Back in March, this website first point out how the current default cycle is so different from previous ones: as we reported half a year ago, the key difference was that recovery rates of defaulted debt had plunged to record lows. JPM's Peter Acciavatti confirmed as much, noting that "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."
The low recovery theme was also observed by credit guru, Edward Altman, who in an interview with Goldman's Allison Nathan said that "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."
Just last week, a handy visualization courtesy of Bond Vigilantes showed the record divergence between the average high yield price and the average recovery rate.
Fast forward to today, when at least one rating agency, Moody's, finally caught up with what readers of Zero Hedge knew half a year ago. Bloomberg summarizes a report released by Moody's on Monday, creditors of energy exploration and production companies that went bankrupt last year recouped less than half the usual amount for their claims, and 2016 is shaping up just as bad.
Moody's even went so far as to even use the "C" word: "Recovery rates for 15 U.S. E&P bankruptcies averaged a “catastrophic” 21 percent last year, well below the historical average of 59 percent, Moody’s said in a report released Monday."
Recovery rates for creditors at the bottom of the totem pole were even more dramatic: "senior unsecured bondholders were hammered even more, averaging just 6 cents on the dollar" Moody's repeated what we said in Q1, and added that "collectively, the debacle could be worse than the telecom industry’s collapse in the early 2000s, measured by both the number of companies that go bust and the recoveries."
Some more details:
Many of the E&P firms that went bankrupt in 2015 were smaller companies with less flexibility to maneuver as energy prices crumbled, while larger companies were able to stave off failure with debt exchanges and new second-lien issuance, analysts led by David Keisman wrote. But more than half of those swaps were followed by bankruptcy, according to the report. “I don’t expect the recoveries for the companies that went bankrupt in the first half of 2016 to be any better,” Moody’s analyst Amol Joshi said in an interview. “The worst may be behind them, but the sector still remains quite stressed.”
While recoveries for unsecured debt were disastrous as a result of the collapse in the value of the enterprise due to plunging oil prices, secured lenders, i.e., banks saw far more modest losses:
Borrowing base revolvers, loans backed by oil and gas reserves, had the highest recovery rate among asset levels, recouping 81 percent. Despite outperforming other debt, that number fell “significantly” short of the historical average of 98 percent, according to Moody’s.
One, and really the only, reason for the record low recoveries, is that many of the larger E&P companies that pursued distressed exchanges made their situations more dire by increasing the amount of debt they faced, Moody’s said. Historically, distressed exchanges followed by bankruptcies have resulted in lower recoveries, according to the report. “As these investors piled on new money into these companies which were stressed, it only added more debt to their balance sheets while their asset value wasn’t really increasing,” Joshi said. “It prolonged the pain.” And when the pain transitioned to bankruptcy, all the unsecured stakeholders realized they are getting about a nickel on the dollar.
Alas, this is a problem not just for E&P companies, but for all companies in both the US and around the globe: as we showed over the weekend, the amount of corporate debt as a % of GDP is now at levels that screams recession, while since the financial crisis the absolute amount of debt issued has doubled, guaranteeing that when the default cycle spreads to all other indutries, recoveries will be just as dire.
As for the energy sector, the default picture remains just as dire in 2016 as they were one year ago: bankruptcies in the sector thus far this year are already about twice 2015’s total, according to the report. Moody’s is monitoring 25 E&P companies that have sought court protection in 2016.