The debt to default ratio has decreased year-on-year according to a report from Global Credit Data, a not for profit data collection initiative.
Since 2016, the ratio of defaults to corporate debt has dropped from 1.12% to 0.73%. The data was collected using portfolios from 26 leading financial institutions over a period of 15 years.
This good news has sparked some concern that low interest rates are creating the possibility of a corporate debt bubble. The decrease may be because of an increase in newly issued corporate debt, which can drive down the debt to default ratio.
Executive Director of Global Credit Data (GCD), Richard Crecel said: “While the numbers look good, there remains a risk of a credit bubble developing, as these historically low default rates could be explained by easier access to funding and higher debt levels, permitted by historically low rates and the necessity for banks to find yield.”
A corporate debt bubble
This new debt is more worrisome because it is being issued to lower-rated companies, Crecel added: “This is the calm before the storm – the quality of global debt seems to have slipped toward highly leveraged non-investment-grade companies and weaker covered instruments. The next default spike, whenever it occurs, could be significant.”
While there is some cause for concern, GCD Membership and Methodology Executive, Daniela Thakker says banks typically err on the side of caution when estimating the probability of default (PD).
She stated: “Our data show that banks’ internal PD estimates used for regulatory purposes are typically conservative when compared to realised defaults. The average PD estimates over the last 15 years stand at 1.63% compared to an average default rate of 0.90% over the same period.
“To maintain this level of prudence and keep track of changing default risks, banks will need to continue benchmarking their PD-related calculations against industry peers. Traditionally, banks have compared their estimates to external benchmarks such as those produced by credit rating agencies (CRAs), but the GCD PD report provides a valuable and bespoke alternative.”
Crecel echoed this sentiment: “The observed default frequencies of the GCD dataset are based on a broader dataset, and are less volatile, than CRA default frequencies. We would encourage all financial institutions to supplement their benchmarking work with the GCD dataset. This will enable them to anonymously compare their PDs and observed default rates with their peers in the most accurate way.”
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