untitled

Default, Transition, and Recovery:

Recovery Study (U.S.): Are SecondLiens and Senior Unsecured BondsLosing Ground As Recoveries Climb?

Global Fixed Income Research:

Diane Vazza, Managing Director, New York (1) 212-438-2760; [email protected]

Evan M Gunter, Associate Director, New York (1) 212-438-6412; [email protected]

Table Of Contents

Senior Instruments Gain In Recent Recoveries

Historical Recovery Rates By Instrument Seniority

Recovery Rates And Collateral Vary By Sector

Recovery Rates Typically Follow the Credit Cycle

Recovery Rates By Issuer Ratings

Definitions

Related Criteria And Research

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT DECEMBER 16, 2013 1

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Default, Transition, and Recovery:

Recovery Study (U.S.): Are Second Liens andSenior Unsecured Bonds Losing Ground AsRecoveries Climb?

In the recent post-recession period (2010-2013), recoveries at emergence for defaulted companies have risen from the

lows of 2008-2009. However, this rising tide has not lifted all instruments equally. While revolving credit facilities,

first-lien term loans, and secured bonds have experienced higher-than-average recoveries in recent years, relatively

less-senior instruments such as second-lien term loans, senior unsecured bonds, and subordinated bonds have

experienced lower-than-average recoveries. Whether this indicates a structural shift among defaulting debt, or is

merely a function of the relatively small sample size that will eventually revert to the mean, remains to be seen.

Overview

• Recovery rates have risen since 2009 as valuations for companies emerging from default have been supported

by the strengthening of the credit cycle.

• Despite the rising overall recovery rate, second-lien term loans and senior unsecured bond average recoveries

have fallen in recent years (2010-2013) for companies reorganizing through bankruptcy.

• In recent years, secured instruments have comprised a growing share of defaulting instruments, placing an

increasing share of principal ahead of senior unsecured bondholders.

With a relatively low number of company defaults in recent years, and surging investor demand for yield, companies

have been able to reach higher valuations at emergence, enabling creditors to receive higher recoveries overall. The

U.S. speculative-grade default rate has fallen to 1.9% as of Nov. 30, 2013, from its recent cyclical high of 11.7% in

November 2009. Meanwhile, average recovery rates have been rising since they reached a cyclical low of 42% in 2008

(see chart 1). The average overall recovery rate climbed to 60% in 2010, and is approaching 70% for instruments that

defaulted and emerged in 2013. However, it's important to note that the 2013 sample of defaulters presently consists

primarily of prepackaged bankruptcies that have both defaulted and emerged this year. This concentration of

prepackaged bankruptcies is likely elevating current average recovery for the companies in our dataset that defaulted

in 2013. As more companies that defaulted in 2013 eventually emerge from default, we may see this average fall more

in line with recent defaults from 2010-2012.


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Chart 1.

Still, when we look at overall recoveries from 2010-2013, we see that these recent recoveries of 60.6% are considerably

higher than the historical average of 51.1% from 1987 to the present. Even if we look just at bankruptcy defaults,

excluding distressed exchanges, the overall recovery is still above-average at 57.7%. For the period of 2010-2013, our

overall sample consists of 153 defaulted instruments from 52 issuers. These averages are based on the ultimate

recovery, or the amount that creditors receive from defaulted instruments at the time of emergence from default.

Secured instruments have made up a greater share of defaulted instruments since 2009 than unsecured instruments.

While the overall recovery rate has risen over this same time period, second-lien term loans and senior unsecured

bonds have not shared in the overall rise in average recovery rates. Further, if we exclude distressed exchanges,

looking at the recovery of second-lien term loans and senior unsecured bonds following bankruptcy restructurings

post-2009, then the average recovery rate has fallen noticeably. Though the sample of recent defaults remains small,

it's of interest that these senior unsecured bonds and second-lien term loans are not sharing in the gains.

We based all of the recovery analysis in this study on Standard & Poor's LossStats database, which is available in

Standard & Poor's CreditPro® database and contains ultimate recovery values for more than 3,900 defaulted

instruments from 927 issuers in the U.S. that emerged between 1987 and August 2013. We've included a section of

definitions at the end of this study, which also includes details about our calculation method. Except where noted,


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Default, Transition, and Recovery: Recovery Study (U.S.): Are Second Liens and Senior Unsecured Bonds LosingGround As Recoveries Climb?

recovery values cited in this study refer to the discounted recovery, where the discount rate applied is the instrument's

effective interest rate. Standard & Poor's Ratings Services provides a comprehensive, fundamental approach to

estimating post-default recovery prospects on instruments through its recovery ratings. Note that Standard & Poor's

recovery ratings map to nominal values, while this study focuses on discounted recovery values. As Standard & Poor's

recovery ratings refer to nominal values, investors may choose their own discount rates when making decisions based

on their nominal estimates. For a study of the performance of these ratings, please see "Leveraged Finance: Standard

& Poor's U.S. Recovery Rating Performance--A Five-Year Study," published Jan. 29, 2013.

Senior Instruments Gain In Recent Recoveries

When we compare recoveries by instrument class, we see that those instruments with higher seniority or stronger

collateral typically have higher recoveries. Historically, from 1987 to the present, loans and revolvers have recovered

74%, while bonds have recovered 38% on average. The recent post-recession period is no exception as higher priority

instruments continue to experience higher recoveries. However, more senior instruments are gaining, while

lower-tiered instruments are losing ground.

Revolving credit facilities and term loans (excluding second-lien term loans), both of which are instruments at the top

of the debt structure, had the highest average recovery rates-- 82% and 73%, respectively, following bankruptcies in

the post-recession period. These loan instruments, which are more senior types of debt, have payment priority in the

event of a default and are often secured by some type of collateral. The recent recovery rates for these instruments are

higher than their average recovery rates from 1987-2009.

Meanwhile, second-lien term loans and senior unsecured bonds that defaulted in the post-recession period have lower

recovery rates than their average historical recovery rates. Second-lien term loans recovered 11% in recent years,

down from 57% historically, while senior unsecured bonds recovered 42%, down from 43% historically. However, if we

exclude distressed exchanges and other defaults that were resolved outside of bankruptcy, and look just at

bankruptcies, senior unsecured bonds have performed even worse. Average recovery from bankruptcy for senior

unsecured bonds has fallen in recent years to 18% from 42% historically (see Chart 2 and Table 1).


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Chart 2

Table 1

Recovery Rates By Instrument Type (Recent Vs. Historical)

Recent (2010-2013*)

--All defaults-- --Bankruptcy only--

Instrument type Mean (%)

Dollar weighted rate

(%) Count Mean (%)


(%) Count

Revolving credit 82.4 80.6 40 82.2 79.8 39

Term loans (excluding

second-lien)

70.5 63.7 44 73.0 66.3 37

Term loans (second-lien) 10.6 6.5 10 10.6 6.5 10

All loans/facilities 69.2 60.7 94 69.9 61.9 86

Senior secured bonds 63.7 70.6 22 54.4 56.9 17

Senior unsecured bonds 42.4 36.6 25 18.2 17.4 15

Subordinated bonds 25.1 33.1 12 17.4 22.0 10

All bonds 46.8 50.7 59 32.7 34.9 42

Total defaulted instruments 60.6 56.8 153 57.7 52.9 128


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Table 1

Recovery Rates By Instrument Type (Recent Vs. Historical) (cont.)

Historical (1987 - 2009)

--All defaults-- --Bankruptcy only--

Instrument type Mean (%)


(%) Count Mean (%)


(%) Count

Revolving credit 78.0 65.3 667 78.0 65.0 645


second-lien)

70.5 72.4 649 70.6 73.2 619

Term loans (second-lien) 56.6 54.1 34 56.6 54.1 34

All loans/facilities 73.8 69.2 1,350 73.9 69.5 1,298

Senior secured bonds 56.3 53.7 313 56.2 54.6 291

Senior unsecured bonds 43.0 40.4 1,156 41.5 34.9 940

Subordinated bonds 26.1 26.5 978 20.8 21.3 817

All bonds 37.9 38.4 2,447 35.3 33.9 2,048

Total defaulted instruments 50.7 48.8 3,797 50.3 48.0 3,346

* Through August 31, 2013. Tallied by year of default. Source: Standard & Poor’s CreditPro, Standard & Poor’s Global Fixed Income Research.

Alternatively, if we weigh recoveries by the dollar amount of defaulted debt, then the recent performance of

second-lien term loans and senior unsecured bonds is starker. On a dollar-weighted basis, average recoveries of

second-lien term loans have fallen to 7% for instruments defaulting in the recent period (2010-2013) from 54% in the

historical period (1987-2009). Meanwhile, the dollar-weighted average recoveries of senior unsecured bonds has fallen

to 37% in the recent period from 40% in the historical period (see table 1). When we measure recovery on a

dollar-weighted basis, we take the discounted sum of debt recovered, divided by the total of defaulted debt in the

sample.

Second-lien term loans, which are secured by assets that are also pledged to higher priority lenders, tend to show

much lower recoveries than other types of secured loans. While the recent recoveries of 11% for second-lien debt are

well below the 57% average from prior years, one caveat is that the sample of recent defaults remains small at just 10

issues. As the sample size grows, there is the possibility that the recovery rate may revert nearer to the mean.

Second-lien issuance has been rising in recent years, reaching $22 billion in the first three quarters of 2013 and

surpassing the full year 2012 total of $17.8 billion, according to S&P Capital IQ Leveraged Commentary & Data.

Though second-lien issuance has risen in recent years, it still lags the pre-recession peak of $30.1 billion with 178

issues in 2007. Issuance plummeted with the onset of the recession, but has been steadily returning since then. As

issuance second-lien term loans are surging, and recoveries are faltering, this area of the loan market may be at risk.

Recoveries for senior unsecured bonds have fallen from their highs in the pre-recession period. For issues that

defaulted between 2003 and 2007, the average recovery was 62%. As the number of defaults rose during the recession

period, senior unsecured bond recoveries fell steeply to 37%. Even this recovery level was bolstered by the

predominance of distressed exchanges during the recession, without which the recovery rate would have been even

lower. Senior unsecured bonds that defaulted through a distressed exchange during the recession recovered 43% on

average, compared with a 28% average recovery for those restructuring through bankruptcy.


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While the recovery rate for senior unsecured bonds has risen to 42% from the recession lows, a number of recent

distressed exchanges such as that of Energy Future Holdings Corp. are boosting this recovery average. If we exclude

distressed exchanges from the averages, then the recovery rate of senior unsecured bonds has fallen further, down to

18% for the recent defaults from 2010 to 2013, compared with the 42% historical average. One factor that is affecting

the recoveries of both second-lien and unsecured debt is the changing mix of seniority and collateral among defaulting

instruments in recent years.

Secured debt (first-lien) comprises nearly two-thirds of the defaulting debt from the recent period of 2010 to 2013. In

the period from 1987 to 2009, unsecured debt comprised the majority of defaulting instruments, and first-lien secured

instruments were just 39% of the total number of defaults (see chart 3). With first-lien debt taking priority for

repayment in a default, this surplus of senior secured debt dims the recovery prospects for unsecured bonds and

second-lien term loans.

Chart 3: Distribution Of Collateral Type Among Defaulted Instruments

Tallied for the year of default by count of defaulting instruments. Includes only bank debt and bonds that defaulted.

Source: Standard & Poor's CreditPro, Standard & Poor's Global Fixed Income Research.

In many companies' debt structures, there are often several layers of debt that are senior to the senior unsecured

bonds. This principal above the unsecured bonds can be in the form of revolvers, term loans, and secured bonds. As

secured debt comprised a growing share of defaulting debt in the last few years, we've seen the average amount of

principal above senior unsecured bonds in default increase precipitously. An average of 40% of firms' principal was

ranked higher than the senior unsecured bonds that defaulted between 2010 and 2013. This was a higher share of

principal above senior unsecured bonds than during either 2008 to 2009 (34%) or 2003 to 2007 (27%), (see chart 4).

Though there was a greater share of company principal above senior unsecured debt between 2010 and 2013, the

average dollar amount of principal above senior unsecured debt was higher in 2008 and 2009 as the recession years

included several large company defaults, such as General Motors Corp., Lyondell Chemical Co., and Charter

Communications. The average amount of company principal above the senior unsecured bonds averaged $4.5 billion

between 2010 and 2013, down from $6.3 billion between 2008 and 2009.


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This flood of senior and secured instruments into the pool of defaulting instruments, could dampen recovery prospects

for second-lien term loans, senior unsecured debt, and subordinated debt recoveries if it continues. Ample market

liquidity and strong demand has helped to lift post-default company valuations and recoveries in recent years. When

the credit cycle turns, bringing higher default rates and lower valuations, then these instruments with little collateral

protection, if any, could experience an even sharper fall in recovery rates.

Chart 4

Historical Recovery Rates By Instrument Seniority

When we pool all defaulted instruments, we find that overall recovery rates averaged 51% for debt that emerged from

1987 through the third quarter of 2013 (see chart 5). This mean is near the median of 50% and the dollar-weighted

mean of 49% (see table 2).

As we separate instruments by seniority, those instruments with higher seniority tend to have higher recovery rates.

Revolving credit facilities had the highest average recovery with a mean of 78% and a median of 94% (on a nominal

basis, the median recovery of revolving credit is 100%). Term loans (excluding second-lien term loans) followed with a

mean of 70% and a median of 81%. Senior secured bonds tended to have higher average recoveries (57%) than


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second-lien term loans (46%). In many cases in our sample, the senior secured bonds had no term loan principal above

them in the capital structure, while all of the second-lien term loans had first-lien collateral ahead of them. When we

look at the distribution of loan recovery rates, we see over a quarter with full recoveries of par or greater (see chart 6).

As we look at the unsecured instruments, the mean recovery tends to be higher than the median recovery. Senior

unsecured bonds had a mean recovery of 43% compared with a median of 38%. Meanwhile, senior subordinated

bonds had a mean recovery of 29% compared with a median of just 17%. For these bonds that are lower in priority, a

large share experienced negligible recoveries of 0 to 10% (see chart 7).

Relative to the size of the average amount recovered, instruments with lower seniority tend to show higher variance in

their recovery rates than higher priority instruments. The coefficient of variation, or the standard deviation scaled by

the mean, rises with instruments that are positioned lower in the capital structure. While the coefficient of variation for

all loans and facilities is a relatively stable 42%, it rises to 87% for bonds overall. Meanwhile, the standard deviations

for instrument recoveries range from 29% to 42%.

Chart 5


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Table 2

Recovery Rates By Instrument Type (1987-2013)

Discounted recovery

Instrument type

Mean

(%) Median (%)


(%)

Standard

deviation

Coefficient of

variation (%) Count

Revolving credit 78.3 94.4 65.7 29.1 37.1 707


second-lien)

70.5 80.5 71.6 31.4 44.5 693

Term loans (second-lien) 46.1 30.6 36.5 41.6 90.2 44

All loans/facilities 73.5 87.7 68.6 31.2 42.5 1,444

Senior secured bonds 56.8 57.3 55.1 31.5 55.6 335

Senior unsecured bonds 43.0 38.3 40.4 31.8 74.1 1,181

Senior subordinated bonds 29.1 17.3 28.3 32.0 109.9 529

All other subordinated bonds 22.7 9.9 23.7 29.2 128.9 461

All bonds 38.2 29.4 38.7 33.2 87.0 2,506

Total defaulted instruments 51.1 49.5 49.1 36.7 71.8 3,950

Nominal recovery

Instrument type

Mean

(%) Median (%)


(%)

Standard

deviation

Coefficient of

variation (%) Count

Revolving credit 88.4 100.0 75.7 34.0 38.4 707


second-lien)

80.0 94.7 78.9 37.0 46.2 693

Term loans (second-lien) 51.5 36.3 41.3 46.5 90.3 44

All loans/facilities 83.2 100.0 76.9 36.5 43.9 1,444

Senior secured bonds 69.2 69.5 66.1 39.0 56.3 335

Senior unsecured bonds 51.0 43.0 46.1 38.7 75.9 1,181

Senior subordinated bonds 34.6 20.0 33.8 37.6 108.7 529

All other subordinated bonds 28.4 12.3 29.6 37.4 132.0 461

All bonds 45.8 33.9 45.0 40.4 88.2 2,506

Total defaulted instruments 59.5 57.0 56.1 43.0 72.3 3,950

Includes only bank debt and bonds that defaulted. Source: Standard & Poor’s CreditPro, Standard & Poor’s Global Fixed Income Research.


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Chart 6


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Chart 7

Recovery Rates And Collateral Vary By Sector

Aside from the seniority of an instrument, several other issue- and issuer-specific characteristics can influence the

ultimate recovery amount, including the collateral backing the instrument and the sector of the issuer. Some forms of

collateral are more easily monetized than others. Collateral assets can range from physical, such as the ships or planes

of a transportation company, to the intangible, such as intellectual property of media companies.

For this study we grouped defaulted instruments into five general categories based on their collateral:

inventories/receivables, all or most assets, second-lien, other, and unsecured. Among the issues that are secured,

second-lien instruments showed the lowest recovery with an average of 49.5%, though this was still higher than the

36.3% average recovery of unsecured instruments. However, when we weigh the recoveries by the dollar value of

defaulted debt, then second-lien collateral performed similarly to unsecured debt, with both recovering near 38%. Debt

secured by inventories or receivables had the highest average recovery of 87.7%, followed by debt secured by all or

most assets with 73.2% (see table 3).


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Table 3.

Average Discounted Recovery By Collateral Type

Collateral type Mean recovery (%) Standard deviation Dollar weighted rate (%) Count

Inventories/receivables 87.7 21.7 84.5 116

All (or most) assets 73.2 30.4 66.9 1,049

Other 68.2 30.3 59.2 110

Property, plant, and equipment 65.8 31.8 75.6 296

Second-lien 49.5 37.9 38.1 125

Unsecured 36.3 33.0 37.9 2,254

For bonds and loans which defaulted. Source: Standard & Poor’s CreditPro, Standard & Poor’s Global Fixed Income Research.

Companies in different sectors have various types of assets that can be posted as collateral, and this is one factor that

can influence the range of recoveries by sector (see table 4).

When we look at loan recovery by sector, the energy and natural resources sector and the transportation sector show

the highest average recoveries. The energy and natural resources sector has the highest average recovery for loans,

with 88.2%. Most of these loans were secured by collateral of all (or most) assets or oil and gas reserves.

Transportation company loans recovered by 79.8%% on average, with most of these loans secured by all or most of

the firm's assets.

Meanwhile, the telecommunications sector shows the lowest overall recovery rate of 37.1%.The low overall recovery

rate for the telecommunication sector stems from the timing of the defaults. The majority of the defaulted instruments

that we looked at from this sector defaulted during the period of 2000 to 2002, as the tech bubble was bursting.

The strength of bond recoveries generally corresponds to loan recoveries within a sector. For instance, the energy and

natural resource sector has the highest average loan recovery rate, and also has one of the highest average bond

recoveries with 46%. The telecommunications sector has the second lowest loan recovery rate of 63%, and the lowest

average bond recovery of 27%. One exception to this trend is the utility sector, which has the highest average bond

recovery rate (64%) and the lowest average loan recovery rate (62%). One thing that sets the utility sector apart from

the other sectors is the high share of its loans that were unsecured. Of the defaulted utility sector loans, 46% were

unsecured versus just 7% of loans in the other sectors. Also of note, unsecured bonds from the utility sector

experienced nearly double the average recovery of bonds from other sectors. As a regulated industry, the companies'

abilities to add debt are restricted, while the values of their assets have historically been resilient.

Table 4

Average Recovery By Nonfinacial Sector

Sector

All instruments

(recovery, %)

Loans

(recovery, %)

Bonds

(recovery, %)

Loan

(count)

Bond

(count)

Total

(count)

Aerospace and defense/automotive/capital

goods/Metals, mining, and steel

52.3 75.2 35.3 276 372 648

Consumer products/Service 51.2 74.4 33.6 347 457 804

Energy and natural resources 60.2 88.2 46.1 63 125 188

Forest and building products/Homebuilders 54.1 79.2 38.2 102 160 262

Health care/Chemicals 49.4 65.7 34.7 144 160 304


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Table 4

Average Recovery By Nonfinacial Sector (cont.)

High technology/Computers/Office

equipment

48.0 68.9 32.8 82 113 195

Leisure time/Media and entertainment 51.6 77.4 39.1 189 393 582

Telecommunications 37.1 63.4 27.2 109 289 398

Transportation 49.0 79.8 37.9 47 131 178

Utility 63.6 62.3 64.1 56 173 229

For bonds and loans which defaulted. Note: nonfinancial sectors excludes the insurance, financial institution, and real estate sectors. Source:

Standard & Poor’s CreditPro, Standard & Poor’s Global Fixed Income Research.

Recovery Rates Typically Follow the Credit Cycle

Outside of the individual characteristics of an instrument and its issuer, the timing and type of a default have a large

impact on the eventual recovery amount. During recession years and when the credit cycle ebbs, companies tend to

recover less.

In the recent recession, we saw many companies resorting to distressed exchanges as a way to restructure their debt

with the creditors and postpone or avoid bankruptcy. If we exclude distressed exchanges and other non-bankruptcy

restructurings from the recession-period defaults, we find that the average recovery dips further for the senior

unsecured and subordinated bonds (see chart 8).

Instruments that go through a distressed exchange, or other non-bankruptcy restructuring, tend to exhibit higher

recovery values than bankruptcy restructurings, especially for the unsecured and subordinated creditors. In a

distressed exchange, a company that's on the verge of default negotiates with its creditors to revise terms such as

maturity extensions, lower principal balances, or provide covenant exceptions to avoid, or at least postpone, a

bankruptcy. Generally, lenders will only agree to the terms of the distressed exchange if it offers better terms than

expected recovery value of the instrument following a bankruptcy.

Bonds overall experienced better recoveries through distressed exchanges, averaging 52.5% through non-bankruptcy

restructurings compared with 35.3% through bankruptcies, with the lowest-ranked securities, subordinated bonds,

showing the most improvement (see table 5).

The default rate for speculative-grade debt is an important part of the credit cycle. The supply of defaulted debt rises

with the default rate. We compared bond and loan recoveries based on the 12-month trailing speculative-grade default

rate at the time of the instrument default (see chart 9). We see that as the default rate rose, average bond recoveries

fell and loan recoveries were less affected. When the speculative-grade default rate was less than 4%, bond recoveries

averaged 43%. As the default rate climbed to 9.5% and higher, bond recoveries fell to 32%, on average. At the end of

November, Standard & Poor's 12-month trailing speculative-grade default rate touched 1.9%. This default rate is

well-below the long term (1981-2012) average rate of 4.5%, and we expect that the default rate will begin rising next

year. Our current forecast shows the 12-month trailing speculative-grade default rate rising to 3.1% by the end of June

2014.

Meanwhile, average recoveries for loans have not shown as clear a link with default rates. The average of overall loan


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recovery rates ranged within a narrower band, between 70% and 75%, regardless of the default rate.

Recoveries typically follow a similar trend when we group them by year of emergence. Recoveries for both bonds and

loans tend to slide as the economy enters a recession, reaching their lowest point either during the recession or shortly

afterwards (see chart 10). Recoveries then reach cyclical peaks in between recession years, as the credit cycle provides

positive momentum with ample liquidity, fewer defaults, and tighter credit spreads.

Chart 8.

Table 5.

Recovery By Type Of Default

Debt type

Bankruptcy (recovery,

%)

Distressed exchanges*

(recovery, %) Bankruptcy (count)

Distressed Exchanges*

(count)

Revolving credit 78.3 78.0 684 23

Term loans 69.2 66.2 700 37

Total loans 73.7 70.7 1384 60

Senior secured bonds 56.1 64.2 308 27

Senior unsecured bonds 41.1 50.7 955 226

Subordinated bonds 20.8 54.5 827 163

Total bonds 35.3 52.5 2090 416


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Table 5.

Recovery By Type Of Default (cont.)

Total defaulted

instruments

50.6 54.8 3474 476

*Includes distressed exchanges and other non-bankruptcy restructurings. Source: Standard & Poor’s CreditPro, Standard & Poor’s Global Fixed

Income Research.

Chart 9:


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Chart 10

Recovery Rates By Issuer Ratings

When we look at the recovery performance of instruments based on the credit rating of the issuer, we see that a higher

issuer rating does not necessarily imply a higher recovery value. Standard & Poor's issuer credit ratings focus on the

obligor's capacity and willingness to meet its financial commitments as they come due. This issuer credit rating does

not account for the nature and provisions of an obligation, or the ultimate recovery prospects for an issuer in

bankruptcy. With this in mind, it's not too surprising that issuer credit ratings do not show a clear indication of ultimate

recovery.

However, the variance of recovery rates by rating category changes considerably by the amount of time prior to

default (see table 6). Loans tend to show greater variance in recovery based on the rating 30 days prior to default,

while bonds tend to show greater variance based on the rating category one year prior to default.

Companies at the lowest rating levels typically have very different debt capital structures from more highly-rated

entities. These differences among debt structures that we commonly see among companies from investment-grade to

low-speculative-grade rating categories can affect the recovery level for bonds.


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The issuers that were investment-grade a year prior to default tended to have capital structures primarily comprised of

senior unsecured bonds. Only 35% of these issuers had term loans in their capital structure as they defaulted.

In contrast, issuers that were speculative-grade a year prior to default had capital structures with more loan debt ahead

of the bonds. Of these issuers, 59% had term loans in their capital structure at the time of default. With repayment of

term loan principal taking priority over bonds in default, these bonds tended to recover less than those from more

highly rated companies without term loans in the capital structure.

When we group the recoveries of loans by the rating category of the issuer one year prior to default, we see a fairly

tight range of recoveries, between 68% and 79%. The highest average recovery came from those issuers that were in

the lowest rating category. Meanwhile, loans from the issuers in the 'BB', or high-speculative-grade rating category,

recovered the lowest average amount (68%).

Separately, grouping loans by the issuer rating categories just 30 days prior to default, recoveries ranged from 72% to

36% by rating category. Those issuers in the 'CCC/C' rating category had average loan recoveries of 72%, more than

double the average recovery from issuers that were investment-grade ('BBB-' and above) one month prior to default.

One important point to note when looking at these averages is that the sample of investment-grade issuers shrinks as

we draw nearer to default. Our study includes just three issuers that were investment-grade one month prior to their

default: HealthSouth Corp. in 2002, Enron Corp. in 2001, and Armstrong World Industries Inc. in 2000. In each case,

the company's plunge into default came on suddenly and entailed a rapid reevaluation of the assets and liabilities

within the firms. In the cases of HealthSouth and Enron, accounting irregularities and fraud led to a rapid write-down

of assets, while Armstrong World filed for bankruptcy protection amidst rising asbestos claims against the industry.

For bonds, we see a fairly broad range of recovery values when we separate them by the rating category of the issuers

in our sample one year prior to default. However, as the issuers approach default, the range of recoveries narrows. For

instance recoveries by rating category one year prior to default ranges from 61% for investment-grade issuers, to 38%

for 'CCC/C' issuers. As we look at the rating just 30 days prior to a default, the range is much narrower, from a high of

40% for investment-grade issuers to a low of 29% for 'BB' issuers.

Table 6.

Recovery By Issuer Credit Rating Prior To Default

Issuer rating category --Rating 1 Year prior-- --Rating 90 days prior-- --Rating 30 days prior--

Loans/revolvers Recovery (%) Issuer count Recovery (%) Issuer count Recovery (%) Issuer count

Investment-grade 69.2 21 56.5 11 35.8 2

BB 67.6 61 65.2 26 65.6 10

B 73.8 246 70.4 123 66.8 78

CCC/C 79.3 65 76.5 131 71.7 140

Bonds

Investment-grade 61.0 23 54.2 12 40.4 3

BB 31.6 72 40.9 25 28.7 9

B 32.3 367 34.0 177 34.5 104

CCC/C 38.4 105 35.6 207 38.3 225


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Table 6.

Recovery By Issuer Credit Rating Prior To Default (cont.)

Tallied by issuer credit rating prior to default. Includes only bank debt and bonds that defaulted. Source: Standard & Poor’s CreditPro, Standard &

Poor’s Global Fixed Income Research.

Definitions

We define recoveries as the ultimate recovery rates following emergence from three types of default: bankruptcy

filings, distressed exchanges, and non-bankruptcy restructurings. Unless specified otherwise, we base recoveries at the

instrument level, and we discount them by using each instrument's effective interest rate.

In the Standard & Poor's LossStats database, the coupon rate at the time the last coupon was paid is the effective

interest rate used for the discount factor. We calculated the discounted recovery values by discounting instruments or

cash received in the final settlement on the valuation date back to the last date that a cash payment was made on the

prepetition instrument. The last-cash-pay date represents the true starting point for the interest accrual, which is why

this date is used as the starting point for the discounting rather than the default date of the instrument or the

bankruptcy date of the company. For fixed-coupon instruments, this is the fixed rate; and for floating-rate instruments,

it is the floating rate used at the time of default. Nominal recovery rates, which are the non-discounted values received

at settlement, are also reported.

We prefer discounted rates in this study because they allow us to better compare bankruptcies of different lengths. For

example, the nominal rate on a distressed exchange could be the same as that on a bankruptcy case that takes two

years. However, investors in the bankruptcy case are significantly worse off because they could lose significant time

value while waiting for the final settlement. On the other hand, a distressed exchange could take only a day. In a

historical study, discounted recovery rates offer the major benefit of making different time periods more comparable

by preventing any major bias that could occur if time between default and emergence differs greatly. Note that

Standard & Poor's provides recovery ratings that map to nominal values. This is appropriate because it lets investors

choose their own discount rates when making decisions based on their nominal estimates.

Recovery is the value creditors receive on defaulted debt. Companies that have defaulted and moved into bankruptcy

will usually either emerge from the bankruptcy or will be liquidated. On emergence from bankruptcy, creditors often

receive a cash settlement, new instruments (possibly debt or equity), assets or proceeds from sale of assets, or some

combination.

Ultimate recovery

Ultimate recovery is the value of the settlement a lender receives by holding an instrument through its emergence from

default. The recovery is based on the amount received in the settlement divided by the principal default amount.

Within the Standard & Poor's LossStats database, three recovery valuation methods are used to calculate ultimate

recovery:

• Trading price at emergence. We can determine the recovery value of an instrument by using the trading price or

market value of the prepetition debt instruments upon emergence from bankruptcy. Of the three methodologies, this

one is the most readily available because most debt instruments continue to trade during bankruptcy proceedings.


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• Settlement pricing. The settlement pricing includes the earliest public market values of the new instruments that a

debtholder receives in exchange for the prepetition instruments. It is similar to the trading price method, except that

it is applied to the new (settlement) instrument instead of the old (prepetition) instrument.

• Liquidity-event pricing. The liquidity event price is the final cash value of the new instruments or cash from the sale

of assets that the lender acquires in exchange for the prepetition instrument.

Related Criteria And Research

• Default, Transition, and Recovery: ‘Til Debt Do Us Part: Serial Defaults In The U.S. Show Lower Recoveries And

Higher Losses, Sep. 30, 2013

• For more details on recovery rates and potential modeling methods, see "Ultimate Recoveries," by Craig Friedman

and Sven Sandow, published in Risk magazine on Aug. 10, 2003; and "Estimating Conditional Probability

Distributions Of Recovery Rates: A Utility-Based Approach" by Craig Friedman and Sven Sandow, published in

"Recovery Risk: The Next Challenge In Credit Risk Management," Risk Books, 2005, edited by Edward Altman,

Andrea Resti and Andrea Sironi


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