Default, Transition, and Recovery:

Til Debt Do Us Part: Serial Defaults In The U.S. Show Lower Recoveries And Higher Losses
Global Fixed Income Research: Diane Vazza, Managing Director, New York (1) 212-438-2760; diane.vazza@standardandpoors.com Evan M Gunter, Associate Director, New York (1) 212-438-6412; evan.gunter@standardandpoors.com

Table Of Contents
Definitions Related Research:

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Default, Transition, and Recovery:

Til Debt Do Us Part: Serial Defaults In The U.S. Show Lower Recoveries And Higher Losses
Many of this year's defaulting companies have previously defaulted, either through a bankruptcy or a distressed exchange. Looking at a sample of serial defaulters from 2001 to mid-2013, we see that the average recovery decreases and the dollar value of defaulting debt increases when a company defaults multiple times. In particular, overall instrument recovery drops when the second default is a bankruptcy. During the Great Recession, the U.S. saw a wave of corporate defaults as companies bargained with investors to extend maturities, lower principal balances, and buy-back debt at a discount. These 'distressed exchanges' enabled many companies to stave off bankruptcy and buy time until liquidity returned to the credit markets. In order to avoid bankruptcy and its related costs, lenders maximize a firm's value through a distressed exchange. While this may prevent an immediate bankruptcy, it could leave a firm hindered by an unsustainable debt structure. Though the U.S. credit market has been flush with liquidity for most of this year, we're still seeing an increase in serial defaulters. For the purposes of this study we considered both distressed exchanges and bankruptcies as a form of default, and included all instruments that missed a principal or interest payment. Looking at a sample of 26 issuers that have defaulted multiple times from 2001 through the first half of 2013, we found that the average instrument recovery rate fell by 16% from the first default to the second (see chart 1). For this instrument-weighted average, we weighted all defaulted instruments equally, regardless of their size. Alternatively, if we weight the recoveries by the total dollar amount of defaulting debt, overall instrument recovery fell by 7% after the subsequent default. The sharpest decline in recovery rates was felt by bondholders, with average bond recoveries falling 29% from the first default to the second (or 23% on a dollar-weighted basis). This dollar-weighted basis is the sum of the dollar amount of debt recovered divided by the sum of all defaulted debt in the sample. Though a small number of large deals in the sample can skew the dollar-weighted average recovery, it may also more closely reflect an investor's experience than an instrument-weighted average would.

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Default, Transition, and Recovery: Til Debt Do Us Part: Serial Defaults In The U.S. Show Lower Recoveries And Higher Losses

Chart 1

High levels of leverage, cyclical performance, and a history of debt-fueled acquisitions or leveraged-buyouts are common characteristics of serial defaulters. The per-company value of defaulting debt rose from $1.4 billion for the first default to $2.0 billion for the second. Many companies initially defaulted through a distressed exchange, with subsequent defaults tending toward bankruptcies. The average time between defaults for these companies is two years. The majority of serial defaulters in this sample are nonfinancial corporates, with the notable exception being Residential Capital LLC, which defaulted twice in 2008. The type of default is an important factor for determining recovery rates, and the prevalence of distressed exchanges has helped to raise the average recovery for initial defaults. Bankruptcies typically exhibit lower recoveries than distressed exchanges, especially for bonds. The instruments with the lowest average recovery in our sample were bonds during a company's second default, especially if the default was a bankruptcy. Aside from default type, another key factor for determining recovery is the type and seniority of an instrument. A company's capital structure may include a range of instruments with different seniorities and collateral. As creditors struggle to recover value after a default, the company's debt structure can make a big difference. Loans often show higher recovery values on average than bonds as they are higher than bonds in the capital structure and are more frequently secured.

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Default, Transition, and Recovery: Til Debt Do Us Part: Serial Defaults In The U.S. Show Lower Recoveries And Higher Losses

In our study, we compared 178 bonds and 74 loans from 26 serial defaulters. Bond recovery rates averaged 55% on a discounted basis after the initial default, dropping to 26% after subsequent defaults (see table 1). While the average bond recovery fell less sharply on a dollar-weighted basis, from 57% to 35%, the drop in the average recovery remains steep. The amount outstanding of defaulting bonds dipped slightly from $32.7 billion in initial defaults to $31.0 billion in subsequent defaults. In the second round, the debt structures of the defaulting companies included more loans than in the first round. As loans comprised a larger share of the defaulting instruments, less of the firms' residual value and assets was left to repay bondholders. While average bond recovery fell sharply, loans held up much better. Loan recovery averaged 81% (discounted) after the initial default, only falling to 76% after the subsequent default. If we weight recovery performance by dollar value, loans performed better in the subsequent round of defaults than during the initial round. The dollar weighted average of loan defaults from initial defaults was 68%, rising to 76% for the second round. With this relatively small pool of loans in the initial round of defaults, the dollar-weighted recovery value can easily be skewed by one issuer. With a distressed exchange on $880 million in loans in 2002, Superior Telecom Inc. comprised a third of our total sample for initial loan defaults. The 35% recovery rate for these loans brings the total average for dollar-weighted loan recoveries down. If we were to exclude Superior Telecom's loans from the initial round, then the average would rise from 68% to 85%.
Table 1

Recovery Rates For Serial Defaulters (2001-2013)

Issue-weighted recovery (%) Initial default Loan Bond Total Subsequent default Loan Bond Total 75.7 26.3 44.4 75.9 34.7 51.0 55 95 150 20.2 31.0 51.3 81.0 55.2 60.0 68.3 57.2 58.1 19 83 102 2.6 32.7 35.3 Dollar-weighted recovery (%) Instrument count Default amount (Bil. $)

Data includes all defaulting instruments of the serial defaulters. Source: Standard & Poors CreditPro and Standard & Poors Global Fixed Income Research.

Loans comprised only a small portion of the initial pool of defaulted instruments (19% of total instruments), though this portion grew to 37% in subsequent defaults. The dollar value of defaulting loans grew from $2.6 billion in the first round of defaults to $20.2 billion for the second round. The 26 issuers in the study had $35.3 billion in debt that defaulted during the initial default, with the total climbing to $51.3 billion in the subsequent default. One reason for this is that distressed exchanges often affect a much narrower portion of a company's debt than a bankruptcy. For example, Charter Communications Holdings LLC (the holding company for Charter Communications Inc.) initially defaulted through a distressed exchange in 2005 on senior notes with $6.5 billion in outstanding principal. At the time, Standard & Poor's noted that this exchange "meaningfully

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extended debt maturities" for the notes, and "minimally reduced debt leverage" for the company. Charter Communications later filed for Chapter 11 bankruptcy on March 27, 2009, affecting approximately $21.7 billion in outstanding debt. Eighteen of the 26 initial defaults by companies in this study were distressed exchanges. For the second round the number of distressed exchanges dropped to seven, as bankruptcies became the most common form of default. Bond recoveries fell with the higher occurrence of bankruptcy and the greater prevalence of more senior loans among the defaulted instruments. One example of this is theme park operator Six Flags Theme Parks Inc. We lowered our corporate credit rating on Six Flags to 'SD' (selective default) on June 16, 2008, when the company completed an exchange offer on senior notes, recovering around 70%. One year later, all of the issue-level ratings for Six Flags and its related entities were lowered to 'D' when the company filed for bankruptcy. In this subsequent default, loans recovered 99% and bonds recovered 42%. If we compare the initial defaults of serial defaulters to overall defaults by all issuers (see table 2), we see that the initial defaults of serial defaulters had higher average recoveries for both bonds and loans than overall defaults. These above-average recovery rates set the bar high for subsequent defaults. In our prior studies, average loan recoveries are less affected by the type of default than bond recoveries are. Since 2001, loan recoveries following a bankruptcy have averaged 74%, with loan recoveries following a distressed exchange dropping to 62%. However, with only 22 loans in our sample having defaulted through a distressed exchange, this average is heavily skewed toward defaults occurring during periods of recession when recoveries are generally lower.
Table 2

Overall Recovery Rates For Corporate Defaulters (2001-2013)

Issue-weighted recovery (%) All defaults Loans Bonds Total Bankruptcies Loans Bonds Total Distressed exchanges Loans Bonds Total 62.3 49.0 50.0 53.3 51.1 51.3 22 280 302 7.8 110.4 118.2 73.4 37.0 52.9 68.9 34.7 49.3 836 1,077 1,913 197.0 265.0 462.0 73.2 39.5 52.5 68.3 39.6 49.7 858 1,357 2,215 204.7 375.4 580.2 Dollar-weighted recovery (%) Instrument count Default amount (Bil. $)

Data includes all defaulting instruments, and is not limited to serial defaulters. Source: Standard & Poors CreditPro and Standard & Poors Global Fixed Income Research.

In these prior studies, we've also shown that bonds typically have higher recoveries through distressed exchanges than through bankruptcies. During the recent credit cycle, the Great Recession in particular, there was a spike in the number of distressed exchanges as companies struggled to find liquidity and investors were concerned that

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bankruptcies could result in little or no recovery of their debt. In our sample, which goes back to 2001, distressed exchanges for bonds have recovered 49% on a discounted basis, while bankruptcies have resulted in average bond recoveries of 37%. On a dollar-weighted basis these recoveries have been 51% after distressed exchanges, dropping to 35% after bankruptcy. In large part, the discrepancy between recoveries after the initial default and subsequent ones can be explained by the different default types and debt mix. Initial defaults were more frequently distressed exchanges, which typically offer higher recoveries than bankruptcies. This is to be expected, as a rational investor would only accept the exchange if it offered a higher recovery than they would expect to get from a bankruptcy reorganization. Subsequent defaults in this study were more often bankruptcies, either as investors may have become less willing to support a subsequent exchange, or as defaulting companies may have had less room to negotiate an acceptable alternative to bankruptcy. With the prevalence of distressed exchanges in the first default for a serial defaulter, this first round typically shows an above-average recovery on a relatively narrow slice of company debt. However, a lower recovery could follow.

Definitions
Ultimate recovery is the value of the settlement a lender receives by holding an instrument through its emergence from default. The recovery is based on the amount received in the settlement divided by the principal default amount. Data for this report is based on the LossStats database in S&P Capital IQ's CreditPro. We define recoveries as the ultimate recovery rates following emergence from three types of default: bankruptcy filings, distressed exchanges, and nonbankruptcy restructurings. For this study we based recoveries at the instrument level, and we discounted the recovery to account for the time value of money. The coupon rate at the time the last coupon was paid is the effective interest rate used for the discount factor. We calculated the discounted recovery values by discounting instruments or cash received in the final settlement on the valuation date back to the last date that a cash payment was made on the prepetition instrument. The last-cash-pay date represents the true starting point for the interest accrual, which is why this date is used as the starting point for the discounting rather than the default date of the instrument or the bankruptcy date of the company. For fixed-coupon instruments this is the fixed rate, and for floating-rate instruments it is the floating rate used at the time of default. We prefer discounted rates in this study because they allow us to better compare bankruptcies of different lengths. For example, the nominal rate on a distressed exchange could be the same as that on a bankruptcy case that takes two years. However, investors in the bankruptcy case are significantly worse off because they could lose significant time value while waiting for the final settlement. On the other hand, a distressed exchange could take only a day. In a historical study, discounted recovery rates offer the major benefit of making different time periods more comparable by preventing any major bias that could occur if time between default and emergence differs greatly. Note that Standard & Poor's provides recovery ratings that map to nominal values. This is appropriate because it lets investors choose their own discount rates when making decisions based on their nominal estimates.

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Related Research:
Default, Transition, and Recovery: Global Corporate Default Tally Remains At 58 Issuers With No Defaults This Week, Sept. 26, 2013 European Default Update: Serial Defaulters Pressure Europe's Corporate Sector, Sept. 9, 2013 Default, Transition, and Recovery: Recovery Study (U.S.): Recoveries Come Into Focus As The Speculative-Grade Cycle Turns Negative, Dec. 13, 2012 Default, Transition, and Recovery: 'Til Debt Do Us Part: A Study Of Serial Defaulters, Nov. 10, 2010

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