Investors see bigger losses on defaults

By Anousha Sakoui in London Published: April 20 2009 03:00 Last updated: April 20 2009 03:00 Investors face bigger losses on defaulted debt than in previous downturns as companies crumble under the weight of the complex debt structures created in the boom years. Last week, an auction to settle claims on credit default swap contracts - a form of insurance against a default on company debt - set the recovery on bonds issued by chemical company LyondellBasell (whose US unit is in Chapter 11 bankruptcy protection) at just 2 per cent of face value - or €2 for every €100 ($131) of bonds held. "The result of the Lyondell-Basell auction highlights to investors how low recoveries are going to be in this cycle," said Mahesh Bhimalingam, credit strategist at Barclays Capital. Investors would normally expect to recover 40 per cent of the value of defaulted junk bonds and between 70 and 100 per cent for loans. But Mr Bhimalingam forecasts loan recoveries at 40 per cent on average and defaulted bonds at under 10 per cent. The situation is much worse for investors in mezzanine, or more subordinated, loans. They can expect to recover on average just 8.5 per cent, according to research by Fitch, the ratings agency. The credit crisis and recession is increasing the potential magnitude of losses as falling earnings and availability of financing, together with little activity among trade buyers, makes restructuring much harder. Recoveries were expected to be worse due to the size and complexity of debt structures, the number of stakeholders involved and the added complexity of companies operating across borders. In the restructuring of chemicals company Vita, its private equity owner is providing fresh funds in exchange for maintaining majority equity control. Senior lenders received a smaller equity stake but had to write off two-thirds of their debt claims. An auction to settle CDS claims on its loans determined the recovery on the most senior loans at just 15 per cent. An auction of CDS on luxury boat maker Ferretti's senior loans set the estimated recovery rate at 10.875 per cent of face value. The situation is not set to improve for a while. In a recent report, Fitch Ratings said it did not expect companies to recover from the credit crisis until mid-2011. The credit quality of leading companies continues to deteriorate. Moody's recently said the ratio of companies having their credit ratings cut versus the number of companies being upgraded - an indicator of declining credit quality - had reached its highest level since 1983.