Question

1) A company goes bankrupt with $60 million in assets (market value at time of dissolution). It also has $100 million in outstanding bonds in 2 classes: $50 million in senior secured bonds, and $50 million in junior subordinated bonds. In theory, what will be the recovery rates of these bonds? What might cause the actual recovery rate on the junior bonds to be higher?

Answer 1

As senior debt is paid first , and the total assets are valued higher than Senior debt, 100% recovery of $ 50 million of senior secured bonds is possible

Since the assets are valued at $ 60 million, after the payment of senior secured bonds , only $10 million remains and  will be paid to junior subordinated bondholders making their recovery rate = $ 10 million/$50 million = 20% recovery rate for Junior subordinated bonds

The actual recovery rate for junior bonds may be higher because the assets when actually sold may fetch a higher price because of various macroeconomic factors as well as Industry and company specific factors.