What Is the Recovery Rate?
When a borrower defaults, creditors rarely lose everything — they recover some portion of what they are owed through a bankruptcy reorganization, an out-of-court restructuring, or a liquidation of the company's assets. The recovery rate expresses that portion as a percentage of the debt's face value, and it equals one minus the loss given default. A bond that recovers 40 cents on the dollar has a 40% recovery rate and a 60% LGD.
Recoveries can be measured two ways. Ultimate recovery tracks what creditors actually receive by the time the bankruptcy process concludes, including cash, new debt, and equity in the reorganized company. Trading-price recovery instead uses the market price of the defaulted instrument roughly 30 days after default, which is how many historical studies and credit derivative contracts define the figure.
What Drives Recovery Rates
Position in the capital structure matters most. Bankruptcy's priority rules pay secured creditors from their collateral first, then unsecured creditors share what remains, with equity holders typically wiped out. Historical studies from the rating agencies show senior secured loans recovering roughly 60 to 70 cents on the dollar on average, senior unsecured bonds closer to 40 cents, and subordinated debt often 25 cents or less.
Beyond seniority, recoveries depend on the quality and liquidity of the borrower's assets, the industry's condition at the time of default, and where the bankruptcy takes place, since creditor protections vary by jurisdiction. Recoveries are also cyclical — they tend to fall in recessions, when defaults cluster and distressed assets must be sold into weak markets. The credit default swap market conventionally assumes 40% recovery for senior unsecured debt when quoting spreads.
Why Recovery Rates Matter
Recovery assumptions feed directly into expected loss, which equals the probability of default multiplied by one minus the recovery rate, applied to the exposure at risk. Two bonds with identical default risk deserve very different spreads if one is secured by hard assets and the other is deeply subordinated. Rating agencies capture this by notching issue-level ratings up or down from the issuer rating based on expected recovery.
For distressed investors, the recovery rate is the whole game: buying a defaulted claim at 30 cents that ultimately recovers 55 generates a large return, so the work centers on building recovery waterfalls that allocate estimated enterprise value across the capital structure. Restructuring bankers run the same analysis for creditor committees, making waterfall mechanics a frequent interview topic for RX and credit-focused roles.
