Recovery Rates Are Falling - Can Your Manager Handle Workouts?

With increasing urgency, investors are asking us, “Where do you think defaults and recoveries for middlemarket loans are going?” The short answer is that defaults are increasing, and recovery rates appear to be falling—a trend that should continue as long as the higher-for-longer interest-rate environment persists. The more complete answer, though, is that increased defaults should prompt a rising volume of loan workouts. In that case, we would ask investors two questions: “Are you willing to go through the workout process?” followed by “Is your middle-market lending manager equipped to handle workout situations to maximize recoveries?”

To fully explain our view, it is helpful to see today’s market conditions in the perspective of the recent past. Our key takeaway is that expectations formed by previous conditions have left most investors unprepared for what we believe will happen.