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28 April 2024

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S&P default rates and the risks in bond investing

While yields have increased in Australia, including on investment-grade bonds which are rated in the BBB space, it’s also good for investors to know their money is relatively safe.

Standard & Poor's (S&P Global Ratings) releases a report every year looking at default rates for each categoty of credit ratings over time. The 2022 report will be released in 2023 but the most recent report provides some good illustrations and commentary.

Global and Australian defaults statistics

In 2021, 72 global corporate issuers defaulted but most of these were in the non-investment grade CCC/C/B categories. The only default in 2021 from an Australian corporate was from Australian drilling services provider, Boart Longyear, and this was well flagged.

The majority of defaults were in the US, reflecting the breadth of the bond market over there.

Source: S&P 2022

The statistics show that global default rates in investment-grade have been extremely low over time.

Historically, the Australian default statistics are lower than the Global default statistics, in part due to it being a largely investment-grade market locally but also a concentration towards the major banks, which are all rated AA-.

Over the 30-year study period, investors should take confidence in investment-grade bonds. The table shows the probability of default for AAA rated to CCC/C rated, including average default rates of investment grade, speculative grade and all rated.

Source: S&P 2022

For example, a BBB-rated bond has a probability of default over five years of 1.48%. This increases to 6.19% and 16.67% for a BB and B rated bond. Digging deeper, a US BBB-rated bond has a probability of default of 1.83% implying that an Australian BBB-rated bond would have a probability of default over five years of significantly less than 1.48%.

Again, this shows the safety net of the Australian corporate bond market.

 

Matthew Macreadie is a Credit Strategist at Income Asset Management, a sponsor of Firstlinks. To discuss this topic further and access corporate bonds please reach out IAM. This article is general information and does not consider the circumstances of any investor. Please consider financial advice for your personal circumstances, including eligibility for these investments.

For more articles and papers from Income Asset Management, please click here.

 

3 Comments
Martin
September 18, 2022

Doesn't seem to deal with non-rated bonds where the problems in Australia seem to be. Covid tripped a few up/

Warren Bird
September 14, 2022

Thanks for the update Matthew.

Of course, what you haven't said - though it's something that I know you know! - is that default risk still needs to be managed appropriately. The high degree of safety in the Australian investment grade space won’t be much use to an investor who happens to have 10% of their portfolio in the bond that does default.

Yes, it’s a low probability of default, but it’s not zero. I’m going to sound like a broken record, I know, but the way to manage the risk that does exist is to diversify – to hold lots of small exposures to credit risk in different industries, not to hold just a few exposures. The beauty of this is that you don’t have to give up return in order to reduce risk. 100 bonds paying 1.5% above your benchmark will deliver the same gross return as 10 bonds paying 1.5% above your benchmark. But you have a much greater chance of actually earning that 1.5% in a diversified portfolio than a concentrated one.

I wrote about what credit risk is and how to manage it in these two articles 9 years ago. They’re not time-sensitive, so still apply today: https://www.firstlinks.com.au/give-risk-credit-deserves and https://www.firstlinks.com.au/managing-credit-risk-requires-healthy-dose-cynicism

Lisa
September 14, 2022

Thank you, I have a significant investment allocation in global and Australian BBB bonds, so am heartened and encouraged to read this report.

 

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