What Is Recovery Rate?

The recovery rate is the principal and accrued interest on defaulted debt that can be recovered, expressed as a percentage of face value. The recovery rate also reflects the value of a security when it emerges from default or bankruptcy.

Formula

The recovery rate can be done for an individual or a group of loans over a specified period. This helps lenders evaluate the performance of loan products and adjust them. To calculate the recovery rate, divide the amount repaid thus far when the default o💦ccurs, including any funds recovered after bankruptcy or default by the total balance of the loan or bond.

Recovery Rate = Total Amount Repaid / Total Balance of the Loan

Suppose a bank makes a loan to a business for $200,000. The $200,000 is the total amount owed including interest. The business makes payments for two years totaling $40,000. At this point, the business goes bankrupt and stops making payments on the loan. $40,000 divided by $200,000 is 0.2. The recovery rate is 20%.

Measuring Loss

The recovery rate helps estimate the loss that would arise in default. This is called 澳洲幸运5官方开奖结果体彩网:loss given default (LGD) and is calculated by the following formula:

 ( 1 - Recovery Rate ) * Exposure at Default = Loss Given Default (LGD)

If the recovery rate is 60%, the LGD rate is 40% (1 - .60). On a $10 million debt instrument, the estimated loss arising from default would be $4 million.

What Affects Recovery Rates?

Recovery rates depend on the instrument type, corporate issues, and 澳洲幸运5官方开奖结果体彩网:macroeconomic conditions. The recovery rate is affected by an instrument’s seniority in the 澳洲幸运5官方开奖结果体彩网:capital structure. 澳洲幸运5官方开奖结果体彩网:Senior debt will usually have a higher recovery rate than 澳洲幸运5官方开奖结果体彩网:junior debt. For example, senior secured bonds often have a high recovery rate, while holders of junior subordinated bonds can expect a minimal recovery rate.

Corporate issues include the company’s capital structure, equity, and level of indebtedness. 澳洲幸运5官方开奖结果体彩网:Debt instruments issued by a company with a lower level of debt to its assets may have higher recove🌺ry rates ඣthan a company with substantially more debt.

Macroeconomic conditions include the stage of the 澳洲幸运5官方开奖结果体彩网:economic cycle, the overall default rate, and 澳洲幸运5官方开奖结果体彩网:liquidity conditions. If many companies default on their debt during a deep 澳洲幸运5官方开奖结果体彩网:recession the recovery rates may be lower than during normal economic times. A 澳洲幸运5官方开奖结果体彩网:Moody’s Investors Service study, “Corporate Default and Recovery Rates, 1920–2008,” found that “the average recovery rate for senior unsecured bonds dropped from 53.3% in 2007 to 33.8% in 2008,” as a result of the 澳洲幸运5官方开奖结果体彩网:Great Recession that gripped the United States from December 2007 to June 2009.

The Bottom Line

The recovery rate is a percentage of face value and reflects the principal and accrued interest on defaulted debt that can be recovered. Lenders and businesses use the recovery rate to determine the estimated recovery value of an asset or debt instrument in the event of liquidation or bankruptcy.