What Is Constant Default Rate (CDR)?

The Constant Default Rate (CDR) is an annualised measure of the rate at which loans in a pool default. It is commonly used to assess the performance of loan pools underlying structured credit products such as collateralised loan obligations (CLOs) and asset-backed securities (ABS). Analysts use the CDR to price structured credit products and determine how much loss they anticipate from a specific loan pool.

Although CDR is expressed as an annualised rate, it is typically calculated using monthly default rates. Analysts can convert between monthly default rates and annualised CDRs, allowing them to compare loan pools that report performance on different cycles e.g. monthly versus quarterly. 

CDR Formula 

CDR is generally calculated using the following formula: 

Monthly Default Rate (MDR) = Total amount of loans that defaulted during the month ÷ Portfolio balance at the beginning of the month.

The formula annualises the monthly default rate over 12 months, assuming the same monthly rate continues throughout the year. 

Worked CDR Example 

If a CLO manager reports that £500,000 of loans defaulted during a month when the pool had a beginning-of-month balance of £100 million, the calculation is:

Therefore, based on a monthly default rate of 0.5%, the annualised CDR is approximately 5.84%.

Why CDR Matters 

A rising CDR indicates a higher rate of defaults within the loan pool and can increase the credit risk of the associated structured securities. When loans are pooled and structured into securities, a higher number of defaults can put greater pressure on lower-rated tranches (the layers of a security that absorb losses first) before senior tranches. 

Rating agencies may consider a loan pool's CDR alongside prepayment rates and expected loss estimates when assessing the credit risk of a structured investment and the value of the underlying cash flows. 

CDR is closely related to other measures used in securitisation, particularly when assessing pooled loans and structured securities such as collateralised debt obligations (CDOs).