While bond and note recoveries for instruments that have emerged in 2019 have fallen (to 43% from 58% in 2018), they remain above their long-term average of 39%, based on an analysis of 18 instrument recoveries in 2019 and 37 in 2018. These recent recoveries have been boosted by the prevalence of distressed exchanges, which are the leading reason for defaults globally and through October 2019 accounted for over a third of U.S. corporate defaults. Should bankruptcies become more frequent, or financing conditions for debt exchanges turn less favorable, then bondholders could experience a swift fall in recovery values.

Meanwhile, recoveries for term loans and revolvers continued to fall in 2019 and remain below their long-term average, based on an analysis of 18 instrument recoveries in 2019 and 39 in 2018. Term loans and revolving credit facility recoveries have fallen to near 60% on a discounted basis for those instruments that emerged in 2019 (through August), down from an average of 70% in 2018 and below the long-term average of 74% (see chart 1).

Chart 1

We based our analysis for this study on data from S&P LossStats®, which is available through S&P Global Market Intelligence's CreditPro® and contains ultimate recovery values for nearly 4,261 defaulted instruments from over 1,100 U.S. issuers that emerged from default between 1987 and August 2019. Except where noted, recovery values we cite here refer to the discounted recovery, where the discount rate applied is the instrument's effective interest rate. The discounted recovery value accounts for the time value of money between default and emergence, whereas the nominal value includes no such adjustments (see the Definitions section for more details about our calculation method). In this study, we most often refer to discounted rates to better compare bankruptcies of different lengths.

This recovery methodology is different from how S&P Global Ratings determines its recovery ratings when determining speculative-grade issue or instrument-specific ratings. S&P Global Ratings' recovery ratings are estimates of recovery for debt instruments from entities rated speculative grade ('BB+' or lower). These recovery ratings indicate expected recovery prospects, calculated on a nominal basis, based on a future hypothetical default scenario and reflecting the expected recovery following an entity's emergence from bankruptcy via a going concern or liquidation. These recovery ratings are issue-specific and range from '1+' (high expectations for a full [100%] recovery) to '6' (0%-10% recovery).

Note that the approach used to determine recovery values in this report also differs from those in the study "A 10-Year Lookback At Actual Recoveries And Recovery Ratings," published Feb. 4, 2019. That study excluded recoveries following distressed exchanges, and used the implied recoveries from the bankruptcy plans as the basis for the value received, rather than trading prices because the bankruptcy plan information was more consistently available for the issuers included.

In addition to the discounted recovery values presented in this study, we also provide nominal (or nondiscounted) and dollar-weighted averages in table 1. When we measure recovery on a dollar-weighted basis, we calculated the discounted (or nominal) sum of debt recovered and divided it by the total amount of defaulted debt in the sample for that instrument type.

Bonds Show Higher Average Recoveries Following A Distressed Exchange

Non-bankruptcy restructurings such as distressed exchanges tend to result in more favorable recoveries for unsecured creditors than they typically realize through a restructuring under Chapter 11 of the U.S. bankruptcy code. Bonds that have emerged from default in 2017 through August 2019 are showing below-average recoveries following bankruptcy (particularly unsecured bonds) and above-average recoveries following distressed exchanges.

Chart 2

Despite rising corporate leverage in recent years, bond recoveries over the past couple of years have continued to exceed their long-term averages as distressed exchanges have gained prominence.

Leverage Continued Rising For Newly Issued First Liens In 2019

Leverage has been rising for first-lien term loans over the past several years, and this leaves little cushion below first-lien loans, increasing the thickness of senior secured instruments and resulting in more debt obligations ahead of the junior bonds. The increase in leverage has affected the eventual recoveries. Total leverage across large corporate loans increased to 5.3x EBITDA in the first three quarters of 2019, up from 4.4x in 2011, according to S&P Global Market Intelligence's Leveraged Commentary & Data. Much of the increase in leverage in new transactions has been concentrated in first-lien debt.

Chart 3

With this rising leverage, senior secured has grown as a portion of debt structures, contributing to the increased senior debt leverage and eroding debt cushions. These trends could contribute to falling recoveries on first-lien loans when financing conditions turn less accommodative, since instruments with smaller debt cushions tend to experience lower average recoveries. For instance, first-lien term loans with a debt cushion of 25% or less of the firm's debt structure recovered close to 62% on average in our study, while instruments with a debt cushion of 75% or more of the debt structure recovered nearly 90% on average (see chart 4). Notably, most of the loan recoveries in our data set for 2018 and 2019 came from instruments with debt cushions of just 25% or less of the firm's debt structure.

Chart 4

Furthermore, with leverage increasing in first-lien term loans, bonds have more principal obligations senior to them in the debt structure that need to be met before they have a claim on anything, resulting in potentially lower recoveries. For example, bond and note recoveries average just 23% when 75% or more of the firm's principal is senior to them in the debt structure, while the average recovery is higher, at 45%, when less than 25% of the firm's principal is ahead of them (see chart 5).

Chart 5

The Energy And Retail Sectors Accounted For Half Of Recoveries In Recent Years

By sector, the largest share of emergences from 2017 through third-quarter 2019 has come from oil and gas, followed by retail and restaurants. Together, these sectors account for over half of the instrument recoveries we observed over this period. In each sector, the recovery rate for bonds was above its long-term average. The oil and gas sector in particular exhibited low recoveries for bonds post-bankruptcy in 2016 and so far in 2019, but distressed exchanges have helped lift the observed recovery values for bonds in recent years. While bonds from the oil and gas sector that have emerged from default in 2017-2019 have recovered 56% (on average), this average has been lifted by distressed exchanges, which account for more than a third of the observations and averaged recoveries of 76%. These recent oil and gas bond recoveries were well above the sector's long-term average recovery of 33%.

Chart 6

Term Loan Issuance Suggests A Renewed Focus On Credit Quality

With loan recoveries declining, investors are showing a renewed focus on credit quality. Newly issued loans in third-quarter 2019 showed a meaningful uptick in recovery estimates, as fewer newly issued first-lien loans were assigned a '3' recovery rating (indicating a meaningful recovery of 50%-70% in an event of payment default), and a greater share of new first liens were assigned a '2' (indicating a more promising 70%-90% recovery).

Covenant-Lite Issuance Is Slowing

The volume of new covenant-lite loan issuance fell by 33% in 2019 (through October) to $222 billion year over year through October, reflecting the slowdown in overall term loan issuance. During the prior credit cycle, lenders would extend covenant-lite loan terms only to issuers viewed as the strongest credits, but in the current market, most issuers of rated debt in the loan market issue covenant-lite loans. Covenant-lite continues to account for nearly 80% of new loan issuance.

Our recovery dataset includes a sample of 36 covenant-lite first-lien loans that defaulted between 2002 and 2019 for which we have sufficient information on their ultimate recovery. For the instruments that defaulted before 2010, covenant-lite bank debt experienced a higher average recovery (79%) than non-covenant-lite debt (which averaged 75%). In our view, this may be because before 2010 only higher quality borrowers were able to negotiate covenant-lite loans. However, since 2010, recoveries for covenant-lite loans have averaged 60%, lower than the 80% discounted recovery for non-covenant-lite loans over the same period (see chart 7). This coincides with covenant-lite loans becoming a larger proportion of the overall loan market, and a third of these covenant-lite instruments in our study emerged from default in 2017 and after.

Chart 7

Recovery By Instrument Type

Among instrument types, more senior debt tends to exhibit higher recoveries with lower variance than more junior debt. Historically, revolvers show the highest recoveries, with a mean recovery of 79% and a median recovery of 95%. First-lien term loans follow with a mean recovery of 72% and a median of 81%. However, the average recovery for second-lien and unsecured term loans is considerably lower, 44% with a median of 28%. These loans show the highest standard deviation and often display a bimodal distribution for recoveries that are either "fully paid" or "not paid at all."

Bonds overall have lower average recoveries than loans, though recoveries vary widely by bond type. Senior secured bonds have the highest mean recovery, at 56% (median of 58%), and senior unsecured bonds have a mean recovery of 45% (see table 1).

Because subordinated debt typically accounts for a small share of the firm's debt structure, there is often no value left to provide recoveries for these instruments in a bankruptcy after the senior debt holders are paid, resulting in a concentration of recoveries at the low end.

Table 1

On a nominal basis, where the ultimate recovery value has not been discounted to account for the time between default and emergence, recoveries are notably higher: loan and revolver recoveries average 83% while bond and note recoveries average 47%. Instruments with lower seniority tend to show higher variance in average recoveries than higher-priority instruments. The coefficient of variation, or the standard deviation scaled by the mean, rises for instruments positioned lower in the capital structure. While the coefficient of variation for loans and revolvers is 42%, it rises to 85% for bonds overall.

In the event of a default, the quality of collateral provides further support for secured debt. By type of collateral, we see the highest average recoveries for debt secured by inventories or receivables, which averages a 91% recovery with a lower standard deviation than that of the other collateral types, while debt secured by a second or third lien showed lower recoveries (see table 2).

Table 2

Recoveries vary by sector, and sector-level recoveries may be influenced by collateral available, differences in financing structures (e.g. a higher/lower propensity for asset-based financing or secured or unsecured debt), as well as by cyclical and structural imbalances. When many defaults in a sector are concentrated around the end of a cycle of overinvestment and overleverage, recoveries tend to fall. For instance, telecommunications recoveries are weighed down by a glut of defaults that followed the bursting of the tech and telecom bubble in 2001 and 2002, just as homebuilders and real estate recoveries are brought lower by the concentration of defaults from the U.S. housing crisis in 2008 and 2009 (see table 3).

Table 3

The Distribution Of Recoveries Varies By Instrument

Given their seniority in the debt structure, term loans and revolving credit facilities tend to show higher recoveries than bonds and notes. For loans and revolvers, recoveries of par or greater occur much more often than for bonds or notes. Most defaulted loans and revolvers experienced elevated recoveries of 80% or higher, and nearly 27% of loans and revolvers recovered at par or greater (see chart 8).

Chart 8

On the other hand, the distribution of bond and note recoveries skews lower. Less than 5% of defaulted bonds and notes have recoveries at par or greater, while 27% of defaulting bonds and notes experienced negligible recoveries of 10% or less (see chart 9).

Chart 9

Definitions

We define recoveries as the ultimate recovery rates following emergence from three types of default: bankruptcy filings, distressed exchanges, and nonbankruptcy restructurings. We exclude instruments that did not default from this study. Unless specified otherwise, we base recoveries at the instrument level, and we discount them by using each instrument's effective interest rate.

In the S&P 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 we use this date 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 nondiscounted 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 periods more comparable by preventing any major bias that could arise if times between default and emergence differed greatly. S&P Global Ratings provides recovery ratings that map to nominal values.

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 be liquidated. On emergence from bankruptcy, creditors often receive a cash settlement, new instruments (possibly debt or equity), assets or proceeds from the sale of assets, or some combination thereof.

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 S&P 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 valuation methods, this one is the most readily available because most debt instruments continue to trade during bankruptcy proceedings.

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. This method 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 Research

• Distressed Exchanges Are The Leading Reason For Defaults In 2019, Nov. 7, 2019
• U.S. Leveraged Finance Q3 2019 Update: First-Lien Recovery Prospects Improve As Investors Focus On Capital Structure Mix, Nov. 5, 2019