Moodys on the Ratings Assigned to Companies Emerging from Bankruptcy

A couple tidbits from a Moodys report entitled "Ratings Assigned to Non-Financial Corporates Emerging from Bankruptcy" (11/9/2010).

Companies Emerging from Bankruptcy are Typically Assigned Single-B Ratings Exhibit 1 below shows the distribution of corporate family ratings (CFRs) newly assigned to 84 companies that filed for bankruptcy sometime after January 2000.  The data show that 77% of these ratings were single B, while approximately 15% were Ba3 or higher and 8% were Caa1 or lower.

The predominance of single B corporate family ratings assigned to companies emerging from bankruptcy can largely be accounted for by two factors.  First, the amount of pre-petition debt extinguished during Chapter 11 proceedings often results in companies that emerge with financial metrics (e.g., leverage and coverage measures) similar to those of other single-B issuers as outlined in applicable industry rating methodologies.  These financial metrics reflect the outcome of Chapter 11 proceedings which attempt to balance the competing goals of providing for a viable going-concern business while minimizing losses to pre-petition debt holders.  The data indicate this balance is often achieved by companies emerging from bankruptcy with financial metrics similar to other single-B issuers.  

Second, bankruptcy often results from factors other than high debt levels, including weak business models or poor management.  To the extent that a given Chapter 11 proceeding did not address these types of fundamental business considerations, the ratings at emergence would usually be constrained to single B or below. 

While the results above (in the report but not in my post) suggest that past ratings assigned to companies at emergence from bankruptcy may have been modestly too conservative, there are several caveats.  First, and most importantly, the default and transition rate results for emergers are based on a very small sample of issuers.  For example, the sample of single B emerging issuers is only 56, which compares against over two thousand issuers for the all corporates results.  And the number of emerging issuers underlying the Ba and Caa-C results is only 19 and 29, respectively.  Given these small sample sizes, it would have required only 1-2 additional defaulters by emerging issuers over the ten-year sample period to reverse the conclusion that default rates on emergers are lower than for all corporates.

Rest of report here: Moodys on Bankruptcy Emergers

I found the report - and its conclusions - interesting and worthy of note.  If the sample (admittedly small) is representative of a broader group of "bankruptcy emergers", then companies emerging from bankruptcy and rated BB (possibly up to low BBB) could be decent trades/positions.  If they are priced cheap to the BB bucket and/or peers, it is worth taking a deeper look at the company.  If the industry is viable, fresh start accounting helps the company to be viable.  Not gospel, but something to try to disprove.  Just thinking out loud.

Be careful though, because Yes, There Will Be Blood.