Banks' chances of recovering on a defaulted loan are better when bank loans are a smaller portion of a bankrupt company's total debt, a new study finds.
In what may be the most thorough analysis of debt recovery to date, Standard & Poor's and Portfolio Management Data LLC conclude that on average, bank lenders holding less than 66% of a company's debt are able to recoup 89.3% of the loan's face value.
"Studies in the past never went beyond just confirming that senior debt paid better," said Steven M. Bavaria, director for bank loan ratings at S&P. "We found that you can be a senior secured creditor but if the whole structure is senior secured you don't have an advantage."
In a yearlong effort, S&P and Portfolio Management Data studied bankruptcies between 1987 and 1997. The statistics on more than 1,200 bank loan and high-yield bond recoveries were culled from U.S. Bankruptcy Court filings on more than 300 defaults.
Though the findings are unlikely to surprise loan and credit professionals, the study is the first to quantify the risk in detail. Loan recoveries were examined not only by industry, but by type of collateral.
Those distinctions may be of great use to risk managers at banks or teams that structure collateralized loan and bond obligations, according to David Keisman, a principal with Portfolio Management and former risk management officer for Citibank.
Mr. Keisman said many banks have proprietary data bases that can gauge the probability of recovery using industry and debt criteria, but those data bases are often culled from that bank's lending history, not from national bankruptcy records.
For instance, loans secured with a company's inventory-which usually carry more value in liquidation-had a higher recovery rate (90%) than those secured with weaker collateral such as capital stock and second liens (79.6%).
"There was a tendency of bankers to say security is security is security," Mr. Bavaria said. "As long as they can check off the box they were happy. Now there are more boxes to check off and it allows them to decide if they're getting paid for the risk they're taking."
Christopher Snyder, president of Data Analytics and a consultant to Chase Manhattan Corp.'s investment bank, said the study should prove useful for a market that had used bond market information for risk management.
"Those models tend to allocate too much capital to higher rated credits and not enough to lower rated credits," Mr. Snyder said. By using more precise default information, "the capital allocation going on at the banks will be closer to reality and that capital allocation will influence pricing in the market."
Results of the study will be reported at a conference Tuesday in New York. Speaking will be representatives from S&P, Portfolio Management Data, as well as Jeffrey Garner, chief investment officer of CypressTree Investment Management Co., and Loretta Hennessey, a managing director of loan portfolio management at CIBC World Markets.
S&P and Portfolio Management are hoping the study will spur interest in a data base it plans to unveil this summer. The product will be updated with the ongoing research at Portfolio Management. A price for the product has not been set.
Said Mr. Keisman, "this is the beginning of a long and ongoing process. The landscape of recovery changes and it has to be followed."