For credit professionals, bond markets often provide an early warning system that can reveal deteriorating credit quality before it becomes apparent in financial statements, news items, or credit ratings. While no single indicator predicts default with certainty, distressed bond pricing has historically been one of the strongest market-based signals of elevated default risk. Monitoring bond trading can give you additional insight into the actual and perceived credit risk associated with the company.
It is important to first understand the characteristics of a bond. When a company wants to raise money, it can issue a bond, which are basically loans that investors provide to the issuing entity. Bonds are originally issued at face or par value, which is the amount the bond holder receives at maturity. Since bonds are traded in the open market, their prices can fluctuate. Bonds that trade above the par value are considered a premium, while bonds that are traded below par are trading at a discount.
A bond’s price reflects investors’ assessment of the probability that they will receive promised interest and principal payments. When investors become concerned about a company’s financial health, they demand higher yields to compensate for increased risk. Because bond prices and yields move in opposite directions, those concerns manifest as falling bond prices.
Generally speaking:
- Investment-grade bonds often trade near par value (100 cents on the dollar).
- Highly distressed issuers often have bonds trading below 70 cents.
- Bonds trading below 50 cents frequently signal that investors believe a restructuring or default is increasingly likely.
While sometimes difficult, keeping an eye on a company’s bond trading is a useful tool in measuring risk if you can source the trading data. You can check platforms like FINRA and Cbonds to see if your customers’ corporate bonds are listed. Bond investors are often highly sensitive to changes in a company’s liquidity and cash burn, refinancing prospects, competitive pressures, litigation exposure, macroeconomic forces, and overall credit profile. As a result, bond prices frequently react to emerging risks before those concerns become evident in financial statements, trade payment experience, or even credit rating actions. While bond prices should never be used as a standalone predictor, they can provide valuable early warning signals that help credit professionals make more informed credit decisions.
