Default

The failure of an issuer to meet a contracted obligation - a missed coupon, a missed principal repayment, or the breach of a term that permits creditors to demand repayment.

Example

Most corporate defaults occur at a refinancing date rather than after a single poor result, because that is the moment the borrower must persuade somebody to lend again.

Important

Default is an event, not an outcome. What a creditor finally receives depends on seniority, security and what the assets realise, which is why the recovery assumption matters as much as the default probability.

Related terms

• Recovery rate — The proportion of a claim a creditor actually receives after a default, once the borrower's assets have been realised and distributed in rank order.
• Credit risk — The risk that an issuer fails to make a contracted payment. It is the risk most associated with bonds and, for high-quality issuers, rarely the one that moves the price.
• Seniority — Where a particular claim sits in the queue for payment if the borrower fails. Secured claims are paid from their collateral first, then senior unsecured claims, then subordinated ones, with shareholders last.
• Covenant — A promise written into a bond contract that limits what the issuer may do while the debt is outstanding - additional borrowing, dividends, asset sales, or a minimum level of interest cover.

Lessons that explain it

• Four risks, an invisible dealing cost, and why interest is often the worst-taxed return — Credit, rates, inflation and liquidity are four separate risks that a single word - safe - is routinely used to dismiss. The tax treatment of interest is the one most holders never price at all. (12 min)
• Interest minus expected losses minus fees — A lending return is the interest collected, less the share of principal lost to defaults after recoveries, less fees. Expected loss is the number the headline rate leaves out. (12 min)
• Defaults cluster, exits close, and interest is often taxed as income — The key risks are defaults rising together in a downturn, being unable to exit, and intermediary failure. Costs include layered fees, and interest is frequently taxed less favourably than gains. (12 min)

All 578 terms in the Investing glossary