PD from external credit ratings

A corporate treasury holding bonds, a parent lending to a subsidiary, or a company with deposits at several banks all need PDs but rarely have default data. Rating agency studies fill the gap. This guide explains how to use cumulative default rates, how to map unrated borrowers to a grade, and works through two examples.

By Mirza Fahad Baig, Chartered Accountant. Reviewed by Hamza Fida, Chartered Accountant. 3 minute read.

Short answer

Companies and banks without enough default history of their own often derive PD from external ratings. Rating agencies publish long-run cumulative default rates for each rating grade and horizon; the lender maps each borrower to a grade, using its public rating or an internal assessment for unrated borrowers, takes the cumulative default rates for that grade, converts them into marginal PDs, and adjusts them to point in time for current conditions and forecasts. Investment grade exposures often qualify for the low credit risk exemption from staging, which keeps them in stage 1.

At a glance

Source
Rating agency default studies
Data
Cumulative default rates by grade and year
Unrated borrowers
Map to a grade
Adjust
To point in time
Investment grade
Often low credit risk
Excel
PD term structure model
PD from external credit ratingsSource: Rating agency default studies; Data: Cumulative default rates by grade and year; Unrated borrowers: Map to a grade; Adjust: To point in time; Investment grade: Often low credit risk; Excel: PD term structure model.KEY FACTS AT A GLANCEPD from external credit ratingsSourceRating agency defaultstudiesDataCumulative default ratesby grade and yearUnrated borrowersMap to a gradeAdjustTo point in timeInvestment gradeOften low credit riskExcelPD term structure modelTax BakersPD from external credit ratingsSource: Rating agency default studies; Data: Cumulative default rates by grade and year; Unrated borrowers: Map to a grade; Adjust: To point in time; Investment grade: Often low credit risk; Excel: PD term structure model.KEY FACTS AT A GLANCEPD from external credit ratingsSourceRating agency default studiesDataCumulative default rates by grade and yearUnrated borrowersMap to a gradeAdjustTo point in timeInvestment gradeOften low credit riskExcelPD term structure modelTax Bakers
Key facts at a glance, as set out in this guide.

How do you get a PD from external ratings?

  1. Find the borrower's rating, or map an unrated borrower to an equivalent grade.
  2. Take the cumulative default rates for that grade from the latest rating agency default study.
  3. Convert the cumulative rates to marginal PDs for each year of the exposure.
  4. Adjust the long-run rates to point in time, reflecting current conditions and forecasts.
  5. Use the 12-month PD for stage 1, or the lifetime PD for stage 2.

What do the curves look like?

Illustrative cumulative default rates by gradeIllustrative cumulative default rates by gradeRoughlyYear 1Year 5Grade 1AAA0.01%0.25%Grade 2AA to A0.05%0.50%Grade 3BBB0.20%1.90%Grade 4BB0.80%7.10%Grade 5B3.50%17.50%
Illustrative only: replace with the latest rating agency default study.

The figures above are illustrative, chosen to show the typical pattern of the cumulative default rates published by the agencies; use the latest published study for real calculations. Default rates rise steeply as ratings fall, and for weaker grades most of the lifetime risk comes early, because surviving borrowers improve on average.

An example: a corporate bond

A company holds a five-year bond rated BBB, measured at amortised cost, with a carrying amount of 2,000,000. Using an illustrative 12-month PD of 0.20% for the grade, taken from a default study of similar issuers, adjusted upwards by 10% for a weaker outlook to 0.22%, and an LGD of 60% for senior unsecured debt, 12-month ECL is 2,000,000 x 0.22% x 60% = 2,640. As a BBB bond is investment grade, the company can apply the low credit risk exemption and keep it in stage 1 while the rating holds.

An example: an unrated intercompany loan

A parent lends 5,000,000 for three years to a subsidiary that has no rating and no external debt of its own. The parent assesses the subsidiary's leverage and interest cover against the ratios agencies associate with each grade and concludes it is equivalent to BB, the weakest end of the published range for its industry. With an illustrative three-year cumulative PD of 3.9% for that grade, the 12-month PD is 0.8%. If the subsidiary's credit risk has not increased since the loan was made, the loan is in stage 1 with 12-month ECL; if it has, lifetime ECL using the 3.9% three-year PD.

Mapping unrated borrowers to a rating grade

  • Financial ratios such as debt to EBITDA, interest cover and cash flow to debt, compared with the agencies' published medians for each grade.
  • A credit scoring tool or a bank's internal rating of the borrower, if available.
  • For subsidiaries, the parent's rating adjusted for the likelihood of parental support.
  • Market-implied ratings from bond or credit default swap prices.
  • Once mapped, a migration matrix shows how the grade is likely to evolve.

Why do agency rates need adjusting?

Published default studies are long-run averages across many cycles, so they are through-the-cycle. IFRS 9 requires point-in-time, forward-looking PDs, so the rates are scaled up in a weakening economy and down in a strong one, by a scalar or by using default rates from comparable past periods. Agency studies cover rated companies, mostly large ones in developed markets; smaller borrowers mapped to a grade may behave differently, which should be considered when choosing the grade and the adjustment.

Where to go next

The Ratings sheet of the PD term structure model (Excel) holds illustrative curves you can replace with published data, and converts them to marginal PDs. See probability of default and lifetime PD.

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Questions people ask

How do you derive PD from external ratings?

Map the borrower to a rating grade, take the cumulative default rates for that grade from a rating agency study, convert them to marginal PDs and adjust them to point in time.

Can rating agency default rates be used directly for IFRS 9?

Not without adjustment: they are long-run averages, while IFRS 9 needs point-in-time, forward-looking PDs.

How is an unrated borrower mapped to a rating grade?

Using financial ratios compared with agency medians, internal scoring, parental support or market-implied ratings.

Are investment grade assets automatically in stage 1?

They may use the low credit risk exemption, which allows them to be treated as having no significant increase in credit risk.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 9 Financial Instruments

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

ECLProbability of default (PD)ECLLifetime PD and the PD term structureECLSignificant increase in credit risk (SICR)

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This guide is general information. It is not tax or legal advice for your situation.