Post-default recovery rates for loans are showing signs of weakening, following the 2021 rebound. Extremely favorable financing conditions in 2021 lifted recoveries across debt types as default rates fell, and these tailwinds have lifted bond recoveries so far in 2022. With this uplift, bond and note recoveries now exceed pre-pandemic averages. However, average term loan recoveries between 2020-2022 (through September) remain lower than pre-pandemic, and several structural factors, including shrinking debt cushions and weakening covenant protections, have been weighing on loan recoveries so far in 2022. S&P Global Ratings believes these structural factors will weaken recoveries in the next downturn.

Recoveries Improved In 2021 As Defaults Fell And Financing Conditions Eased

Recoveries sharply improved in 2021 during the period of falling default rates and exceptionally favorable financing conditions. The U.S. trailing-12-month speculative-grade corporate default rate dipped to 1.54% for 2021, down from 6.65% the previous year as business and financial conditions broadly improved with the economic rebound.

Recoveries increased in 2021 for both bonds and loans, with each exceeding long-term averages, (see chart 1). But with financing conditions deteriorating and defaults beginning to tick up, loan recoveries have started to dip in the first three quarters of 2022.

Chart 1

During years with few defaults, recoveries have tended to be higher as the conditions that support lower default rates also tend to support higher recoveries. This certainly held true in 2021. Bond and note recoveries approached a 56% recovery during the year, as the speculative-grade default rate dipped to 1.54%.

Chart 2

Likewise, easy financing conditions tend to coincide with periods of higher recoveries. Financing conditions approached some of their most favorable levels in 2021, before the shock of inflation and central bank tightening sparked volatility in 2022 and uncertainty dampened financing activity. Fortunately, many of the riskier borrowers had been able to access necessary funding during the sweet spot of 2021, lowering default rates and boosting recovery values.

Chart 3

Meanwhile, for loans and revolvers, even though recoveries ticked up in 2021 amid easing financing conditions, recoveries remained only slightly above their long-term average of 73.3% and then once again dipped below this level in 2022.

Term-loan structures have been weakened in the past several years amid strong investor demand, leading to higher first-lien leverage, slimmer debt cushions, and weakening covenant protections. These structural factors could weigh on loan recoveries as defaults eventually rise.

For most debt types, the 2021 rebound helped to lift average recoveries from 2020 through September 2022 to above the average pre-COVID levels. Recoveries in 2020-2022 for revolving credit, second-lien term loans, secured bonds and senior unsecured bonds are each now at, or above, their average levels from 2019 and before (see chart 4).

Only first-lien term loans and subordinated bond recoveries remain below their pre-COVID averages.

Chart 4

We based our analysis for this study on data from S&P Global's LossStats, which is available through S&P Global Market Intelligence's CreditPro. The database provides ultimate recovery values for over 4,500 defaulted instruments from over 1,100 U.S. issuers that emerged from default between 1987 and September 2022. Except where noted, recovery values we cite refer to the discounted recovery, where the discount rate applied is the instrument's effective interest rate.

This approach to calculating recoveries differs from that of S&P Global Ratings' recovery ratings methodology (and recovery studies based on that methodology). S&P Global Ratings' recovery ratings indicate recovery prospects of a given loan or bond from a speculative-grade issuer, calculated on a nominal basis, based on future hypothetical default scenarios. For more details on the approaches, please see the "Definitions" section.

Growing Leverage Concentrated In Senior Debt

Leverage has steadily been increasing for broadly syndicated loans since 2010--and this stands to weigh on loan recoveries going forward. Average leverage for new-issue large corporate loans grew from a 3.9x ratio of loan debt to EBITDA in 2010 to 5.3x in 2021, according to LCD Pitchbook. Leverage rose further (to 5.4x) in the first three quarters of 2022, even amid the steep drop in issuance.

Although second-lien and subordinated debt buffers grew among the relatively fewer deals that came to market in 2022, first-lien leverage has yet to fall (see chart 5).

Chart 5

Eroding Debt Cushions Contributing To Lower Loan Recoveries

Average recoveries of loans and revolvers have fallen well short in 2021 of where they stood in prior years that had comparable default rates. The low 1.54% speculative-grade default rate in 2021 was very close to the default rate from 2006 and 2014. Yet loan and revolver recoveries averaged near 90% in those years, considerably higher than 2021's average of 77.7% (see chart 6).

Chart 6

The growing concentration of leverage in first-lien term loans has contributed to the erosion of debt cushions. With more debt concentrated in first-lien, less-junior and subordinated debt is available to cushion first lien in the event of a default.

This narrowing of debt cushions since prior cycles could contribute to lower rates of recovery for secured loans (with slimmer cushions) and for more subordinated instruments (with more secured debt above).

Most of the first-lien term loans emerging from default in 2020-2022 have had notably thinner debt cushions than those loans that defaulted in earlier years.

• The median debt cushion for loans emerging from default in 2020-2022, was just 5%--reflecting a sharp decline from 42% for loans emerging from 1987-2019.
• Just one loan (representing 1.5% of our sample of first-lien term loans) emerging from default in 2020 through third quarter 2022 has had a debt cushion as large as 75% of the debt structure; versus 12% from prior years.
• Nearly 72% of loans emerging in 2020-2022 had debt cushions of just 25% or less--more than double the share of prior years.

Chart 7a

Chart 7b

First-lien term loans with less cushion from subordinated debt tend to exhibit lower recoveries. Historically, first-lien term loans with a debt cushion of 75% or more of the debt structure showed an average recovery of 88.5%, while loans with a debt cushion of 25% or less showed an average recovery of 62.0% (see chart 8).

Chart 8

Despite Falling Loan Issuance Volumes, Covenant-Lite Predominates

Deteriorating financing conditions contributed to a collapse in leveraged loan issuance volume in 2022. Although institutional volumes fell 62% in 2022 (through November, according to LCD Pitchbook) with investor demand cooling, "cov-lite" loans (those without financial maintenance covenants) continued to rise as a share new broadly syndicated issuance. Cov-lite accounted for close to 92% of the new institutional first-lien term loans issued in 2022 (through November), up from 88% in 2021. Our data suggests these cov-lite loans have lower recoveries than those with financial maintenance covenants.

Chart 9

Our recovery dataset includes a small sample of 62 first-lien term loans that we have identified as covenant-lite and that emerged from default between 2001 and 2022. For the instruments emerging in 2010 and after, cov-lite loans have shown lower recoveries than non-covenant-lite loans. The first-lien cov-lite term loans emerging after 2010 averaged a 60.7% recovery, which is about 12 percentage points lower than the average recovery of non-covenant-lite, first-lien loans over the same period (see chart 10).

Chart 10

We expect recoveries for first-lien term loans will face challenges as new first-lien term loan issuance continues to exhibit rising leverage, shrinking debt cushions, and an absence of financial maintenance covenants--and these are factors reflected in our recovery rating analysis.

Recent Bond Recoveries Show An Upside Surprise

Recoveries from bonds emerging from default in 2020-2022 have come in surprisingly high, averaging 51.7%--12 percentage points higher than the average from 1987 through 2019. While the low default rate in 2021 helped to create favorable conditions for recoveries, strong bond recoveries from a few issuers (including Pacific Gas & Electric Co., Frontier Communications Corp., and The Hertz Corp.) accounted for much of the uplift (see chart 11).

Chart 11

Average recoveries in 2020-2022 (through September) rose for senior secured bonds following both bankruptcy and non-bankruptcy restructurings. Senior unsecured bond recoveries rose following distressed exchanges and remained near flat following bankruptcies. Only the average recoveries for subordinated bonds declined.

The average recovery of senior secured bonds was boosted in large part by Pacific Gas & Electric, which emerged from bankruptcy in 2020. The utilities sector has historically displayed the highest average bond recoveries (see table 1). Many utilities hold critical infrastructure assets and provide essential services, such as power, water, and gas. This supports a business model shielded by regulation, and issuers' ability to add debt is often limited by regulation or secured bond indentures.

Table 1

As in prior years, average bond recoveries were higher following a distressed exchange (or other non-bankruptcy restructuring) than following a bankruptcy. Nonetheless, if the restructuring does not sufficiently address the problems of the firm, then the chance of a repeat default may also be higher.

Among the senior unsecured bonds recovering following a bankruptcy, the average in 2021 was lifted by The Hertz Corp., which benefited from the period of exceptionally favorable financing conditions. A booming market for used and rental cars amid supply-chain disruptions, coupled with strong demand investor demand, enabled Hertz to raise capital post-bankruptcy and shed debt through its restructuring.

Recovery By Instrument Type

Our historical data show how recoveries vary by debt instrument--with more senior instruments exhibiting higher recoveries with lower variance than more junior debt.

• Historically, revolvers show the highest recoveries, with a mean recovery of 79.3% and a median recovery of 95.3%.
• First-lien term loans follow with a mean recovery of 71.1% and a median of 80.5%.
• Second-lien (and unsecured) term loans are considerably lower, with an average recovery of 44.0% and a median of 30.6%.
• These second-lien (and unsecured) term loans show the highest standard deviation (reflecting, in part the relatively small sample size), at 40.6%, and often display a bimodal recovery distribution--either fully paid or not paid at all.

Bonds overall have lower average recoveries than loans, though recoveries vary widely by bond type (see table 2).

• Senior secured bonds have the highest mean recovery, at 57.8% (median of 58.7%)
• Senior unsecured bonds have a mean recovery of 44.8%.

As subordinated debt typically accounts for a small share of the firm's debt structure, there is often no value left to provide recoveries for these instruments in a bankruptcy after the senior debtholders are paid.

• Subordinated bonds show a modal recovery value of zero, even as average recoveries are higher.
• Senior subordinated bonds show an average recovery of 29.9%.
• Non-senior subordinated bonds show an average recovery of 22.8%.

Table 2

On a nominal basis, where the ultimate recovery value has not been discounted to account for the time between default and emergence, recoveries across the debt structure are notably higher: loan and revolver recoveries average 81.7%, while bond and note recoveries average 47.3%.

In addition to these issue-weighted recovery values, we calculate recoveries on a dollar-weighted basis for both the discounted and the nominal rates (see table 2). For these dollar-weighted recoveries, we calculate the discounted (or nominal) sum of debt recovered and divide it by the total amount of defaulted debt in the sample for that instrument type.

Instruments with lower seniority tend to have a wider range of average recoveries than higher-priority instruments. The coefficient of variation, or the standard deviation scaled by the mean, rises for instruments lower in the capital structure. While the coefficient of variation for loans and revolvers is 42.6%, it rises to 84.8% for bonds overall.

Secured debt tends to show higher recoveries than unsecured debt, and among secured debt, we see variance by collateral type. Debt secured by inventories or receivables shows the highest average recovery, at 91.3%, with a lower standard deviation than other collateral types. Debt secured by a second lien (or below) showed lower recoveries (see table 3).

Table 3

Middle-Market Companies Exhibit Higher Recoveries For Loans Than Larger Entities

As in previous periods, term loans and revolvers from small or middle-market companies (those with $350 million or less in debt outstanding at the time of default) continue to show higher recovery rates than loans from larger companies. Loans and revolvers from middle-market firms averaged an 73.8% recovery in 2020-2022, above the 65.8% average from larger firms (chart 12).

For middle-market loans the sample of middle-market issuers included a much higher concentration of loans and revolvers from the retail and restaurant sector, and these firms in our sample experienced recoveries that were notably above the average recovery recoveries of larger retail and restaurant companies.

Chart 12

Higher recoveries for middle-market companies can reflect several factors, including simpler debt structures (such as unitranche) with fewer lenders than are involved in the debt structures of larger issuers, which can reduce the potential for conflicting lender groups. Furthermore, financial maintenance covenants remain common for middle-market loans.

Recovery rates for middle-market first-lien term loans have averaged 77.9% on a discounted basis since 1987, which is higher than the 67.4% average recovery for first-lien term loans from larger corporate issuers (see table 4).

Table 4

One notable caveat for this data is that we only capture ultimate recoveries from publicly available data sources. With less data available for smaller middle-market and private-credit companies, the pool of companies we capture in this study may not necessarily be representative of broader trends within the middle- and private-credit markets.

The Distribution Of Recoveries Varies By Instrument

Given their seniority in the debt structure, term loans and revolving credit facilities tend to show higher recoveries than bonds and notes. In fact, loans and revolvers show recoveries of par or greater much more often than bonds or notes. Some 56% of defaulted loans and revolvers experienced elevated recoveries of 80% or higher, and 26.0% of loans and revolvers recovered par or greater (see chart 13).

Recovery rates are not quite as high among all first-lien debt. Including first-lien senior secured bonds along with first-lien revolving credit facilities and term loans, 54.4% of the defaulted instruments recovered 80% or more, and 25.1% of first-lien instruments recovered par or greater (see chart 14).

Chart 13

Chart 14

In contrast, the distribution of bond and note recoveries skews much lower. Just 5.2% of defaulted bonds and notes have recoveries at par or greater, while 27.4% of defaulting bonds and notes experienced negligible recoveries of 10% or less (see chart 15).

Chart 15

Definitions

We define recoveries as the ultimate recovery rates following emergence from three types of default: bankruptcy filings, distressed exchanges, and nonbankruptcy restructurings. Unless we specify otherwise, we base recoveries at the instrument level, and we discount them by using each instrument's effective interest rate. Instruments that did not default are excluded from this study.

In the S&P Global LossStats® database, the coupon rate at the time the last coupon was paid is the effective interest rate used for the discount factor. We calculate 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 we use this date 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.

Nominal recovery rates, which are the nondiscounted values received at settlement, are also reported.

We prefer discounted rates in this study because they allow us to better compare bankruptcies of different lengths. For example, the nominal rate for a distressed exchange could be the same as that for 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 periods more comparable by preventing any major bias that could arise if times between default and emergence differ greatly. S&P Global Ratings provides recovery ratings that map to nominal values.

Recovery

Recovery is the value creditors receive on defaulted debt. Companies that have defaulted and moved into bankruptcy will usually either emerge from the bankruptcy or be liquidated. On emergence from bankruptcy, creditors often receive a cash settlement, new instruments (possibly debt or equity), assets or proceeds from the sale of assets, or some combination of these.

Ultimate recovery

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. Within the S&P Global LossStats® database, three recovery valuation methods are used to calculate ultimate recovery:

Trading price at emergence.  We can determine the recovery value of an instrument by using the trading price or market value of the prepetition debt instruments upon emergence from bankruptcy. Of the three valuation methods, this one is the most readily available because most debt instruments continue to trade during bankruptcy proceedings. Note that this approach differs from the commonly used "30 days after default" method, which measures recovery estimates shortly after default, rather than at emergence.

Settlement pricing.  The settlement pricing includes the earliest public market values of the new instruments that a debtholder receives in exchange for the prepetition instruments. This method is similar to the trading price method, except that it is applied to the new (settlement) instrument instead of the old (prepetition) instrument.

Liquidity-event pricing.  The liquidity-event price is the final cash value of the new instruments or cash from the sale of assets that the lender acquires in exchange for the prepetition instrument.

Comparison With Recovery Ratings

The approach we use for assessing recovery in this study is different from how S&P Global Ratings determines its recovery ratings. The recovery ratings are estimates of recovery for debt instruments from entities rated speculative-grade ('BB+' or lower). These recovery ratings indicate recovery prospects calculated on a nominal basis, based on future hypothetical default scenarios and reflecting the expected recovery following an entity's emergence from bankruptcy via a going concern or liquidation. These recovery ratings are issue-specific and range from '1+' (high expectations for a full [100%] recovery) to '6' (0%-10% recovery).

The approach to determining recovery values that we use in this report also differs from that in the study "Recovering From COVID-19: Why The Timing Of Bankruptcy And Emergence Matters For Debt Recovery," published on RatingsDirect on Feb. 7, 2022. That study excluded recoveries following distressed exchanges, and it used the implied recoveries from the bankruptcy plans as the basis for the value received, rather than trading prices, because the bankruptcy plan information was more consistently available for the issuers included in the study. In addition, that study only covers companies going through U.S. bankruptcy and uses actual recovery estimates on a nominal rather than discounted basis.

Related Research

• The Morningstar LSTA U.S. Leveraged Loan Index Default Rate Could Rise To 2.5% By September 2023, Dec. 7, 2022
• The U.S. Speculative-Grade Corporate Default Rate Could Reach 3.75% By September 2023, Nov. 21, 2022
• Fourth-Quarter U.S. BSL CLO And Leveraged Finance Report Asks If Winter Is Coming, Nov. 7, 2022