Key Takeaways
- There has been a marked increase in the proportion of selective defaults in recent years, up to more than 66% in 2022 from just 25% in 2008.
- Out of court, often lender-led restructurings do not necessarily result in permanent solutions--because more than one-third of issuers that initially selectively defaulted have subsequently re-defaulted.
- In addition, selective defaults are not necessarily sustainable, with issuers defaulting again, on average, only 1.7 years following the previous selective default.
- Europe has had the highest percentage of selective defaults since 2008, representing 66% of total defaults in the region.
The Rise Of Selective Defaults
Since 2008, S&P Global Ratings has detected a sharp increase in the percentage of selective defaults (the majority of these distressed exchanges). In 2008, just 26% of our total default population were classified as selective defaults, compared with more than 66% in 2022.
Historical data (see chart 1) shows that the number of selective defaults had been steady after the global financial crisis and first jumped in 2015-2016 during the oil and gas crisis. This is when U.S. energy issuers, primarily engaged in distressed exchanges to address their capital structure and avoid bankruptcy, selectively defaulted largely through Chapter 11 proceedings. The percent of selective defaults globally increased to 48.1% in 2016 from just 35.0% in 2014.
Since then, the percentage of selective defaults has gradually increased and peaked at more than 66% in 2022, before dropping year to date in 2023, to just under 50%. This trend has also permeated through most sectors and regions. In 2018, only 23% of consumer service defaults were selective defaults, but that number has since jumped to 67% in 2022. The percent of selective defaults in North America was just 21% in 2008 compared with 65% of defaults in 2022. The same trend has held true in Europe where the comparable percent rose to 65% in 2022, from 44% in 2008.
Chart 1
Chart 2
Default Ratings Explained
An obligor rated 'SD' (selective default) or 'D' (default) is in default on one or more of its financial obligations. S&P Global Ratings will lower the issuer credit rating to 'SD' (selective default) if the issuer conducts a distressed exchange that we consider tantamount to a default, on some obligations, but remains current on others primarily, but not exclusively by way of an out of court restructuring. An 'SD' rating is assigned if the issuer has selectively defaulted on a specific issue or class of obligations but will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. For the purposes of this report, we have focused on the rise in 'SD's in recent years compared to 'D's, which include more general forms of default such as missed interest payment or bankruptcy. In doing so we acknowledge that there are cases, not explicitly covered in this report, where distressed exchange can result in a default, or selective defaults do not always originate from a distressed exchange.
So, Why The Growth?
Companies facing financial distress sometimes elect to improve their liability structure or liquidity by offering creditors less than what was originally promised. Asset value preservation as a going concern, in addition to both time and money saved, are big incentives for lenders and issuers to opt to restructure out of bankruptcy court. Much of the increase in selective default is to some extent linked to the increased growth of sponsor-owned companies in the last decade. During this period, the dynamics of power shifted to the sponsors as some were able to extract better deal terms and build in flexibilities into their credit agreements. The flexibility and weaker covenants provided room for sponsors to effect transactions to tap or preserve liquidity when their portfolio companies underwent stress. These out of court restructurings helped companies avoid a bankruptcy and keep asset value and maintain company ownership control for PE firms.
Of course, there were issues with reputational risk and minimum return thresholds to contend with. In Europe, historical dominance of banks as key holders of debt tranches has been replaced by institutional funds and collateralized loan obligations (CLO), whose expertise and experience in initiating and participating in restructuring negotiations with both issuers and sponsors has evolved.
A Setup For Repeat Offenders
A selective default differs from a general default because an issuer may have only defaulted on one or a portion of its debt obligations, whereas a 'D' rating would mean the issuer has defaulted on its entire capital structure. While the out of court restructurings (in the form of distressed exchanges) may offer a temporary reprieve for the companies, they may not always address the secular or operational issues for the entities. This may partially explain what we see when we explore rating performance post general and selective default, specifically the cadence of defaults.
The data highlights that if an issuer defaulted through a general default (largely missed payment or bankruptcy), there is a 4.8% likelihood the same issuer will default again within a 48-month period. However, if an issuer defaulted because of a selective default, there is a 34.9% likelihood the issuer will default again during that same period.
This indicates to us that in the majority of the scenarios the selective default allows issuers to regain their footing starving off a more comprehensive (and costly) bankruptcy restructuring, but for others appears to be the first step on a slippery slope and may only postpone the inevitable bankruptcy. This is more likely when selective default occurs because of the push back of scheduled amortization or deferral of interest, rather than restructurings involving distressed debt exchange and a debt cancelation.
In addition, the more selective defaults an issuer has, the greater the chance of further defaults, either by way of a selective default or a general default, with the data highlighting that after an issuer's third selective default, there is a 43.7% chance the issuer will default again.
The data set illustrates that further defaults can be expected if a selective default is the root cause. While a multitude of systemic and idiosyncratic factors clearly influence defaults, we think the nature of the default should probably be increasingly incorporated into credit risk premia for issuers rated 'CCC+' and below once issuers emerge from a selective default.
Table 1
The Sustainability Of A Selective Default
A multitude of factors influence the timing of defaults, but we have also analyzed the time to subsequent default for these different cohorts to ascertain whether there was any time difference before a subsequent default. We compared the average time an issuer defaults following a selective default, to the average time of default for an issuer following a general default.
We found that the average time to default varied by rating, with lower-rated entities defaulting sooner, as expected. More interestingly is that the average time to default after one or more general defaults was 2.3 years compared with the average time to default after one or more selective defaults of only 1.7 years. This means that (notwithstanding that multiple factors influence defaults) not only does a selective default increase the likelihood of an additional selective default, it also shortens the length of time to another default compared with those issuers who generally defaulted.
Table 2
| Time to default following ‘SD’ rating in years | ||||||
|---|---|---|---|---|---|---|
| Count | Average | |||||
| B | 50 | 2.8 | ||||
| CCC/C | 227 | 1.4 | ||||
| Total | 277 | 1.7 | ||||
| Average time to default is calculated by taking the average years from when the issuer was re rated to its next default. Therefore, it excludes the time the issuer was rated ‘D’ or ‘SD’. when an issuer is re rated in calculated in years. S&P Global Credit Research and Insights. | ||||||
Table 3
| Time to default following ‘D’ rating in years | ||||||
|---|---|---|---|---|---|---|
| Count | Average | |||||
| B | 29 | 3.1 | ||||
| CCC/C | 31 | 1.5 | ||||
| Total | 60 | 2.3 | ||||
| Average time to default is calculated by taking the average years from when the issuer was re rated to its next default. Therefore, it excludes the time the issuer was rated ‘D’ or ‘SD’. when an issuer is re rated in calculated in years. S&P Global Credit Research and Insights. | ||||||
Average time to default is calculated by taking the average years from when the issuer was re rated to its next default. Therefore, it excludes the time the issuer was rated 'D' or 'SD'. when an issuer is re rated in calculated in years. S&P Global Credit Research and Insights.
Sectors And Regions To Watch
Although the energy sector has had the greatest number of selective defaults since 2008, the sectors with the greatest share of selective defaults includes the transportation and telecom sectors. Historically, 55% of each of these sectors' total defaults were selective defaults.
Meanwhile, the insurance sector had the lowest share of selective defaults with just over 10% of total defaults.
Chart 3
By region, Europe had the highest percentage of selective defaults. Nearly two-thirds of all defaults in Europe since 2008 have been selective defaults, arguably a reflection of the size of the overall market and premium placed on maintaining functional relationships between stakeholders (lenders and sponsors, primarily). Additionally, the data shows that Europe also holds a higher percentage of repeat defaulters, with 15.3% of total defaults being issuers with more than one default compared with only 12.8% in North America.
By country, the U.K., Luxembourg, Netherlands, Spain, and France are driving defaults in the region by count. The U.K. is the only country with less than 50% selective defaults in its total default population, although the percent of selective defaults has grown over time, especially the last five years.
Chart 4
While a number of macroeconomic, secular or cyclical credit and company specific factors clearly drive defaults, the reason for the selective default is an appropriate framework to consider for future risk for issuers that have experienced a selective default. Given the steady growth in the sponsor-owned space, we can expect the rising trend of selective defaults to continue.
Related Research
- Default, Transition, and Recovery: U.S. Media And Entertainment Defaults Take Center Stage, June 12, 2023
- Out-Of-Court Restructurings May Lead To Repeat Defaults Among Distressed U.S. And Canadian Corporates, May 11, 2021
This report does not constitute a rating action.
| Credit Research & Insights: | Nicole Serino, New York + 1 (212) 438 1396; nicole.serino@spglobal.com |
| Patrick Drury Byrne, Dublin (00353) 1 568 0605; patrick.drurybyrne@spglobal.com | |
| Secondary Contacts: | Marta Stojanova, London + 44 20 7176 0476; marta.stojanova@spglobal.com |
| Ramki Muthukrishnan, New York + 1 (212) 438 1384; ramki.muthukrishnan@spglobal.com | |
| Research Contributors: | Lyndon Fernandes, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
| Vaishali Singh, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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