Credit risk and where it comes from

In short

• Credit risk: the risk of economic loss when a borrower fails to make full and timely payments. A borrower that misses a promised payment is in default.
• Lenders feel it in several ways: lost principal or interest, late payments, collateral that sells for too little, and legal and collection costs.
• The Cs of credit: five bottom-up, borrower-specific factors (capacity, capital, collateral, covenants, character) and three top-down factors (conditions, country, currency).
• Corporate debt is repaid mainly from operating cash flow; secured debt adds pledged collateral as a second source. Sovereign debt is repaid mainly from taxes.
• Illiquid (cannot raise cash to pay now) is not the same as insolvent (assets worth less than liabilities).