# Recovery Rate: What It Is and How It Works

![Recovery Rate](https://www.investopedia.com/thmb/hdk7q5Q0BVKGGI8abOHOPc21mmY=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/recovery-rate.asp_Final-a8fac2c32d704c628b7408edd9604684.png)

*— Dennis Madamba / Investopedia*

> **Definition**
>
> The recovery rate reflects the percentage of defaulted debt that a lender can recover.

## 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](https://www.investopedia.com/terms/f/facevalue.asp). The recovery rate also reflects the value of a [security](https://www.investopedia.com/terms/s/security.asp) when it emerges from [default](https://www.investopedia.com/terms/d/default2.asp) or bankruptcy.  

### Key Takeaways

*   The recovery rate reflects the percentage of a loan or an obligation that will be repaid to creditors in default or bankruptcy.
*   The recovery rate calculation divides the total amount repaid by the total balance of the loan.
*   In a firm’s capital structure, the recovery rate on senior debt will generally carry a high recovery rate.

## 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 occurs, 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 [loss given default (LGD)](https://www.investopedia.com/terms/l/lossgivendefault.asp) 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.  

### Ultimate Recovery

Recovery is the value received on defaulted debt. Companies that have defaulted either emerge from bankruptcy or are liquidated. Ultimate recovery is the settlement value a lender receives if they hold an instrument through its emergence from default. 

## What Affects Recovery Rates?

Recovery rates depend on the instrument type, corporate issues, and [macroeconomic](https://www.investopedia.com/terms/m/macroeconomics.asp) conditions. The recovery rate is affected by an instrument’s seniority in the [capital structure](https://www.investopedia.com/terms/c/capitalstructure.asp). [Senior debt](https://www.investopedia.com/terms/s/seniordebt.asp) will usually have a higher recovery rate than [junior debt](https://www.investopedia.com/terms/j/junior-debt.asp). 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](https://www.investopedia.com/terms/e/equity.asp), and level of indebtedness. [Debt instruments](https://www.investopedia.com/terms/d/debtinstrument.asp) issued by a company with a lower level of debt to its assets may have higher recovery rates than a company with substantially more debt.

Macroeconomic conditions include the stage of the [economic cycle](https://www.investopedia.com/terms/e/economic-cycle.asp), the overall default rate, and [liquidity](https://www.investopedia.com/terms/l/liquidity.asp) conditions. If many companies default on their [debt](https://www.investopedia.com/terms/d/debt.asp) during a deep [recession](https://www.investopedia.com/terms/r/recession.asp) the recovery rates may be lower than during normal economic times. A [Moody’s Investors Service](https://www.investopedia.com/terms/m/moodys.asp) 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 [Great Recession](https://www.investopedia.com/terms/g/great-recession.asp) that gripped the United States from December 2007 to June 2009.

## How Do Lenders and Businesses Use Recovery Rates?

The recovery rate is the percentage of defaulted debt a [lender](https://www.investopedia.com/terms/l/lender.asp) can recover. It is also the value of a security after it emerges from default or bankruptcy. Businesses and lenders can use the recovery rate to determine the [estimated recovery value](https://www.investopedia.com/terms/e/estimated-recovery-value-erv.asp) of an asset in the event of liquidation.

## How Do Recovery Rates Affect Lending Practices?

In lending, the recovery rate can be applied to cash extended via loans or credit and recovered by [foreclosure](https://www.investopedia.com/terms/f/foreclosure.asp) or bankruptcy. Knowing a recovery rate can help businesses set rates and terms for future credit transactions. For example, if a recovery rate is low, lenders may increase [interest rates](https://www.investopedia.com/terms/i/interestrate.asp) on a [loan](https://www.investopedia.com/terms/l/loan.asp) product or shorten its payout cycle [to manage the added risk](https://www.investopedia.com/ask/answers/022415/what-factors-are-taken-account-quantify-credit-risk.asp) when issuing new loans.

## Is the Recovery Rate the Same for All Debt?

No. Generally, senior debt has a higher recovery rate than junior debt. Other factors that influence the recovery rate include corporate capital structure, type of debt instrument, level of indebtedness, and macroeconomic issues.

## 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.  

> **Article Sources**
>
> 1.  Faster Capital. "[Recovery Rate: Understanding Recovery Rates: Recovering from Default Risk](https://fastercapital.com/content/Recovery-rate--Understanding-Recovery-Rates--Recovering-from-Default-Risk.html)."
>     
> 2.  S&P Global. "[Default, Transition, and Recovery: U.S. Recovery Study: Loan Recoveries Persist Below Their Trend](https://www.spglobal.com/ratings/en/research/articles/231215-default-transition-and-recovery-u-s-recovery-study-loan-recoveries-persist-below-their-trend-12947167)."
>     
> 3.  Moody’s Investors Service. “[Moody’s Ultimate Recovery Database](https://www.moodys.com/sites/products/defaultresearch/2006600000428092.pdf).” Page 5.
>     
> 4.  Federal Reserve History. "[The Great Recession](https://www.federalreservehistory.org/essays/great-recession-of-200709)."
>     
> 5.  Moody’s. “[Corporate Default and Recovery Rates, 1920–2008](https://www.moodys.com/sites/products/defaultresearch/2007400000578875.pdf).” Page 2.