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Recovery Rate

Recovery Rate

What is the recovery rate?

The recovery rate is the degree of principal recovery and accrued interest on outstanding debt, expressed as a face value rate. The recovery rate can also be described as the value of a security in the event of insolvency or bankruptcy.

The recovery rate allows you to estimate the loss that would occur in a default event, calculated as (1 - Recovery rate). Therefore, if the recovery rate is 70%, the default given loss (LGD) is 30%. Therefore, in a $10 million debt instrument, the estimated loss given default is $ 3 million.


Key Points to Note 

  • The recovery rate is the estimated percentage of a loan or surety that will continue to be paid to creditors in the event of insolvency or bankruptcy.

  • In a company's capital structure, the collection rate for senior collateralized debt will generally have the highest collection rate, while shareholders can expect near-zero collection rates.


Understanding recovery rates

Recovery rates can also vary widely as they are affected by several factors, such as type of instrument, business issues, and macroeconomic conditions. The type of instrument and seniority in the company's capital structure is among the most important recovery rate determinants. The recovery rate is directly proportionate to the instrument's seniority, which means that an older instrument in the capital structure will generally have a higher recovery rate than a lower instrument in the capital structure.

Business issues include the business's capital structure, debt level, and the value of capital. Debt securities issued by a company with a lower debt level than its assets may have higher recovery rates than a company with significantly higher debt.

Macroeconomic conditions include the phase of the business cycle, liquidity conditions, and the aggregate default rate. If many businesses pay off their debts, as would happen in a deep recession, collection rates could be lower than normal economic times. For example, Standard & Poor's estimated that for all defaulting issuers during the 2008-2010 dispute period, the average recovery rate for all instruments was 49.5%, compared to an average of 51.1% over the 1987-2007period.


Recovery rates and loans

For loans, the recovery rate can be applied to money obtained through loans or credits and recovered through foreclosure or bankruptcy. Knowing how to calculate and apply a recovery rate correctly can help businesses define future credit transactions' rates and terms. For example, if a recovery rate turns out to be lower than expected, lenders can increase interest rates on loans or shorten the repayment cycle to manage overall risk better.


How to calculate the recovery rate

To calculate your recovery rate, you must first choose the type of group to focus on and set a period, such as weeks, months, or years. As soon as a target group is identified, it adds how much money it received in a given period and then adds the total amount returned by that group. Then divide the total amount of the payment by the total amount of debt. The result is a recovery rate. For example, you gave $ 25,000 credit for one week and received $5,000 in payments, so $ 5,000/$ 25,000 = a 20% recovery rate for the week.


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