Bond Default Rates

Dec 14, 2014 by Adam C. Powell, Ph.D.

Bonds are rated by Moody’s, S&P, and Fitch, based on their perceived risk of default. Each of the raters uses a slightly different set of ratings. The ratings (borrow from Wikipedia) are:

Moody’s		S&P		Fitch		Description
Long-term	Short-term	Long-term	Short-term	Long-term	Short-term
Aaa	P-1	AAA	A-1+	AAA	F1+	Prime
Aa1		AA+		AA+		High grade
Aa2		AA		AA
Aa3		AA−		AA−
A1		A+	A-1	A+	F1	Upper medium grade
A2		A		A
A3	P-2	A−	A-2	A−	F2
Baa1		BBB+		BBB+		Lower medium grade
Baa2	P-3	BBB	A-3	BBB	F3
Baa3		BBB−		BBB−
Ba1	Not prime	BB+	B	BB+	B	Non-investment grade speculative
Ba2		BB		BB
Ba3		BB−		BB−
B1		B+		B+		Highly speculative
B2		B		B
B3		B−		B−
Caa1		CCC+	C	CCC	C	Substantial risks
Caa2		CCC				Extremely speculative
Caa3		CCC−				Default imminent with little prospect for recovery
Ca		CC
		C
C		D	/	DDD	/	In default

Bonds rated B1/B+/B+ or lower are often called “junk” bonds, while those with a higher ratings are “investment grade” bonds. That being said, default rates are actually a lot lower than one might expect. From 2010 – 2012, there was only a single investment-grade default. While 14 investment-grade defaults occurred in 2008 and 11 in 2009, only 5 investment-grade defaults occurred between 2003 and 2007. When defaults do occur, they are often preceded by credit rating downgrades.

From 1981 to 2012, the default rates of bonds were as follows:

The average default rate for B+ bonds (high-end junk bonds) was only 2.36% per year. Things get truly dicey with the CCC/C bonds, which had an average default rate of 23.53%. To put things in perspective, if one held a B+ bond for five years and it had the average likelihood of defaulting each year, there is an 88.7% one would not experience a default over the five year span. Yes, this represents a degree of risk. However, given that some of the investment may be recovered in the event of a default, it may be even smaller than it seems.