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Tuesday, July 14, 2009

Reading, Reading, Reading

Sorry for the quietness, but I am plowing through a bunch of reports.

In particular, readers might find this Fitch report on recoveries in corporate defaults interesting. It certainly relates to the topic of the prior post. It covers both bonds and loans. You probably have to register to get this pdf.

See, for example, the graph on page 3 which gives current loan recovery rates of 57.5%. That is already 10% below the low of the previous recession, which occurred in 2002. I would expect this to get worse rather than better, and it points up the problem with credit and monetary policy. One can't stimulate with credit when the cash flow to service the loans and keep the company running isn't there, and current economic activity levels are low enough to annihilate debt-loaded companies.

I thought you guys and gals would enjoy this quote, because it made me laugh out loud, which has not occurred for me since I last read a Chinese corporate report (those things are often hysterically funny):
Fitch found that in the period covered by the study, companies with the weakest emergence firm values entered bankruptcy with relatively little bank debt, suggesting that some mechanism, perhaps covenants, allowed senior secured lenders to reduce or avoid exposure to weak credits prior to bankruptcy. However, diminished debt cushions and a pronounced erosion in traditional loan covenants - two trends that accompanied the leveraged loan issuance boom of 2005−2007, are proving to be detrimental to loan recovery rates in this downturn. The average 30-day post-default recovery rate on loans in Fitch’s U.S. High Yield Default Index was just 57.5% in the first five months of 2009, the lowest tally recorded by Fitch in a decade, as shown in the chart above. Changes in underwriting standards can have a very meaningful impact on recovery outcomes.
Well, who'd a thunk? Underwriting reduces losses and loan covenants to stop the flow of money when the underlying credit quality has worsened protect lenders? Where is Gomer Pyle to say "gaaaawlly" when you need him? Believe it or not, Fitch appears to find some sort of revelatory significance in this finding, returning to it later on page 10 with:
Nonetheless, additional findings surrounding secured debt and in particular, senior secured loans (discussed below) suggest that mechanisms were in place that allowed senior secured lenders to avoid the worst bankruptcy situations.
Imitating old Gomer was no longer sufficient to express my feelings, and a loud ejaculation of "No shit, Sherlock" escaped my unladylike lips. On page 11, I collapsed into awed silence at the news that companies with the lowest after-bankruptcy valuations had the lowest ratios of senior secured debt to all debt and that gravity makes objects released from restraint fall toward the largest mass in the area. The data in the report is interesting (see the table on page 17 by industry), but the conclusions are kind of on the Fred Flintstone level.

Anyway, given the current situation, there is not a great deal of badda-bing coming from corporates or small businesses in the months ahead. The losses are just beginning to roll in - generally your maximum credit losses occur a couple of years after the onset of a recession. Maximum credit losses appear to be scheduled to be worse than in the prior recession due to loose lending, and lenders who have indulged in non-underwritten lending are gonna get it in the chops.

Before we all bail out another company, perhaps we should all sit down and contemplate the effective restraints existing in the economy.

Clearly I'm not a Credit Guy, but as student of the markets, I would assume when the young, inexperienced analysts calculated recovery values when making loans, there was no adjustments in LTV to reflect the risk of wholesale liquidation in the borrowers industry. Similar concept as we've seen in Real Estate where entire neighborhoods are toast.
"Existing Restraints on the market"? Does that refer to widespread insilvency? I can't come up with mush else.
Well, industrial production came in this morning down 13.6% over the year, capacity utilization made a new record low at 68%, and manufacturing achieved an awesomely low utilization factor of 64.6%.

Let's face it - running at these levels, or even 5% above these levels, means that the capacity of the economy to absorb new credit is minimal, and the incapacity of the economy to support older debt loads is a severe weakness.

CF - IMO, the lesson of this particular exercise in retrospective futility is that while we were inventing new ways to lose money, we kept using the old ways to lose money.

No doubt it was due in part to youthful optimism, but I kind of cracked up about the differential between bond losses and loan losses and the comments about secured credit. Which entities were rating those bonds, hmmm?
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