In March we explained how 'this credit cycle was different' as recovery rates of defaulted debt had plunged to record lows.
Recovery rates in 2016 are extremely low... for high-yield bonds, the recovery rate YTD is 10.3% (10.5% senior secured and 0.5% senior subordinate), which is well below the 25-year annual average of 41.4%. Final recovery rates in 2015 for high-yield bonds were 25.2%, compared with recoveries of 48.1%, 52.7%, 53.2%, 48.6%, and 41.0% in full-years 2014, 2013, 2012, 2011, and 2010, respectively. Notably, average recoveries for Energy and Metals/Mining bonds were 18.3% and 20.0%, respectively, which weighed down overall high-yield recovery rates. Excluding the troubled commodity sectors, high-yield recoveries were a more respectable 46.1% (32.1% Ex-Energy only). As for loans, recovery rates for first-lien loans thus far in 2016 are 24.5%, compared with their 18-year annual average of 67.2%. Final 2015 1st lien recoveries were 48.2%, while average recoveries for Energy and Metals/Mining 1st lien loans were 44.1% and 38.4%, respectively.
The record collapse in recovery rates is shown below.
It is not just JPM who points out what we first noticed in January: in an interview with Goldman's Allison Nathan, credit guru Edward Altman reiterates that same warning, although he focuses on the 2015 recovery rate which already is more than two times higher than that seen in 2016 defaults:
Allison Nathan: What is your view on recovery rates?
Edward Altman: Our approach to recovery rates is not centered on sectors. What we’ve looked at carefully over 25 years is the correlation between default rates and recovery rates. As you would expect, when the former rise to high or above-average levels, you always observe the latter dropping to below-average levels. This strong inverse relationship is as much a function of supply and demand as it is of company fundamentals. So if we are expecting a higher default rate in 2016 and even 2017, then we would expect a lower recovery rate. Already in 2015, the recovery rate dropped dramatically relative to 2014 even though the default rate was below average; we saw a 33-34% recovery rate versus the historical average of 45%, measured as the price just after default. This is primarily due to the heavy concentration of energy companies whose recovery rates depend on their ability to liquidate their assets at reasonable prices, which in turn depends on the price of oil. Low oil prices have pushed recovery rates in the energy sector below 25% and even into the single digits for some companies. And that’s going to continue. So this year I expect recovery rates much below average, producing a double-whammy of high default rates and low recovery rates for credit investors.
Since then recovery rates have dropped even further... BUT high-yield bond prices have surged on the back of ECB, BOE buying and the knock-on effects of $200 billion per month of 'experimentation' by the world's central-planners...
Simply put, the revelation of a default event exposes the vast gap between 'real' asset values (upon liquidation or bankruptcy) and the artificially supported 'prices' seen in bond markets.
In the 30 year life of the so-called junk bond market, the chasm between reality and central-planner-created markets has never been wider.