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Default Recoveries Top Average in Latest Cycle, Moody’s Says

U.S. companies that emerged from default in 2009 and 2010 had a higher investor recovery rate than the average of all defaults on almost $1 trillion of debt since 1988, according to Moody’s Investors Service.

The average recovery rate for non-financial corporate issuers in the most recent default cycle was 58.3 percent, compared with 54.5 percent for the more than 850 companies in Moody’s database, the ratings company said in report. It also exceeded recoveries from the 1990-1992 and 1999-2004 cycles by 440 basis points and 1,000 basis points, respectively, Moody’s said. A basis point is 0.01 percentage point.

Debt investors got back more of their money because the Federal Reserve injected so much liquidity into the system that it shortened the default cycle and firm-wide recovery rates are influenced by the default rate, said David Keisman, senior vice president at Moody’s. They were also elevated because private-equity sponsors used more distressed exchanges, which typically result in a higher recovery rate than a Chapter 11 proceeding, he said.

“If there was a real concern you could go into bankruptcy, then the question is, could you get financing, would you be forced into liquidation?,” New York-based Keisman said in a telephone interview. “Private equity would go to creditors and say this is a roll of the dice, so let’s do a distressed exchange. It takes away the uncertainty around bankruptcy.”

About 25 percent of defaults in the last cycle used a distressed exchange, compared with 16 percent of the entire database, according to the report.

Shorter Cycle

Distressed exchanges typically offer higher recoveries than both Chapter 11 and prepackaged bankruptcies, while private-equity firms like to negotiate these defaults out-of-court to maintain their equity holdings.

The most recent default cycle was the shortest of the three at just 19 months, compared with 36 months in the early 1990s and the 53 months that included the dot-com crash, according to the report. The 2009-2010 default cycle was more severe than the previous two, Moody’s said, because it was associated with the Great Recession, the credit crisis and the housing slump.

The U.S. speculative-grade default rate peaked at 14.6 percent in November 2009, and then fell to 3.6 percent a year later, according to the report. It is currently about 2 percent. Such debt is rated below Baa3 by Moody’s and less than BBB- by Standard & Poor’s.

The data highlights the importance of a company’s capital structure, according to Moody’s. The historical average recovery for bank debt was 80.4 percent, while subordinated debt, which includes senior subordinated, subordinated and junior subordinated bonds, was 28.8 percent, according to the report.

“Clearly, as debt cushion increases so do recoveries,” Keisman wrote in the report.

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