Recovery Rate

When a borrower defaults, lenders rarely lose everything. They may recover part of what they are owed from the sale of collateral, a restructuring or bankruptcy proceedings. The recovery rate measures this.

For example, if a bond with a face value of 1,000 recovers 400 after the issuer defaults, the recovery rate is 40%. The loss given default is the opposite: 60%.

Recovery rates depend on factors such as the seniority of the debt, whether it is secured, the value of the borrower's assets, the industry, the legal system and economic conditions at the time of default. Senior secured loans have historically had much higher average recovery rates than unsecured or subordinated bonds.

Recovery rates are key inputs for credit risk models, bond pricing, credit default swaps and bank capital requirements. Expected loss on a loan is often estimated as the probability of default multiplied by the loss given default and the amount exposed. Recovery rates tend to be lower during recessions, when many companies default at the same time and asset values fall.