Debt default

A debt default happens when a borrower fails to live up to the terms of its debt. The most direct form is a payment default, missing a scheduled interest payment or failing to repay principal when a loan or bond comes due.

A company can also be in default without missing a single payment. Breaching a covenant, such as letting its leverage rise above an agreed maximum, is often called a technical default. Either way, a default usually gives lenders the right to demand immediate repayment of the full amount, and many debt agreements contain cross default clauses, so a default on one loan can trigger defaults on the company's other borrowings as well.

Default is not the same thing as bankruptcy. A company in default often negotiates with its lenders first, agreeing to a waiver, a higher interest rate or new repayment terms, and only files for bankruptcy when no deal can be reached. For shareholders, though, even a default that gets resolved tends to be costly: lenders rank ahead of equity, so any restructuring usually protects creditors at the expense of the company's owners.

Default risk is what credit risk measures, and credit rating agencies exist to estimate it. For an investor, the useful signals come well before any default: rising debt, shrinking cash flow, a falling interest coverage ratio or a company operating close to its covenant limits all show the cushion protecting its lenders getting thinner.