Different of recovery rates explained

Types of Recovery Rate when a Loan Defaults

Credit control departments have a wide and varied role. They have a significant responsibility to ensure that invoices are paid on time, every time, and customers don’t default on loans and credit agreements. 

To help, business debt collection services are available if you do fall victim to outstanding invoices, helping teams to successfully collect on outstanding debts, saving you considerable time and resources. 

When we look at the area of recovery rates, it’s vital that you understand the probability that a business may default on a debt, i.e., the amount of money left outstanding/not recovered in the event of a default. 

Knowing this information helps to manage cash flow and apply the right and most appropriate credit terms. 

Various factors can influence the amount of money a business can recover when a default occurs and this post explores what recovery is and how to recover rates when a loan defaults. 

Understanding Recovery Rates 

Unfortunately, when a lender defaults on a loan or credit agreement, you incur the loss. 

However, before you write off the debt completely, the good news is you can recover some of these losses with the amount you can recover, known as the recovery rate. 

What is recovery rate? 

Recovery rates equal the percentage of money that is actually recovered when a default takes place. 

The recovery rate calculation is used in credit risk management to understand the amount that businesses can recover when the borrower is unable to settle the full outstanding amount. 

Recovery rate equals the amount recovered divided by the amount loaned, providing you with the value of security. 

It can also be determined by the value of collateral, i.e., what can be sold to recover the money. For example, if there is a lot of collateral, the rate of recovery will be higher, and vice versa. 

You also have to take into account, given default losses, which equals the amount of money not recovered when a default occurs. 

The total debt amount is therefore calculated as follows: 

Recovery rates + loss given default = total debt amount 

Important note: Debt collection service expenses can be deducted from the amount recovered before calculating the recovery rate and your small business debt recovery agency will be able to help you with any questions and further information. 

Types of Recovery Rates 

The types of recovery rates used in credit risk management will depend on how your credit team values exposure. 

The types of recovery rates include: 

Book value recovery – the number of bad debts recovered compared to the debt’s book value. 

Market value recovery – the book value differs from the debt’s market value. 

Settlement value recovery is the legal value of the debt that would have to be repaid if the court ordered it. 

The capital structure of the company – if you have a senior debt the recovery rate on this will generally carry a higher recovery rate, whereas a company may decide to relegate junior debt to a low rate. 

Factors influencing recovery 

There are numerous factors to be aware of that will affect recovery rates. Factors including: 

Industry structure – how competitive is the sector? Is there a lot of competition? Is it varied? What are the dynamics of the sector? Is it a volatile market? Flexible? Adaptable? Where does the company sit within this structure? 

Collateral – how much collateral does the business have i.e. what collateral can be used as security against the loan and used in the case of default? 

Age of the debt—Successful recovery will depend on the age of the debt and the experience of the collection agency you’re working with. 

Type of debt, i.e., secured, non-secured, priority of debt. 

Business issues—factors that affect the business doing business, i.e. What does their order book look like? Is there a possibility they could default? 

Economy—The economy affects businesses incredibly and must be monitored so you can future proof your business. For example, in a recession, businesses are at a greater risk of defaulting on debts. 

Small business debt collection 

Recovery rates are essential to proactively managing credit risk. They provide you with the estimated loss that would arise in the event of a default. 

Knowing this value of security when it emerges from default allows businesses to balance the books and understand the potential monies that can still be received. 

It also allows businesses to set appropriate terms and interest rates, helping companies reduce their risk level, manage this more effectively and accurately to account for risk, and provide you with the right information to make better and more informed decisions. 

For further information on credit control processes and to see how we can help support your business today, call us at +44 7860 19 7476 or email your requirements to memberbenefits@directroute.co.uk.