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This time it's not different: Moody's unveils recovery data
Recoveries in the current round of defaults have been no worse than in previous credit cycles, says Moody’s in a new report. The rating agency calculates that average recovery rates across all instruments for the 57 US corporates that emerged from default between October 2008 and June 2010 has been 50.9%. This, it says, is close to the 54.7% average from 1988 to the present.
However, Moody’s data includes what it classes are distressed exchanges, of which there have been a large number recently. These events typically produce much higher recoveries than defaults as they are usually defined. Excluding these distressed exchanges, the recovery rate would have been in the 40s (45.6% for pre-pack bankruptcies and 41.2% for other bankrupties).
Recoveries on loans have been almost identical to those in the 2001-2002 default cycle at 77.9%. While bond recoveries have been lower, at 31.2% this time compared to 39.9% in the previous cycle, recoveries on subordinated debt has been higher (28.3% compared to 19.3%).
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CFlux secondary
CLO index levels:
| Index | 6 Feb |
|
| CFlux USD AAA | ↑ | 94.9 |
| CFlux USD AA | ↓ | 81.3 |
| CFlux USD A | ↓ | 75.0 |
| CFlux USD BBB | ↑ | 74.8 |
| CFlux USD BB | ↑ |
72.1 |
| CFlux USD EQ | ↑ | 67.6 |
We may find that the recovery rates in this cycle will be lower but that the distressed exchanges are delaying rather than increasing the final recovery. If the exchange results in another default later with lower recoveries, then you end up with a statistical mask over the whole process (which cycle did it belong to?). This will also be complicated by the protracted U shape of this recovery rather than the V of most rebounds. Less rebound in the underlying asset prices and the lower end aggregate demand will mean more restructures will be unsucessful and ultimate recoveries lower.
It makes sense for there to be a general correlation, but it would also be specific to the circumstances of each recession. Clearly the recovery prices are driven primarily be demand in the market for the defaulted debt rather than some theoretical valuation of what it is actually fundamentally worth, therefore the factors that govern recovery rates are probably things like number of distressed debt funds and their ability to raise cash, market sentiment, ability of competitors to acquire the assets. Further as legislation changes e.g. changes to Chapter 11 rules and financial engineering develops (including the arrival of a CDS market) this will alter the number of companies that opt for a distressed exchange and their ability to effect this with creditors
Still, the Moody's report - which I skimmed - does not support the existence of lower recovery during high-default periods. The Moody's analyst believes this relationship exists, but the 2008-2010 data do not bear it out. The report mentions distressed exchanges several times as skewing the results, but this is weak given that (i) there's no comparison to numbers of distressed exchanges in prior periods and (ii) distressed exchanges are defaults - regardless - so they need to be included when searching for alleged dependencies between default rate and recovery.
As to the inverse correlation of default rates and recovery rates, quarterly data show it's not conjecture but stark reality. It's also supported by common sense: when defaults are high, liquidity and animal spirits are at a low ebb, thus low recovery rates. The relationship has been observed going back to the high default rate of the 1990-1991 period.
Moody's boast of having default data going back to the days of the railroad bonds, so why does this analysis only use data going back to 1988? Perhaps those old card files are getting a little dusty.
Proper assessment of recovery upon default is very important. A dominant "state of the art" idea in recent years has been that default recovery has negative correlation with default rate. It's not clear to me from this description above if the Moody's report supports this conjecture or not.