The market value of defaulted bank loans hit an all-time low of 44 for the month of September, setting the table for a feast of upside potential. Edward Altman, Max L. Heine Professor of Finance at New York University, said a look at where distressed debt is now compared to where it usually ends up in terms of recovery bodes well for investors. "Historically, most studies have shown that recovery values for bank debt are roughly 70-80%," said Altman, one of the keynote speakers at the 7th annual Loan Syndications and Trading Association (LSTA) conference in New York. But these historical averages could be misleading in today's environment, and recovery rates may not be as high as they have been in the past, he cautioned.
One of the trends that has led to the historically low market/face values for bank loans and bonds which is at 16.9%--is the huge supply of defaulted debt, noted Altman. "Supply and demand is the basic determinant of price," he said. Through the third quarter of 2002, the size of the distressed and defaulted public and private debt markets has rocketed to its highest level ever--$885 billion in face value and a $488 billion in market value, according to data compiled by the Altman Salomon Center.
Even if market recoveries only reach the 60-70% range, the other big question is: when? Although Altman believes the default rate has peaked, he said the recovery time is not likely to be as fast as historically seen. The default rate through the third quarter of 2002 was 11%, already a record for any calendar year, he noted. The default rate was based on a dollar-weighted rate, which tabulates the total dollars of debt that has defaulted rather than the number of companies that have defaulted.