09 Credit Sights Default Risk

Corporate default risk

Risk that a company fails to make required debt payments (coupon, principal) or files for bankruptcy/Chapter 11.

Forms of default

Includes missed payments, bankruptcy, coercive exchanges (distressed debt exchanges or liability management exercises) where lenders have no real choice but to accept debt restructuring.

Distressed debt exchanges

Technical defaults where company continues operations but restructures debt under pressure.

Historical default rates and stress events

• Telecom bubble burst, Enron failure, 9/11 attacks (2001-2002) pushed default rates over 14%.

• Global Financial Crisis (2008-09) saw defaults near 14%, with spreads up to 2000 basis points.

• Other peaks linked to 2015 oil crash, COVID-19 pandemic, Russia-Ukraine war, and Fed rate hikes.

Default prediction signals

• Financial health deterioration (declining cash flows, rising leverage, falling interest coverage).

• Sharp stock price drops and increased volatility.

• Decline in bond prices and widening spreads.

Qualitative factors considered

Market liquidity, leverage, borrowing costs, maturity schedules, primary market access.

What type of default involves a company exchanging debt for equity while continuing to operate?

• Bankruptcy

• Chapter 11 protection

• Coercive exchange

• Interest forbearance

Coercive exchange

Which of the following are signals that a company might be approaching default? (Select all that apply)

• Increase in stock price volatility

• Increasing bond prices 

• Widening bond spreads

• One quarter of below-consensus earnings

• Increase in stock price volatility

• Widening bond spreads

Which events contributed to high corporate default rates during the 2008-2009 global financial crisis?

• Lehman Brother's failure

• Covid-19 pandemic outbreak

• Hidden leverage in the financial system

• Oil price crash

• Lehman Brother's failure

• Hidden leverage in the financial system