Fitch: Recovery Rates Return to Historical Norms, Credit Erosion Slows for U.S. High Yield.

Business Editors

NEW YORK--(BUSINESS WIRE)--Sept. 22, 2003

Confidence in the much anticipated credit markets recovery has been buoyed this year by a steep drop in defaults in the credit sensitive high yield market. Fitch's par based U.S. high yield default rate ended August at 4.2%, for an annualized rate of just over 6%, significantly lower than 2002's full-year default rate of 16.4%.

The decline in the default rate, though, is only part of the positive trend surfacing this year. Investors have also benefited from a material improvement in recovery rates on this year's defaulted issues. Through August, the weighted average recovery rate (Fitch used the price of the defaulted bonds one month after default as a measure of recovery value) hit 40% of par, the highest level in over two years and a rate more in line with historical averages. In 2001, the weighted average recovery rate on the year's defaults was 30% of par and worse, was just 15% of par excluding the year's fallen angel defaults. In 2002, the rate fell to 22% of par and was just slightly better excluding fallen angel defaults, at 26% of par. This year, the recovery rate was 40% of par even excluding a few small fallen angel defaults.

Certainly, the shrinking pool of telecommunication defaults has contributed to the improvement in the recovery rates. In 2002, for example, the average recovery rate for all defaulted issues outside of telecommunication was 34% of par. But even taking this industry factor into account, recovery rates have improved this year. For non telecommunication defaults the weighted average recovery rate through August was 45% of par, up approximately 30% from last year's non telecommunication rate of 34%. A number of factors may be at work in the uptick in recovery values including greater confidence in economic growth, greater appetite for distressed and defaulted issues, and of course, simply the unique characteristics of this year's batch of defaults. For example, a third of this year's defaults have been concentrated in utilities and healthcare, both producing recovery rates above 50% of par. There have also been generally fewer defaults in industries facing deep structural declines such as the domestic metals and mining and textiles sectors and of course, telecommunication.

Perhaps even more meaningful, investors have lost little on this year's defaults. Fitch examined the trading prices of 2003 defaulted issues at the beginning of the year and calculated that the year's defaults were trading at a weighted average price of 41% of par at the start of 2003. Therefore, on a mark to market basis, defaults did not cause the par value of the bonds affected by the defaults to erode much more than their distressed trading levels at the beginning of the year. In fact, this year marks the first time since the beginning of the default storm in 2000 that defaults have not resulted in additional calendar year mark-to-market losses for investors. In contrast, for example, the weighted average trading price of 2002 defaults at the beginning of the year was approximately 46% of par but following default the same bonds traded down to 22% of par as noted above.

The year to date default rate edged up just slightly in August to 4.2% from July's 4%. The month produced $1.4 billion in defaults, concentrated in Aurora Foods and Horizon PCS. The trailing twelve month default rate remained fixed at 7.7% where it landed in July, notably falling to single digits for the first time in over a year. The year to date default tally totaled $27.7 billion through August and the defaulted issuer count reached 74. For the comparable period in 2002, the par value of defaults through August was $85.9 billion and the defaulted issuer count was 126. Going forward, the true measure of whether defaults will decline further from current levels will depend greatly on a sustained improvement in credit quality, especially at the lower end of the rating scale.

The good news is that the deep erosion in credit worth appears to have slowed considerably this year. For U.S. domiciled high yield issuers the ratio of par value downgrades to upgrades declined from 14.1 to 1 in the last quarter of 2002, 7.4 to 1 in the first quarter of 2003 and 2.5 to 1 in the second quarter of 2003. Preliminary results for the third quarter suggest a further improvement. This indicates that we are unlikely to see an increase in defaults going forward but a note of caution is still in order, namely that given the still large size of the pool of bonds rated 'CCC' to 'C', still in excess of $110 billion or approximately 17% of market value at the end of August, defaults may very well remain elevated until there is a consistent and sustainable improvement in credit quality, namely more upgrades driven by revenue and cash flow growth.

Overview of the Fitch U.S. High Yield Default Index

Fitch's default index is based on the U.S., dollar denominated, non-convertible, speculative grade bond market (the rating equivalent of 'BB+' and below, rated by Fitch or one of the two other major rating agencies). Fitch includes rated and non-rated, public bonds and private placements with 144A registration rights. Defaults include missed coupon or principal payments, bankruptcy, or distressed exchanges. Default rates are calculated by dividing the volume of defaulted debt by the average principal volume outstanding for the period under observation.

Fitch's high yield default studies are available on the Fitch Ratings web site at 'www.fitchratings.com'.