Buybacks, Tenders and Exchanges – A Distortion of the Default Rate

Buybacks, Tenders and Exchanges – A Distortion of the Default Rate

In the world of corporate bonds, the yield spread over the sovereign benchmark reflects the liquidity premium and, more importantly, investors’ compensation for default risk. Accurate measurement of default risk is critical in determining the required risk premium on bonds. But the official default rate, which is measured and published by rating agencies, can be subject to distortions because certain capital losses, corporate buybacks, tenders and exchanges may not be accurately represented in the default rate calculations. In a macroeconomic environment likely to be characterized by greater performance differentiation among credit markets, sectors and issuers, paying closer attention to these potential distortions will prove invaluable to the credit selection process. ...