Monday, January 12, 2009

Paltry Debt Recovery Rates Anticipated in Economic Downturn

The Financial Times has a very good article about debt recovery rates taking it on the chin in this economic downturn.  If you thought that Lehman bondholders were disappointed by the paltry 9 cents that resulted in the CDS settlement after the company's bankruptcy, try being a Tribune bondholder.  The settling of credit derivatives linked to the Tribune bankruptcy provided a mere 1.5 cents on the dollar for bonds, with Tribune's loans settling at 23.75 cents.  Historical bond recovery rates have been around 40 cents on the dollar while historical loan recovery rates have hovered around 87 cents.  Moody's head of corporate default research claims those rates might fall as low as 15 cents for bonds and 52 cents for loans in this downturn.  Sadly, even those levels might prove to be optimistic. 
The explanation for the bleak situation facing bond and loan investors who hold debt in companies that go bankrupt is summed up nicely by David Bullock, managing director at Advent Capital: "You have leverage at historically high levels in an economy that is in historically dire straits."  Furthermore, due to loose covenants struck during the go-go days of the credit boom, companies are allowed to operate longer before triggering a default, assets are therefore depleted and liquidations result in lower recoveries once the company finally does go bankrupt.  It would be easy to pity the poor bond investor who is suffering from this unprecedented downturn.  But covenants were invented so that bond investors could protect themselves if conditions at a company deteriorated unexpectedly.  Why bond investors lost their discipline and chose to lend money without asking for any protection in return at record low risk premiums during the credit boom will always be a mystery to me.  Now they must pay the price.  The real pity is that their reckless lending has inflicted so much pain on the rest of the economy.       

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