. Diversification strengthens your supply chain and can reveal synergies and innovations.

    Read more about making a positive environmental and societal impact.

    Taking a proactive stance will bring stakeholders and the wider public on board.

    Stakeholders and the public are increasingly interested in ESG measures and an organization’s commitment to them, and want to see tangible goals and progress. Regulators are also paying attention: recent developments include Germany passing its Supply Chain Due Diligence Act, and the IFRS Foundation launching its International Sustainability Standards Board.

    But a one-size-fits-all solution isn’t the answer—or likely even possible. “The approach has to be sophisticated—one that fits company, context and industry,” says Ioannis Ioannou, Associate Professor of Strategy and Entrepreneurship at London Business School. And as more organizations innovate to create the programs that best suit them, stakeholders look set to gain through rising standards.
    A commitment to deliver
    ESG risk management is by its nature primarily a long-term exercise, so measuring against transparent goals shows that your organization is prepared to be held accountable by stakeholders.

    “The main risk that our members face is the difficulty of gathering the right data,” says Julia Jasinska, Senior Policy Adviser, Sustainable Finance at UK business organization CBI. “If you work with SMEs and mid-tiers, it might be hard to get the right data to help you assess ESG risk to the extent that you would like to.”

    It is therefore important to work with a provider that can generate accurate proxy scores for companies for which you may have little data, allowing you to assess as much of your supply chain as possible.
    Becoming impactful
    A comprehensive ESG risk management program can also articulate to your stakeholders and investors how you’re able to leverage your supply chain to improve sustainable outcomes. “If you offer financial support, you might link it to ESG improvements, and then you can offer support on the ESG front as well,” says Jasinska. “You then become more attractive than your competitors—there’s a huge altruistic case, but also the business case to engage.”
    Who are you doing business with?
    Finally, monitoring the reputational risks around the organizations and individuals in your supply chain demonstrates to investors that you have comprehensive oversight—and prevents operational disruption.

    The presence of politically exposed persons, bad actors, or sanctioned individuals can turn reputational damage into financial damage in the form of sanctions and fines. “If you overlook something in your due diligence and it then turns out that a person who is in your supply chain is a slum lord, or a drug lord, or a human trafficker, that’s what gets onto the front page,” says Bill Hauserman, Head of Financial Crime Due Diligence at Moody’s Analytics. “Reputation is in the eye of the beholder, which means that the quantity of data that needs to be distilled into insights is much bigger than it was before. And that kind of information tends to be unstructured, such as media.”

    Learn more about sustainable supply chain management.