Defaults Surge, Recoveries Sink in 2009: Understanding the Fundamental and Cyclical Drivers of Corporate Recovery Rates

by Mariarosa Verde of Fitch Ratings,
Eric Rosenthal of Fitch Ratings,
Timothy Greening of Fitch Ratings, and
Mark Oline of Fitch Ratings

July 6, 2009

Summary: A surge in corporate defaults, a consequence of the financial and economic crisis, is unmistakably under way. The U.S. high yield default rate, which a year ago stood at just 2.4% on an annual basis, soared to 9.5% in the first six months of 2009. Just as troubling, while some signs have emerged that the U.S. economy is stabilizing, Fitch believes that defaults will not ease in 2009 or likely even 2010. The record number of companies highly vulnerable to default, with capital structures designed for booming economic conditions and many in industries facing significant challenges, would need an exceptionally strong economic rebound accompanied by forgiving credit markets in order to avoid some form of debt restructuring over the coming year. The U.S. high yield default rate is expected to end this year in a range of 15%-18%.

In this environment, recovery rates, the true measure of loss associated with defaults, are of paramount interest. In this new study Fitch seeks to demystify recovery rates, offering a broad look at their behavior shortly after default, at emergence from bankruptcy and at varying points in the credit cycle. While the study offers insight into the many complex drivers of recovery outcomes using the last cyclical surge in defaults as a frame of reference, importantly, it provides perspective on current conditions. Recovery rates on bonds and loans have dropped precipitously in early 2009, averaging 21.8% and 57.5%, respectively, well below levels recorded in recent years, and reminiscent of the 2000-2002 period. In fact, due to structural issues associated with the leveraged loan issuance boom of 2005-2007, loan recovery rates are showing an even worse trend than in the last downturn.

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