Loan recoveries slump as investors bank on rebound

Charlie Dinning

Data journalist

The average recovery rate for defaults in 2023 has declined considerably due to a combination of factors such as: cov-lite loans, priming activity in previous years, loan-only borrowers defaulting, and the sectors in which the defaults have been concentrated.

Dan Ko, senior principal and portfolio manager at Eagle Point Credit Management says that “cov-lite leads to lower defaults, but also lower recoveries as the issuer has the benefit of time to work through challenging environments. But if the issuer ends up heading to a bankruptcy or restructuring, there may be limited cash or collateral left.”

This can be seen in the case of Diamond Sports (which has a quoted recovery rate around 10%) and other recent defaults, specifically in retail, as Laila Kollmorgen, portfolio manager at PineBridge Investments, points out.

“Recoveries are sector specific. For example, a few recent defaults with low recoveries have been in retail, which had very little collateral to sell off. Once they sell the stock and pay off the ABL, you’ve got nothing left.”

“Recoveries are sector specific”

Laila Kollmorgen, Portfolio manager | PineBridge Investments

Some borrowers that have very low recovery rates are also companies that only issued loans, instead of a loan and bond mix. This can also have a material impact on recovery rates, according to Ko.

“Loan-only issuers tend to have a lower recovery rate than loan and bond issuers,” he says. “Since loans in a loan-only structure are the junior-most tranche above the equity, they have less credit subordination if there is a default.”

Priming in previous years has also been a factor in some defaults, but not all priming has been coercive or unfair, according to sources. In the case of Diamond Sports, for example, the new priming money was offered to all lenders equally and managers had the option of whether to take part. Those that did have seen a considerably higher recovery rate quoted on the new money.

While recovery rates are much lower than previous years, this ultimately does not reflect the true value of the return managers can get, sources say. The recovery rate is often quoted as the price of the loan 30 days after the loan has defaulted and similar to where the loan was trading before it defaulted, according to market participants.

Recovery rates are expected to rebound but not reach previous levels of around 75%, sources say. Philip Raciti, head of performing credit at Bardin Hill, says: “Recovery rates could be about 10 points down from where they once were and somewhere between bond and loan recovery levels of around 65%.”

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Global credit funds & CLO's

May 2023 | Issue 254

Published in London & New York.