Estimates of Recovery Rates

Credit rating agencies measure recovery rates using the value of the debt right after default. This is viewed as the market's best estimate of the future recovery and takes into account the value of the firm's assets, the estimated cost of the bankruptcy process, and various means of payment (e.g., using equity to pay bondholders), discounted into the present.

The recovery rate has been shown to depend on a number of factors.

■ The status or seniority of the debtor: claims with lower seniority have lower recovery rates.

■ The state of the economy: recovery rates tend to be lower when the economy is in a recession.

Ratings can also include the loss given default. The same borrower may have various classes of debt, which may have different credit ratings due to the different level of protection. If so, debt with lower seniority should carry a lower rating.

Tables 19-7 and 19-8 display recovery rates for corporate debt. Moody's, for instance, estimates the average recovery rate for senior unsecured debt at f = 49%. S&P estimates this number at around f = 47%, which is quite close. Generally, agencies conservatively estimate recovery rates to be in the range of 25 to 44 percent for senior unsecured bonds. Derivative instruments rank as senior unsecured creditors and would be expected to have the same recovery rates as senior unsecured debt. Bank loans are usually secured and therefore have higher recovery rates, typically assumed to be in the range of 50 to 60 percent. As expected, subordinated bonds and preferred stocks have the lowest recovery rates, typically assumed to be in the range of 15 to 28 percent.

TABLE 19-7: Moody's Recovery Rates for U.S. Corporate Debt

Seniority/Security

Min.

1st Qu.

Median

Mean

3rd Qu.

Max.

Std.Dev.

Senior/Secured bank loans

15.00

60.00

75.00

69.91

88.00

98.00

23.47

Equipment trust bonds

8.00

26.25

70.63

59.96

85.00

103.00

31.08

Senior/Secured bonds

7.50

31.00

53.00

52.31

65.25

125.00

25.15

Senior/Unsecured bonds

0.50

30.75

48.00

48.84

67.00

122.60

25.01

Senior/Subordinated bonds

0.50

21.34

35.50

39.46

53.47

123.00

24.59

Subordinated bonds

1.00

19.62

30.00

33.17

42.94

99.13

20.78

Junior/Subordinated bonds

3.63

11.38

16.25

19.69

24.00

50.00

13.85

Preferred stocks

0.05

5.03

9.13

11.06

12.91

49.50

9.09

All

0.05

21.00

38.00

42.11

61.22

125.00

26.53

TABLE 19-8: S&P's Historical Recovery Rates for Corporate Debt

Average

Simple

Standard

Weighted

Seniority

Number of

issue size

average

deviation of

average

ranking

observations

($ million)

Price

Price

Price

Senior secured

91

117.8

54.28

24.25

49.32

Senior unsecured

237

97.5

46.57

25.24

47.09

Subordinated

177

145.5

35.20

24.67

32.46

Junior subordinated

144

81.9

34.98

22.32

35.51

Total

649

110.0

41.98

25.23

40.23

Source: S&P, from 649 defaulted bond prices over 1981-1999.

Source: S&P, from 649 defaulted bond prices over 1981-1999.

There is, however, much variation around the average recovery rates, as Table 19-7 shows. The table reports not only the average value but also the standard deviation, minimum, maximum, and first and third quartile. Recovery rates vary widely. In addition, recovery rates are negatively related to default rates. During years with more bond defaults, prices after default are more depressed than usual. This correlation creates bigger losses, which extends the left tail of the credit loss distribution.

Another difficulty is that these recovery rates are mainly drawn from a sample of U.S. firms, which fall under the jurisdiction of U.S. bankruptcy laws. Differences across national jurisdictions will create additional differences among recovery rates. So, these numbers can only serve as a guide to non-U.S. recovery rates.

Credit Reports Inside Out

Credit Reports Inside Out

Powerful Tips For Legally Improving Your Credit Score

Get My Free Ebook


Post a comment