TEXT-S&P: recoveries poise to fall as the credit cycle turns
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 firstname.lastname@example.org. 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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