Recovery Rate

Recovery rate refers to the amount recovered on defaulted debt or loan amount. In other words, recovery rate, usually expressed as a percentage, is the amount that is recovered from a borrower when they are unable to pay a full outstanding loan. Generally speaking, a higher recovery rate is always preferable.

Summary

• The term recovery rate refers to the total defaulted loan amount which can be recovered and paid to the creditors in case of any bankruptcy.
• Recovery rate is written as a percentage and businesses are always on lookout for a higher recovery rate.
• Many factors affect recovery rate, some of the most prominent being recession or poor economic conditions, business cycle, a borrower’s credit rating, etc.

Frequently Asked Questions

Which factors affect recovery rate?

Recovery rate is impacted by various factors, some of them are:

• Business Factors

Business factors have a huge impact on a company's profitability. Any unforeseen event or a natural calamity causes a business failure and severely affects its ability to clear its dues.

For example, natural disasters like floods or fire hamper the business operations and severely affects its loan paying capacity.

• Macroeconomic conditions

Economic downturns, including poor macroeconomic conditions, greatly affect the recovery rates pertaining to loans. Usually, recovery rates are lower during economic recessions as companies have reduced profitability. On the contrary, during favourable economic conditions, companies witness enhanced revenues and increased levels of recovery rates.

• Collateral value

Generally, the higher the value of collateral security, the higher would be the recovery rate. In other words, if a business is unable to pay off its loans, the collateral security would be sold off to pay its creditors. Hence, collateral security with a higher amount would help in paying off more creditors and vice versa.

• Bankruptcy procedure

Recovery rates are greatly impacted by bankruptcy policies. In countries like the UK, bankruptcy procedures generally favour creditors. On the other hand, France and the US have bankruptcy policies more inclined towards borrowers. As such, recovery rates would be higher in the UK in comparison to France and the US.

• Borrower’s rating

Prior to default, if a borrower or an obligator has a poor rating, then the recovery rate is likely to be less as the obligator has lesser assets to liquate and pay off its creditors.

How to calculate recovery rate?

To calculate recovery rate, one must first identify the loan amount or the principal amount. Then an appropriate timeframe must also be chosen.

Recovery Rate= (Amount Recovered/ Total loan amount) %

where, amount recovered is the total amount received from the obligator or the borrower, while

the loan amount is the amount issued or extended as a loan.

What is meant by estimated recovery value?

Commonly known as ERV, estimated recovery value is the forecasted value of an asset that can likely be recovered in an event of winding up of business operations, liquidation or bankruptcy. EVR is calculated as recovery rate is multiplied by the book value of the asset.

What is the global recovery rate?

Commonly known as GRR, the global recovery rate refers to the amount recovered by a business from losses arising from fraudulent activities. In other words, GRR is the money being recovered by a company or a business after experiencing losses through fraudulent activities.

The global recovery rate is generally used in the field of banking and credit services and is expressed as a percentage of EAD i.e., exposure at default. It is noted that EAD is the total probable loss that a bank may encounter in an event of default of payment by the borrower.

What is Moody's ultimate recovery database?

Broadly speaking, Moody's ultimate recovery database comprises comprehensive and detailed information of nominal and discounted ultimate recoveries constituting about 3500 loans and bonds and over $400 billion as debt since 1987, in case of default events by almost 720 non-financial corporates in the US.

Here, bonds’ average recovery rates stand at 37% and median recovery rates are 24%, while the average discounted ultimate recovery rate on loans is 82%.

Can guarantors be held liable if a borrower defaults on the repayment of loans?

If a borrower or an obligator defaults on the repayment of a loan amount, then it is the liability of the guarantor to clear the outstanding dues. In case, if the guarantor refuses to pay and comply with the obligations, he would be treated as a willful defaulter and a legal action may be taken by the creditor against him.

How can businesses improve the debt recovery process?

Below are some of the important things to be considered by companies or business owners which can improve the recovery process and result in greater cash inflows:

• Scrutiny of customers

Prospective borrowers should be thoroughly investigated and examined. A high credit score implies that the person is likely to pay the borrowed loan amount on time and vice versa.

• Clear payment terms

Many a time, borrowers default in their loan repayments, as they do not fully understand the terms of the agreement. Detailed information regarding credit terms, consequences of late payment as well as non-payment, the same should be furnished to them at the time of extending a loan amount.

• Offering incentives for instant payments

If obligators make instant or early payments in lieu of some lucrative discounts or other incentives, businesses get their money soon and that too, without any follow up. Hence, borrowers should be offered attractive incentives in order to persuade them with early and timely loan repayments.

• Get everything signed

While extending credit to borrowers, one should get everything countersigned. Legal action for non-payment of loan can only be undertaken if there is a documentary evidence for the same. Borrowers are more likely to pay on time when presented with clear proof of debt.

• Assignment of a dedicated debt collector

A dedicated debt collector makes follow-ups on repayment of loan amounts quite easy and smooth.

• Offering flexible payment options

Sometimes obligators are willing to repay the loan but do not have sufficient amounts to make payments. Hence, flexible payment options should be offered to obligators who are struggling to repay the loan amount, thereby bringing the recovery rate to the maximum.