NOVEMBER 30, 2011

CORPORATES

SPECIAL COMMENT

Moody's Ultimate Recovery Database

Lessons from 1,000 Corporate Defaults

At 1,000 defaults, our recoveries database highlights the importance of debt structure and the normalcy of the latest default cycle

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Table of Contents: RECOVERIES DATABASE HITS A MILESTONE HOW THE DEFAULT CYCLES STACK UP STRUCTURE MATTERS CONCLUSION MOODYS RELATED RESEARCH

Moodys Ultimate Recovery Database reaches 1,000 defaults. Our database has reached 1,000 defaults of US non-financial companies representing nearly $1 trillion of debt. The database provides detailed recovery data for more than 4,800 defaulted debt instruments dating back to 1988. Data continue to reinforce the importance of debt structure. The average firm-wide recovery for the entire database of 1,000 defaults was 54.5%. Around that figure is a wide range of average instrument-level recoveries, from 80.4% for bank debt to 28.8% for subordinated bonds. This clearly illustrates the significance of an instruments location in a companys capital structure and the amount of subordinated debt beneath it that can take first losses. Recoveries in the latest default cycle were close to historical averages. Despite the severity of the credit crisis, Great Recession and the 2009 spike in speculative-grade defaults, the latest default cycle has been normal in terms of investor recoveries on defaulted debt. The average firm-wide recovery for companies that emerged from default in the 2009-2010 cycle was 58.3%, consistent with the 54.5% average for the full database of 1,000 defaults. Latest default cycle topped the previous two. The average firm-wide recovery in the 2009-2010 default cycle of 58.3% exceeded the cycles of 1990-1992 and 1999-2004 by about 440 and 1,000 basis points, respectively. This reflects the shorter duration of the most recent cycle and the heavy use of distressed exchanges by private equity sponsors.

Analyst Contacts:
NEW YORK 1.212.553.1653

David Keisman 1.212.553.1487 Senior Vice President-Data Products & Consortia david.keisman@moodys.com Thomas Marshella 1.212.553.4668 Managing Director-US and Americas Corporate Finance tom.marshella@moodys.com Randy Lampert 1.212.553.2932 Associate Analyst randy.lampert@moodys.com

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Recoveries Database Hits a Milestone

Moodys Ultimate Recovery Database has reached a milestone of 1,000 defaults covering nearly $1 trillion of debt. The database now includes more than 4,800 defaulted debt instruments issued by US companies. The data stretch across three historical default cycles dating back to 1988. A review of the database at the 1,000-mark puts the most recent default cycle of 2009-2010 into context. Despite the tumult of the credit crisis and Great Recession, firm-wide investor recoveries remained consistent with historical averages and were actually better than they were in the prior two default cycles. This reinforces the importance of a defaulted companys debt structure as the main driver of investor recoveries Figure 1 shows average recovery rates for the 1,000 defaults in Moodys Ultimate Recovery Database and the clear role that seniority plays in recoveries at the instrument level.
FIGURE 1

Moody's Ultimate Recovery Database

Average Recoveries

Bank Debt Senior Secured Bonds Senior Unsecured Bonds Subordinated Debt* All Family Recoveries
Source: Moodys Investors Service *Includes senior subordinated, subordinated and junior subordinated bonds.

80.4% 63.6% 48.4% 28.8% 54.5%

Figure 2 shows the number of emergences from default each year. Defaults only reach the database when investor recoveries are finalized upon emergence from default or completion of a liquidation process. The chart highlights the three major default cycles covered by the database. Of the 1,000 emergences from default, 62% occurred during these three cycles. There will be more as the companies involved in the wave of defaults that peaked in 2009 continue to emerge. There were about 200 defaults of Moodys-rated US companies in 2009, but so far fewer than 125 have emerged.
FIGURE 2

Default Emergences by Year

120 100 80 60 40 20 0

1987

1997

1991

2000

2008

2004

2006

2009

2003

2005

2002

1990

Source: Moodys Investors Service

NOVEMBER 30, 2011

SPECIAL COMMENT: MOODY'S ULTIMATE RECOVERY DATABASE - LESSONS FROM 1,000 CORPORATE DEFAULTS

2007

1988

2001

2010

1998

1994

1996

1989

1999

1993

1995

1992

2011

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In Figure 3 we illustrate the three default cycles, which were of varying lengths, intensities and causes 1: January 1990 December 1992 This default cycle, lasting 36 months, was associated with the recession of the early 1990s, a rash of defaulting leveraged buyouts and a residential real estate downturn. It has been said that many of the companies that defaulted at this time were good businesses with bad debt structures. October 1999 February 2004 This 53-month default cycle was associated with a relatively mild recession, the crashing of the dot-com bubble and defaults in the telecom industry. Many of the telecom and technology businesses that defaulted during this cycle were essentially start-ups with valuations that were more common for mature enterprises. February 2009 - August 2010 This most recent default cycle, shorter in duration at 19 months but more severe than the previous two, was associated with the Great Recession, a credit market crisis and a severe residential real estate downturn.

FIGURE 3

Three Default Cycles

Average Default Level 16.00% US Spec U.S. Speculative-Grade Default Rate

US Trailing 12 Months Speculative-Grade Default Rate

14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00%

11/30/1988 12/31/1987 1/31/1987

53 Months Above Average 36 Months Above Average

12/31/1998 11/30/1999 9/30/2001 9/30/1990 10/31/1989 6/30/1993 4/30/1995 8/31/2002 5/31/2005 8/31/1991 2/28/1997 1/31/1998 2/29/2008 3/31/2007 10/31/2000 5/31/1994 7/31/1992 6/30/2004 3/31/1996 4/30/2006 7/31/2003

19 Months Above Average

12/31/2009 11/30/2010 1/31/2009

0.00%

Source: Moodys Investors Service

How the Default Cycles Stack Up

Figure 4 on the following page shows firm-wide and instrument-level recoveries for the three default cycles in comparison to the entire Moodys Ultimate Recovery Database. The first observation from these data is the outperformance of firm-wide recoveries during the most recent default cycle of 20092010. Despite the Great Recession and sluggish recovery, the freezing of credit markets after the Lehman Brothers bankruptcy, the European sovereign debt crisis, the relentless housing slump and other headwinds, investors actually had an average firm-wide recovery of 58.3%, which was about 440 basis points higher than recoveries in the 1990-1992 default cycle and about 1,000 basis points higher than in the 1999-2004 cycle.

For purposes of this study, a default cycle is defined as the period beginning when the US speculative-grade default rate crosses above the historical average for the period 1988 2011 and ending when it drops back below the historical average.

NOVEMBER 30, 2011

SPECIAL COMMENT: MOODY'S ULTIMATE RECOVERY DATABASE - LESSONS FROM 1,000 CORPORATE DEFAULTS

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FIGURE 4

Average Recoveries in Three Default Cycles

Moody's Ultimate Recovery Database 12/31/1989 12/31/1992 9/30/1999 2/29/2004 1/31/2009 8/31/2010

Bank Debt Senior Unsecured Bonds Subordinated Debt* All Family Recoveries

80.4% 48.4% 28.8% 54.5%

87.7% 56.8% 32.6% 53.9%

75.8% 34.0% 23.1% 48.1%

78.5% 44.5% 25.6% 58.3%

Source: Moodys Investors Service *Includes senior subordinated, subordinated and junior subordinated bonds

If history was a guide, recoveries should have been much worse. The US speculative-grade default rate and recoveries are typically negatively correlated, so the very sharp spike in the default rate in 2009 should have produced unusually low recoveries. Instead, firm-wide recoveries at 58.3% were near the historical average of 54.5% seen over 1,000 defaults dating back to 1988. We attribute this in part to the short tenor of the default cycle. Although it was severe, it was over comparatively quickly. After peaking at 14.6% in November 2009, the US speculative-grade default rate plummeted to 3.6% a year later and it is currently around 2%. Consequently, many companies that defaulted during the crisis actually emerged from default in a more benign environment featuring a much lower default rate. Another driver of stronger recoveries in the latest cycle was the widespread use of distressed exchanges by private equity sponsors. About one quarter of the defaults in the latest cycle were distressed exchanges, compared with about 16% for the entire recovery database. Distressed exchanges typically have higher recoveries than either Chapter 11 proceedings or prepackaged bankruptcies. Private equity firms often prefer to negotiate these defaults out of court in order to influence recovery rates and maintain their equity holdings in the sponsored company. Stripping out distressed exchanges and looking only at bankruptcies, firm-wide recovery rates were 51% in the most recent default cycle, compared with 44.5% for the 1999-2004 cycle and 47.8% in 1990-1992.

Structure Matters
Our comparison of recoveries in the three default cycles also reveals the importance of debt structure. At the instrument level, recoveries are likely to be higher where there is a larger cushion of structurally subordinated debt. This is most clearly shown in the 1990-1992 cycle. Bank debt recoveries were unusually high at 87.7%, and in the cycle that followed they were unusually low at 75.8%. Given the similar average firm-wide recovery rates in the two cycles (53.9% and 48.1%, respectively), the difference is ultimately attributable to differences in structuring. The average debt cushion for bank debt was 48.7% in 1990-1992 and 44.1% in 1999-2004. Each cycle had a type of debt that was the most prominent cushion supporting more senior tranches. Subordinated bonds were a common bottom tranche for the 1990-1992 cycle, senior unsecured bonds for 1999-2004 and bank second liens were prominent in 2009-2010, following a rush of hedge funds into these instruments beginning around 2004. Figure 5 on the next page shows the low average recoveries for these debt types in each cycle. Despite disparities in seniority and security for these three

NOVEMBER 30, 2011

SPECIAL COMMENT: MOODY'S ULTIMATE RECOVERY DATABASE - LESSONS FROM 1,000 CORPORATE DEFAULTS

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FIGURE 5

The Lower Tranches

1990-1992 Default Cycle 1999-2004 Default Cycle 2009-2010 Default Cycle

Average Recovery Debt Type

26.7% Subordinated Bonds

28.0% Senior Unsecured Bonds

19.7% Second-Lien Bank Debt

Source: Moodys Investors Service Note: Average recoveries in this chart only include cases where the debt was the lowest tranche in a defaulted companys capital structure.

types of debt, the recovery data make clear that a tranches position on the balance sheet is the key factor, rather than the name or specific attributes of the debt instrument. In Figure 6 we jump to the top of the capital structure to illustrate how bank debt recoveries perform with increasing amounts of debt cushion. Clearly, as debt cushion increases so do recoveries, and the standard deviation of those recoveries narrows. The lower standard deviations indicate that there is less variability and more confidence in the average recovery level. This kind of conclusion can be important to risk managers and others modeling recovery data. It is better to consider an instruments location in the debt capital structure and amount of subordinate cushion than to estimate its loss given default strictly based on historical experience for that type of debt.
FIGURE 6

Bank Debt Cushion and Recovery

Average 100.00% Std Dev

Instrument Discounted Recovery

90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% <10% 10-20% 20-30% 30-40% 40-50% 50-60% 60-70% 70-80% 80-90% >90% Debt Cushion

Source: Moodys Investors Service

Conclusion
As Moodys Ultimate Recovery Database crosses the 1,000-default mark, it continues to reinforce the importance of debt structure for instrument-level recoveries and provides a way to compare the recovery characteristics of different default cycles over time. The data indicate that the 2009-2010 default cycle was quite benign from a recoveries standpoint, despite the accompanying turmoil in the economy and financial markets. With many defaulted companies yet to emerge, the database will continue to provide new information for modeling recoveries based on the latest observations.

NOVEMBER 30, 2011

SPECIAL COMMENT: MOODY'S ULTIMATE RECOVERY DATABASE - LESSONS FROM 1,000 CORPORATE DEFAULTS

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Moodys Related Research

Special Comments: Hard Data for Hard Times II: The Crisis That Wasn't, February 23, 2011 (131330)

Hard Data for Hard Times, July 2010 (126338) Moodys B3 Negative and Lower Corporate Ratings List, September 2011 (136137) Cheating Death: Private Equity Manages Solid Recoveries When Sponsored Companies Default, November 2010 (128561) Building the Better LGD Mousetrap, December 2010 (129319) After Black Swans, Now What? Recoveries on Defaulted Debt as the New Normal Begins, May 2010 (124964) Recoveries on Defaulted Debt in an Era of Black Swans, June 2009 (117573)

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

NOVEMBER 30, 2011

SPECIAL COMMENT: MOODY'S ULTIMATE RECOVERY DATABASE - LESSONS FROM 1,000 CORPORATE DEFAULTS

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Report Number: 137405

Author David Keisman

Senior Production Associate Ginger Kipps

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