Telecom Failures Reduce Junk-Bond Recovery Rate
By MITCHELL PACELLE
Staff Reporter of THE WALL STREET JOURNAL
The wave of telecommunications defaults and bankruptcies has dragged down the recovery rate on defaulted junk bonds to unprecedented lows, according to a new study.
During the first half of 2001, investors owning defaulted telecom junk bonds recovered an average of 12 cents on each $1 of face value, down sharply from 25 cents on the dollar in 1999 and 2000, according to prominent high-yield bond researcher, Edward I. Altman of New York University's Stern School of Business. "I don't know if I've ever seen a recovery that low," he said.
The assets of troubled telecommunications companies are valued at so little because the huge investment industrywide in recent years has led to massive overcapacity of fiber-optic networks and other equipment -- and given the fast-changing technology, much of this gear has an early obsolescence.
The low telecom recovery rates -- defined as the market price of the bonds just after default -- are a blow to investors who bought the bonds at par when they were issued, and even to distressed bond investors who bought them on the way down, betting on a rebound or a favorable restructuring. In addition, the low rate is bad news for bank lenders, because it signals that recoveries on defaulted bank loans could also be disappointing.
The dismal values of defaulted telecom bonds dragged down average recovery rates on all defaulted junk bonds to 25.7 cents on the dollar in the first half of the year. But that number, said Prof. Altman, was skewed upward by high valuations of defaulted bonds of Finova Group Inc., which benefited from a bidding war between GE Capital Corp. and Warren Buffett's Berkshire Hathaway Inc.
The average recovery rate for all other defaulted bonds slipped to just 15.5 cents on the dollar, the lowest level in the market's history, which Prof. Altman has analyzed back to 1978. His results have just been published by Salomon Smith Barney. In the long term, recoveries on defaulted bonds tend to range between 40 and 45 cents on the dollar, market analysts say.
All told, 58 bond issues by 21 telecom companies, with a combined face value of $16.1 billion, defaulted in the first half of 2001, said Prof. Altman. Investors can expect further defaults in the second half, as the industry remains depressed. Junk bonds, also called high-yield bonds because they offer a higher interest rate to investors, carry higher risk because they are sold by less creditworthy companies to raise money.
Beginning late last year, the telecom industry has been rocked by a wave of defaults, including such onetime high-fliers as ICG Holdings, Winstar Communications, and PSINet. A slew of companies have sought Chapter 11 bankruptcy-law protection. The value of their defaulted junk bonds could eventually rise above trading levels at the time of default, depending on the results of restructurings or assets sales.
"The reason recovery values are so low is because people don't attribute much asset value to them," said Martin Fridson, chief high-yield strategist at Merrill Lynch & Co. "It underscores how uncharacteristic a lot of early-stage capital financing was. A lot of it was venture-capital financing."
During the last big wave of junk-bond defaults, from 1989 to 1992, about half of the failures resulted from ill-fated leveraged restructurings, including leveraged buyouts, Prof. Altman said. "Many of them were good companies with bad balance sheets," he said. In contrast, many investors characterize recent telecom failures as bad companies with bad balance sheets.
An estimated 10% of the entire high-yield bond market was in default at midyear, with an additional 21% trading at distressed levels, which represent lower rates than during the worst period a decade ago. The weakest of the junk bonds issued between 1996 and early 1999 are "being flushed out of the system," Prof. Altman said. "There is some indication that it's peaked."
Moody's Investors Service Inc. has forecast the trailing 12-month default rate to peak in February or March 2002 at 10.1%. Others have predicted the peak rate to be lower, such as Merrill Lynch, which has forecast a year-end rate of 7.5%.
Write to Mitchell Pacelle at mitchell.pacelle@wsj.com |
