Credit Events: Default, Missed Payment and Restructuring

A credit event is an occurrence that a written document listed in advance. A party the document names may declare that it has happened, and a consequence the document already wrote then becomes available. A missed payment is the occurrence; a default is the status conferred on it. A restructuring event rewrites the promise. A liquidity event asks a different question: whether cash is in the right place.

Why was every part of this settled while things were going well?

One odd fact about this whole subject comes first. With it in hand, the rest follows easily. Everything that follows a credit event was decided by people who had no idea whether it would ever be needed. The definitions, the entitlements, the consequences, the sequence in which competing claims get met: all of it was fixed in writing at a time when every payment was arriving on its date and nobody involved had any reason to think about any of it.

Fixing all of it in advance is not clumsy drafting. Advance drafting is the only arrangement that can work. A rule agreed while everybody is calm is a rule; the same rule proposed once money is short is a negotiation, and a negotiation between parties who each want a different answer produces no answer at all. Wait until something has gone wrong and every party can see exactly which definition suits them. Fix it beforehand and nobody knows yet which side of the line they will be standing on, so the line gets drawn somewhere both sides can live with.

The same logic appears outside finance. A cricket club writes down what counts as a no ball before the season starts, not while eleven people are shouting on the pitch. A housing society settles how a repair bill is divided while the roof is still sound. After the roof leaks, the flat directly underneath and the flat on the ground floor want two very different formulas. At eight in the evening with two hundred guests waiting, neither a wedding caterer nor the household will be reasonable about a late delivery. So the two of them agree in advance what counts as one and what happens then.

So the work in this subject is textual rather than predictive. The work is not forecasting but reading: find the sentence, read the condition, establish who is entitled to act on it. Reading is a smaller job than most readers expect and a much more definite one, and the definiteness is why the answers in this subject come out so much crisper than the answers in most of finance. There is a document. The document already decided.

Where does a credit event actually live?

A credit event lives on a list. Not in a definition, not in a textbook, not in anybody's judgement about how serious a situation looks: on a list, inside a written document, drawn up before anything happened.

Palash Cements Limited, an invented borrower, issued a bond, and it issued that bond under a written document. Those written terms run five years and put the face amount at Rs 1,000.00/-. The terms strike a couponThe interest a bond's written terms promise on each dated occasion, set as a rate on the face amount and payable whether the borrower has had a good year or a poor one. of 9.10 per cent a year on that amount, once a year. Those terms are called the document throughout. Somewhere inside that document is a list of conditions with a label attached to the list, and the label says that each item on it is a credit event.

Anything on the list is one. Nothing off the list is one, however serious it looks from outside. The second of those two sentences is the one people find hard, so sit with it for a moment. An occurrence that would alarm anybody, that would make the newspapers if this issuer existed, that would empty a boardroom by nine in the morning, is still not a credit event under this document unless the document put it on the list. And an occurrence that sounds administrative and dull is a credit event if the list says so.

The everyday shape of it is worth carrying about. A courier contract names what counts as a late delivery, names who signs the note that records it, and names what the customer may do once that note exists. The meaning of late was settled months earlier in a room where nothing was at stake, so nobody stands at the door arguing about it. The delivery either meets the written test or it does not, and the argument that would otherwise take a fortnight takes about ninety seconds.

Two documents can list different things. Different lists are the part readers skip, and they decide whether any of this can be used. The two documents were drafted by different people with different worries. So the same occurrence, on the same day, in the same business, can answer a condition in one lending document and answer nothing at all in another. So a question that begins has a credit event happened cannot be answered by looking at the world. The question can only be answered by opening a document and asking: which one?

Every later question here, and in this whole sequence, is downstream of that one physical fact: somebody wrote a list, and the list came first. Missed, and every definition met afterwards reads as a description of a situation. Held, and every definition reads as a test that can be run.

What is a Credit Event, and what makes something count as one?

Now that the list exists, the definition can be stated without being mistaken for a description. A credit event is an occurrence that a document defined in advance as one. A party the document names may then declare that it has happened, and a consequence the document already wrote becomes available to somebody.

Three parts, and all three are needed. With any one of them removed, nothing operates.

The first part is a definition fixed in advance. Without it there is no test, only an argument. The second part is a party entitled to declare. Without an entitled party the test can be run by anybody and by nobody, and those come to the same thing: no document changes when a stranger forms an opinion. The third part is a consequence already written. Without it the declaration is a statement that nothing follows from, and a statement nothing follows from is not machinery.

Notice how much of the popular meaning that definition throws away. Nothing in it mentions how bad things are. Nothing in it mentions how much money is involved, whether staff have been let go, whether anybody has stopped answering the telephone, or whether the situation feels grave. Severity, size and silence are all real, they may all be true at once, and not one of them appears in the test.

Readers meeting the phrase for the first time almost always arrive holding only the first of the three parts, and often a loose version of it at that. A reader with the definition and nothing else can recognise the words in a document and cannot do a single useful thing with them. The definition alone gives the popular meaning of a credit event; all three parts give the working one.

Default vs Missed Payment: which of the two is a matter of fact?

Default and missed payment get used as though they were one word wearing different clothes. The two are not the same, and the gap between them is where nearly every question in this material lives.

A missed payment is an occurrence. A scheduled amount did not arrive on its date. A missed payment is a matter of fact in the plainest sense: there was a date, there was an amount, and either the money turned up or it did not. Anybody with the schedule and a bank record can check it. Nobody has to agree with anybody. The occurrence does not depend on how anyone feels about the borrower or on anybody's authority.

A default is a status. A document confers that status on an occurrence once the document's own conditions have been answered. A status is not a fact about the world in the way an occurrence is; it is a fact about a document, and it arrives by a route that runs through people and paperwork rather than through a bank record.

Run the household version. A tenant does not pay rent on the first of the month. The unpaid rent is an occurrence, and the landlord, the tenant and anybody looking at the bank record all agree on it without discussion. Whether the tenant is now in breach of the agreement is a completely separate question, and the answer sits in the agreement: what it says about the date, what it says about a period after the date, and what it says about who has to do what before anything follows. The unpaid rent is visible to everybody. The status is visible only to somebody reading the paper.

So the relationship between the two is one direction only. A missed payment is capable of becoming a default. A missed payment is not a default by itself, and no amount of missing makes it one. The occurrence is a matter of fact and the status is a matter of the document. Two informed people can therefore agree completely about what happened and still disagree about whether a default exists.

Getting this backwards is expensive in a very specific way. A reader who takes a missed payment simply to be a default will believe that consequences follow automatically from the occurrence, and will not go looking for the step in between. The step in between is the whole subject: who is entitled to declare.

What is a Restructuring Event, and why is nothing missed when one happens?

A restructuring event breaks the picture almost everybody arrives with, so it is worth slowing down for.

A restructuring event is the promise itself being rewritten. The amount, the dates, the rate or the ranking of what was promised gets changed by agreement between the parties, rather than broken by one of them. Nothing goes wrong on any particular morning. There is no unpaid date to point at.

Nothing is missed. That single line is the whole of the block. Every payment up to the change arrived on its date. Every payment after the change will arrive on the new dates. A picture of a credit event built out of the words unpaid and overdue has no room for a restructuring. The restructuring has none of those parts and is still an event that documents name in their own right.

Why would a document bother? Because of what a holder is left with. Somebody who lent against a five year promise carrying a 9.10 per cent annual coupon has, after the change, something else. Maybe the dates run further out. Maybe the rate is lower. Maybe the amount to be handed back at the end is smaller. Maybe the promise now sits behind somebody else's claim in the sequence rather than beside it. In every one of those cases the holder is holding a different thing from the thing they bought, and they got there without anybody breaking anything.

The everyday version is a rented shop. A shopkeeper and a landlord agree, without any dispute and with every month's rent paid on time, to move to a longer lease at a lower monthly figure. Nobody defaulted on anything. The landlord's rental income is now a different stream from the one they signed for, and if that landlord had borrowed against the old stream, their lender would want to know. Same parties, same building, same friendly conversation, and a genuinely different arrangement afterwards.

How a specific offer to swap one promise for another actually works, and how the two sides are priced against each other, is covered separately in this sequence. Only the shape matters: a promise can be rewritten by agreement, with every payment made on time, and that rewriting is itself the event.

What is a Liquidity Event, and why is it a different question?

A liquidity event asks whether cash is in the right place at the right moment. Cash in the right place at the right moment is the whole of it. The promise is untouched, the amount owed is exactly what it was, the dates are the dates and the rate is the rate. Timing and access are in question: money that exists but is somewhere else, or money that arrives next quarter when the payment is due next week.

Here is why it deserves its own name rather than being filed as a milder kind of credit trouble. The two questions are independent. Not loosely independent, not usually independent: independent, in the sense that all four combinations of the two answers are possible and none of them is strange.

Households run the same distinction without naming it. A household with a fixed deposit maturing next month and a school fee due this week has a cash timing problem and has not renegotiated anything with anybody. A different household refinances a loan on to a longer term with lower monthly instalments while its salary account is comfortably full. Both households are fine, both are worth talking about, and the two conversations are about different things.

Telling the two apart in a situation where both descriptions genuinely fit is a job in its own right, and it is covered separately in this sequence. Only one point matters at this stage: the two questions do not collapse into each other.

Four defined words have now appeared, and each of them answers a different question. A reader who merges any two will misread every document they open afterwards, so the words are worth putting beside one another.

Five words, five different questions, and the only thing they have in common is that all five get asked about the same borrower on the same afternoon.

Who gets to say that it has happened?

Most readers never think to ask who gets to say so, and that question is the one that turns a definition into machinery.

An occurrence does not announce itself. Nothing rings. A holder who reads the news, checks the schedule, opens the document and concludes with complete confidence that a listed condition has been answered has changed precisely nothing in any document anywhere. Their certainty is worth exactly as much as their opinion about the weather: quite possibly correct, and moving nothing.

A declaration is what moves the documents. A party the document names, acting under a clause the document names, states that the defined condition is answered. Before that, the occurrence is a fact and the status is not. After it, the status is a fact too, and every consequence the document attached to that status becomes available to whoever the document gave it to.

Two people can look at exactly the same facts and reach opposite conclusions about whether a condition has been answered. Opposite conclusions are normal and not a scandal; conditions are written in words, and words have edges. The disagreement is not settled by who argues better. Only one of the two is entitled to declare, and the document says who.

For a bond held by many holders at the same time, the document usually places that power somewhere central rather than handing a copy of it to each holder separately, and the reason is practical. Scattered, the power leaves five hundred people entitled to make five hundred inconsistent statements about one borrower, and five hundred inconsistent statements help nobody, least of all the holders. The party in that central position is called the trustee here. The wording covering what a trustee must actually do, and the moment each of its duties begins, is kept by the Securities and Exchange Board of India (SEBI) at sebi.gov.in.

Certainty is not a declaration, and no reader is ever in a position to change a document by being sure about something. The formal act itself, and everything it sets in motion, is covered separately in this sequence.

What did the document already say would follow?

Three consequences are worth naming, and the reason they are worth naming is that each was written rather than decided. Nobody weighs them up in the moment. The three consequences sit in the document waiting.

The first brings the principalThe amount a borrower has agreed to hand back at the end of the arrangement, held separately from the interest paid along the way. forward. What was payable at the end becomes claimable now. Bringing the principal forward is usually called acceleration, and it is the consequence with arithmetic attached.

The second is a link to other documents. A declared status under one agreement answers a condition in another, without anything further needing to happen and without anybody else having to notice. Such a link is usually called cross default. One declaration, and a set of conditions elsewhere is answered at the same instant.

The third is a change in who may act. Steps that needed everybody's agreement before can be taken by a smaller set of parties afterwards. Changing who may act is quiet and often the most consequential of the three: it changes who is in the room.

Now the arithmetic, and this is what this sequence carries instead of an outcome.

Palash Cements Limited's five year bond pays Rs 91/- at the end of each of five years and Rs 1,000.00/- more at the end of the fifth, on Rs 1,000.00/- of face amount, compounding once a year throughout. Run those five dated amounts back to today at the very 9.10 per cent the document struck, and the total lands on Rs 1,000.000000/-, the face amount to the last place. Add those five dated amounts up without discounting anything and the document promises Rs 1,455.00/- in all, on Rs 1,000.00/- of face amount. That is what at parA price that equals the face amount. It happens whenever the rate used to discount the payments is the same as the rate written into them. means here, and it is why the coupon rate and the discounting rate read as the same number rather than by coincidence.

Suppose now, as a supposition rather than anything that has happened to anybody, that one scheduled payment does not arrive. With no declaration, the amount unpaid is Rs 91/-. After a declaration that brings the principal forward, the amount claimable is that Rs 91/- plus the Rs 1,000.00/- of principal, for Rs 1,091.00/- in all.

Now what did not change. The borrower is identical in both readings. The business is identical. Every payment already made is identical. The five year government SPOT rate this bond is measured against reads 6.90 per cent a year under both, and the distance between the two, written here as 2.20 percentage points and, in the other unit, as 220 basis pointsA hundredth of a percentage point. Two hundred and twenty of them make 2.20 percentage points, and the two units are never swapped for one another., sits where it sat.

A sentence in a document, and somebody exercising it, moved the size of the claim by a factor of nearly twelve. The arithmetic stands in place of a story about an outcome, and it is worth more than a story: every step of it can be checked, and no part of it depends on anybody's recollection.

One more note beside those figures rather than buried underneath them. Every price here runs on a once a year clock. Each year of distance from today costs an amount one division by 1.0910, and no more than one. The same sum redone on a half yearly basis lands somewhere else entirely, from figures that look identical to the ones printed here, and the reader is left concluding that the error is their own.

Why is the order competing claims are met in fixed before it is needed?

Once more than one party is owed money by the same borrower, somebody has to settle who gets paid before whom. The sequence cannot be decided by whoever asks first, and it cannot be decided once the money has run short, for exactly the reason given at the outset: at that point every party can see which sequence suits them, and no sequence gets agreed.

So it is fixed in advance. Partly in the documents the parties signed between themselves, and beyond the point where private parties are able to settle it, by law.

The contents of that sequence are settled elsewhere. The empty rows below are not a hole in the material. The emptiness is the material.

The reasoning behind that emptiness applies far beyond this subject. Who ranks where, what has to be shown before anything begins, which parties may begin it and how long any step of it runs are all set by the Insolvency and Bankruptcy Board of India at ibbi.gov.in, and every one of them gets revised. Written out from recollection, such an item does not quietly go out of date when the wording moves. Such an item goes false, it stays false, and nothing on its surface says so: a wrongly printed figure and a rightly printed one look identical to the reader holding both.

A blank row carrying an address is a route. A number somebody typed out two years ago in perfect confidence is a hazard. One of those sends a reader to the live wording; the other stops them looking.

Two things about the order do not move: that an order exists, and why it has to exist before it is needed. Both are structural rather than statutory. How an amount actually works its way down through ranked claims, with the arithmetic drawn out, is covered separately at the close of this sequence, where there is a control to attach it to.

What kind of answer can never be produced, and why

An answer about an outcome cannot be produced from machinery that has never been made to run.

Palash Cements Limited is a name attached to a promise and a handful of figures. No default sits behind it, no promise attached to it has been rewritten, and no amount has been recovered by anyone. There is no case to draw a history from, so there is no history of any kind.

The subject is machinery that exists whether or not it ever runs. A single invented instance of the machinery running travels away with every reader and leaves the machinery behind. The borrower, the drama and the number at the end are remembered. The list that came first, the declaration in the middle, and the fact that the size of a claim is a property of a document rather than of a situation are not. So in place of a story there is a document, in place of an amount recovered there is an order with nothing filled in, and in place of a duration there is the address of the authority that decides.

There is one recovery figure anywhere in this material, and since it is the number readers reach for hardest, it is worth being exact about what it is.

A recovery rateHow much of what is owed finds its way back. Its base is the amount owed, never any price somebody paid, and those two bases give different answers. of 40 per cent of the amount owed sits behind the arithmetic here. The 40 per cent is an assumption used to invert a price, and it is nothing else. The assumption was chosen so that a credit spreadHow much more a borrower pays than the government does for the same length of time, always quoted over a named reference and for a named term. of 2.20 percentage points, equal to 220 basis points, could be turned into an implied annual default rate. Assume a recovery of 40 per cent and the loss given defaultWhatever a recovery leaves behind, sitting on that same base, so the pair of them close on one hundred per cent together. sits at 60 per cent on that base. Put 2.20 over 0.60 and the answer lands on 3.6667 per cent a year. Carry 3.6667 back through the same 0.60 and 2.2000 percentage points comes out, the figure the arithmetic set off from.

Two cautions travel with those figures wherever they go. The first is that the printed answer is not the input. The check run back from 3.67 rather than from 3.6667 gives 2.2020 percentage points instead of 2.2000. The difference is rounding rather than a mistake, and it is exactly the kind of small residual that makes a careful reader distrust their own arithmetic. The second is larger. Nobody measured that 40 per cent. No study stands behind it, and it describes no borrower, no instrument and no outcome. Rs 400.00/- and Rs 600.00/- on Rs 1,000.00/- of amount owed are the only recovery numbers anywhere in this sequence, and neither of them is attached to anything that came back to anybody.

One thing to say plainly before any of this gets used

A lender who was not repaid did not make an obvious mistake. An outcome looks plain once it has happened and was not plain in advance, and the entire apparatus described here exists precisely because careful parties who fully expected to be paid knew that they might turn out to be wrong.

Palash Cements Limited is a promise and a set of figures, with no management, no history and no conduct to describe. The machinery is the subject, and nobody is being held up as an example of anything.

Deciding what to do when a payment does not arrive is a separate matter from the machinery. Whether to declare, whether to accept an offer, whether to act alongside others or alone are decisions taken under a particular document, with consequences particular to that document. Only three things hold generally: the mechanism, the party the document names, and the address of the authority that sets the rest.

Why there is no control to move

Everything above is a definition, a party or a written consequence, and not one of those is a quantity that varies with an input. The single calculation here moves between exactly two positions, before a declaration and after one, so a control would offer two stops and would show less than the two figures already printed beside each other.

The second reason is the stronger one. A control on a subject like this one would drag a borrower further into difficulty and show what happens. Such a control presents a manufactured degree of trouble as though it were information, with nothing at all standing behind any position of it. The one structure here worth moving is what an order does to competing claims, and that is covered separately at the close of this sequence, where there is arithmetic to attach it to.