Recovery Rate

What it is

The recovery rate is the percentage of a loan or bond’s face value (principal plus accrued interest) that creditors recover after a default or bankruptcy. It represents the settlement value a lender receives when an instrument emerges from default or when assets are liquidated.

Key points

• Recovery Rate = Amount Repaid (including post‑default recoveries) / Total Balance Owed
• Recovery rates vary by instrument seniority, issuer financial health, and macroeconomic conditions.
• Recovery rates are used to estimate expected losses and to set lending terms, pricing, and reserves.

Formula and example

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

Example: A $200,000 loan has $40,000 repaid before default. Recovery rate = $40,000 / $200,000 = 20%.

Measuring loss: Loss Given Default (LGD)

Loss Given Default quantifies expected loss when default occurs:

LGD = (1 − Recovery Rate) × Exposure at Default

Example: If Recovery Rate = 60%, LGD = 40%. On a $10 million exposure, expected loss = 0.40 × $10,000,000 = $4,000,000.

Ultimate recovery

Ultimate recovery is the final settlement value received if a creditor holds the claim through the company’s restructuring or liquidation process. It reflects the outcome after bankruptcy proceedings and asset dispositions.

What affects recovery rates

1. Instrument seniority and security
2. Senior secured debt typically has higher recovery rates.
3. Subordinated or junior debt generally recovers less.
4. Issuer characteristics
5. Capital structure, equity cushion, and leverage influence recoveries—lower indebtedness and more equity typically boost recovery prospects.
6. Macroeconomic and market conditions
7. Recessions, widespread defaults, and poor liquidity reduce recoveries. For example, average recovery rates for senior unsecured bonds fell sharply during the Great Recession.
8. Asset quality and collateral realizability
9. The nature and marketability of collateral determine how much can be recovered through liquidation or sale.

How lenders and businesses use recovery rates

• Credit decisioning and pricing: Lower expected recoveries increase required interest rates, tighter covenants, or higher collateral requirements.
• Risk modeling: Recovery rates feed into expected-loss models, capital allocation, and provisioning.
• Portfolio management: Historical and forward-looking recovery estimates help set limits and stress‑testing scenarios.

Are recovery rates the same for all debt?

No. Recovery rates differ across debt classes (secured vs. unsecured, senior vs. subordinated), industries, issuers’ financial strength, and economic environments.

Bottom line

The recovery rate is a fundamental input for estimating losses on defaulted debt and for making informed lending, pricing, and risk‑management decisions. Understanding the drivers of recovery—seniority, issuer health, collateral quality, and macro conditions—helps creditors anticipate outcomes and structure credit to mitigate loss.