TEXT-S&P: recoveries poise to fall as the credit cycle turns

Thu Dec 13, 2012 11:54am EST

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Dec 13 - As the credit cycle enters another period of declining credit
quality and the speculative-grade cycle turns negative, investors face rising
defaults and deteriorating recovery prospects, said an article published today
by Standard & Poor's Global Fixed Income Research, titled "Recovery Study
(U.S.): Recoveries Come Into Focus As The Speculative-Grade Cycle Turns
Negative."

"Recently, we've seen a surge in the issuance of bonds rated 'B-' and lower as 
newly issued speculative-grade bond yields near historic lows and investors 
pursue their quest for yield," said Diane Vazza, head of Standard & Poor's 
Global Fixed Income Research. "And although the speculative-grade default rate 
is low, we expect it to increase to 3.7% by September 2013 from 3.0% as of 
September 2012." If the past is any guide, then the turning of the credit 
cycle should prove challenging to future recovery values.

As default rates and credit spreads increase, we tend to see lower average 
recoveries. Conversely, we tend to see higher recoveries when issuance of 
bonds rated 'B-' and lower increases. However, throughout all periods of the 
credit cycle, instruments with higher seniority and higher quality collateral 
tend to have higher recoveries with less variance. 

The speculative-grade bond market runs in cycles. Valuations peak in the boom 
years and fall during the down periods. Similarly, average recovery rates run 
in cycles, varying from year to year. The annual average discounted recovery 
rate has ranged from a low of 35% in 1990 to a high of 70% in 2006. We tend to 
see the sharpest drops in recoveries around periods of recession, since 
corporate stress increases and credit starts to tighten during those periods. 

Ultimate recovery, or the amount that creditors receive from defaulted 
instruments, including bonds and loans, varies substantially and is affected 
by several factors, and not just cyclical ones. The average recovery rate 
generally falls during the "down cycles" in the credit market. Likewise, 
overall average recovery in the U.S. fell to 48.0% across all instruments in 
2008-2009 and average recoveries fell to 29.2% for bonds emerging from 
bankruptcy. On a discounted basis, ultimate recoveries averaged 50.9% from 
1987 to 2012 across all instruments, including average recovery of 73.7% for 
all loans and facilities and 38.0% for all bonds. 

"Standard & Poor's Global Fixed Income Research believes that the credit cycle 
is entering a period of declining credit quality and, as the speculative-grade 
cycle turns negative, recoveries could prove challenging for investors in the 
future," said Ms. Vazza.

The report is available to subscribers of RatingsDirect on the Global Credit 
Portal at www.globalcreditportal.com. If you are not a RatingsDirect 
subscriber, you may purchase a copy of the report by calling (1) 212-438-7280 
or sending an e-mail to research_request@standardandpoors.com. Ratings 
information can also be found on Standard & Poor's public Web site by using 
the Ratings search box located in the left column at www.standardandpoors.com.
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