Bankruptcy Filing and the Expected Recovery of Corporate Debt

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1 Bankruptcy Filing and the Expected Recovery of Corporate Debt Wei Wang Queen s University April 13, rd International Conference on Credit and Operational Risk HEC, Montreal (C) Wei Wang

13, 2007 3rd International Conference on Credit

2 Motivations Recovery analysis has taken on a more prominent role in credit risk management (Fitch, 2005) Basel II Framework (2004): the estimated LGD parameters must reflect economic downturn conditions where necessary to capture the relevant risks and should reflect the possibility that the bank would have to recognize additional, unexcepted losses during the recovery period Fitch (2005): Recovery Ratings (C) Wei Wang

necessary to capture the relevant risks and should reflect the possibility that the bank would have to

3 Motivations Cont. Book by Lynn LoPucki, Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts In 1990, the U.S. Bankruptcy Court for the District of Delaware began competing for big bankruptcy cases and in six years, that court achieved a near monopoly In recent years, 70% of the large, public firms that file for reorganization choose the bankruptcy courts of Delaware or New York. From 1991 to 1996, 54% of the Delaware organizations failed. The corresponding figures for New York and other courts are 31% and 14%. (C) Wei Wang

In recent years, 70% of the large, public firms that file for reorganization choose the bankruptcy courts of Delaware or New York.

4 Main Purpose of This Study To study whether venue choices of bankruptcy have an impact on the expected recovery of corporate bondholders. (C) Wei Wang

5 Summary of Findings Creditors achieve smaller recoveries in bankruptcies filed in New York or Delaware than in other states. Recoveries are lower in New York than in Delaware. Recoveries are higher for companies that file for bankruptcy in their home state than for companies that file outside their home state. Creditors of defaulting companies that do not file for bankruptcy recover more than creditors of companies that file for bankruptcy. Recoveries are higher in prepackaged bankruptcies than in non-prepackaged bankruptcies. Recoveries are much higher in non-tort bankruptcies than in tort bankruptcies. (C) Wei Wang

Recoveries are higher for companies that file for bankruptcy in their home state than for companies that file outside their home state.

6 Media Exposure the first to measure whether the choice of bankruptcy court has an effect on creditors expected recovery rate. Wall Street Journal (January 24, 2007) the first of its kind to measure whether a creditors rate of recovery depends on the location. Bankruptcy Law 360 (January 17, 2007) (C) Wei Wang

Wall Street Journal (January 24, 2007) the first of its kind to measure whether

7 Roadmap Motivations Summary of Findings Background Stories Research Questions Related Literature Data Empirical Results Further Work (C) Wei Wang

8 Background Stories In 1978, the U.S. Congress enacted a new, modern bankruptcy code that gave top managers the right to remain in control of their firms during bankruptcy. U.S. firms have more freedom on where to file for their bankruptcies. It s often the management that decide where to file for bankruptcy. 85% of the Chap 11 filings are voluntary. The state of Delaware dominated all other courts in attracting large filings since early 1990 s. New York became dominant since year (C) Wei Wang

Congress enacted a new, modern bankruptcy code that gave top managers the right to remain in control of their firms during

9 Research Questions Are bondholders better off when their bankruptcy cases were filed in the states of Delaware and New York by the management of their companies? Are bondholders better off when their bankruptcy cases were filed in their home states? Are bondholders better off in private workouts? Are bondholders better in prepackaged bankruptcies and non-tort bankruptcies? (C) Wei Wang

Are bondholders better off when their bankruptcy cases were filed in their home states?

10 Related Literature Studies on recovery upon default: Recovery of Par Altman and Kishore (1996), Hamilton and Carty (1999), Keisman et al. (2003), and Varma et al. (2003) on time variations of recovery. Altman et al. (2004), Bruche and Gonzalez-Aguado (2006), and Hu and Perraudin (2003) on correlations between defaults and recovery. Convitz and Song (2005) on bankruptcy jumps. Acharya et al. (2006) on factors affecting recovery of par. Studies on ultimate recovery (bankruptcy costs) Frank and Torous (1989), Warner (1977), and Weiss (1990) on APR violations in reorganizations. Gilson et al. (1990) on formal bankruptcies vs. private workouts Tashjian et al. (1996) on prepakcaged bankruptcies. Bris et al. (2005) on filings in Arizona and New York. Eraslan (2006) on a bargaining model in negotiations. (C) Wei Wang

Convitz and Song (2005) on bankruptcy jumps. Acharya et al. (2006) on factors affecting recovery of par.

11 Data S&P LossStats Bankruptcy Research Database Compustat US Federal Reserve Board EDGAR New York Times Archives (C) Wei Wang

12 Our Sample 1,118 defaulted instruments of 457 firms from S&P. Merge with BRD and keep firms that filed for bankruptcy within 45 days after default. We are left with 225 firms with 631 defaulted instruments. 58 firms with 120 defaulted instruments did not file for formal bankruptcy. (C) Wei Wang

after default. We are left with 225 firms with 631 defaulted instruments.

13 Time Series of Mean Recovery Mean Recovery Rates (C) Wei Wang

1990 1991 1992 1993 1994 1995 1996 1997 1998

14 Summary Statistics On Recovery: Bank loans have the highest recovery and subordinated bonds have the lowest recovery. Bonds with collateral recover more than unsecured bonds. Industries of Chemicals, Petroleum and Plastic Products have the highest recovery. Investment-grade bonds recover more than speculativegrade bonds. (C) Wei Wang

Bonds with collateral recover more than unsecured bonds.

15 Summary Statistics Cont. On Bankruptcy Filings: Delaware has the most bankruptcy filings compared to New York or all other states. 1/3 of the cases were filed in courts that are located in the corporate headquarter states. The states of South Carolina, Oregon, Virginia, Nevada, and Missouri have the highest expected recovery. Close to 90% of the filings in there states are home-state filings. If a bankruptcy case if not filed at home, it will be very likely filed in either Delaware or New York (with a possibility of 85%) (C) Wei Wang

The states of South Carolina, Oregon, Virginia, Nevada, and Missouri have the highest expected recovery.

16 Delaware and New York vs. For all defaulted debt, Other States Average Recovery Delaware New York Other States For senior unsecured bonds, Average Recovery Delaware New York Other States (C) Wei Wang

Delaware 38.35 38.29 New York 32.16 28.80 Other States 40.49 50.

17 Home State vs. Away State For all defaulted debt, Average Recovery Home Away Home (Ex. DE&NY) Away (Ex. DE&NY) For senior unsecured bonds, Average Recovery Home Away Home (Ex. DE&NY) Away (Ex. DE&NY) (C) Wei Wang

46 Away 35.02 34.60 Home (Ex. DE&NY) 44.00 59.49 Away (Ex. DE&NY) 29.92 33.

18 Prepackaged Filings Prepackaged vs. Non-Prepackaged Average Recovery Prepackaged Non-Prepackaged defaulted debt instruments are from Prepackaged filings. 77 instruments were filed in DE and 42 were filed in NY. Average Recovery Delaware (Ex. Prepacks) New York (Ex. Prepacks) Other States (Ex. Prepacks) (C) Wei Wang

77 instruments were filed in DE and 42 were filed in NY.

19 Tort Filings Tort bankruptcies are defined as filings caused by fraud, asbestos, environmental or other tort reasons. Tort vs. Non-Tort Average Recovery Tort Non-Tort defaulted debt instruments arise from tort filings. 41 instruments were filed in NY and only 9 were filed in DE. Average Recovery Delaware (Ex. Tort) New York (Ex. Tort) Other States (Ex. Tort) (C) Wei Wang

83 66 defaulted debt instruments arise from tort filings.

20 Default vs. Bankruptcy (C) Wei Wang

21 Firm Financial Characteristics (C) Wei Wang

22 Multivariate Analysis (C) Wei Wang

23 (C) Wei Wang

24 Further Work How would equity holders react to the venue choice of bankruptcy filings? Can we predict which court a firm is likely to file for bankruptcy? Institutional holdings and locations? Bondholders locations? Companies other liabilities? CEO s equity holdings? CEO shares the same political view as the judge? (C) Wei Wang

Recoveries on Defaulted Debt

Recoveries on Defaulted Debt Michael B. Gordy Federal Reserve Board May 2008 The opinions expressed here are my own, and do not reflect the views of the Board of Governors or its