Recovery Rate

You’re Bob the Bank, BFF of Thomas the Tank Engine. You, Bob the Bank, hear some sad news: the first loan you ever loaned out...defaulted. A loan of $2,000. By the time it defaulted, the borrower owed $2,500 because of accrued interest. That means the person who borrowed it couldn’t manage to pay it off, leaving you with...what?

Well, you’ll probably go see what you can recover. It’d be nice if you could get the full $2,500 back that you lent out, but that might not be possible. Maybe you’re able to get $2,000 back by making the borrower sell their soul, which would be 80% of what you were owed.

That 80% is the recovery rate. The recovery rate is the recoverable amount of money a lender can get, expressed as a percentage, and based on the total amount owed (principal + accrued interest). You can use the recovery rate to figure out your loss rate. If Bob the Bank ends up with 80% recovery, that means there was a loss, or loss given default (LGD), of 20%.

You, Bob the Banker, have different expectations for different types of debt. You know that debt that’s collateralized and highly rated will likely have a higher recovery rate. However, equity is much riskier, and can be expected to have a lower recovery rate.

So...everybody’s thinking it: how was the recovery rate during the 2008 financial crisis? Answer: not good. Around 50%. Ooof. Sorry, Bob.