Recovery Rate
Categories: Credit
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.
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Finance: What are Secured Bonds v Unsecu...54 Views
finance a la shmoop what are secured bonds versus unsecured bonds and
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unsecured bond what is an unsecured bond well this is that was an unsecured bond
old school like 15 century old school it was just a handshake one guy promised to [People shake hands]
pay back another 400 pounds of barley in return for three sheep next year or
something like that and the sheep were the payment form not the guarantee and
the bond was loan emic bond ursins word in fact the promise to pay was secured
but by his word or commitment to repay the loans kind of old school debenture
unsecured bonds work similarly today corporations sell debentures to Wall [Corporations sending debentures to Wall St]
Street all the time debenture being a fancy word for an
unsecured bond it's just debt that the company promises [Definition of debenture]
to pay back well if they don't then oh well and yes the debenture holders could
in theory then take ownership of the equity of the company but in reality [Debenture holders take the majority of the company equity pie chart]
unsecured bonds when not paid back almost always mean the death of the CEOs
career and likely also of the careers of all the other members of the management [Gravestones for the management board]
team so while unsecured bonds are notionally more risky than secured bonds
well this issue hasn't been tested all that often in real life okay so if
that's an unsecured bond what's a secured bond well it's one that
is secured by a specific asset or value or other stores of wealth which get [Definition of secured bonds]
forfeited if the lendee doesn't pay back the lender on time and in accord with
the terms of the debt deal example the dung and the restless' is a company that [Sign for 'The Dung and the Restless']
makes fertilizer by collecting old political speeches and grinding them up [Speeches going into the grinding machine]
selling them to farmers in the Midwest you know for a coin but they also own a [Tractor spraying crops]
pork farm which is kind of separate from their main fertilizer biz they need [Hogs Gone Wild logo appears]
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pledged their pork farm as collateral behind that secured bond offering that [Collateral sign on the pork farm]
is if they don't pay back the bond interest and principle on time then they
lose the pork farm to the lenders yeah and that would be a pig mistake... [Guy snorts like a pig]