What is the difference between a credit rating and recovery rating?
What will be an ideal response?
Recovery ratings were developed in response for the market's need for more information for particular bond issues than could be supplied by a credit rating. While a credit rating can provide guidance on recovery if a firm is in default, a recovery rating corresponds to a specific range of recovery values. More details are given below.
While credit ratings provide guidance for the likelihood of default and recovery given default, the market needed better recovery information for specific bond issues. In response to this need, two ratings agencies, Standard & Poor's and Fitch, developed recovery rating systems for corporate bonds. Standard & Poor's introduced recovery ratings in December 2003 for secured debt using an ordinal scale of 1+ through 5.
In July 2005, Fitch introduced a recovery rating system for corporate bonds rated single B and below. The factors considered in assigning a recovery rating to an issue by Fitch are (1) the collateral, (2) the seniority relative to other obligations in the capital structure, and (3) the expected value of the issuer in distress. The recovery rating system does not attempt to precisely predict a given level of recovery. Rather, the ratings are in the form of an ordinal scale and referred to accordingly as a Recovery Ratings Scale. Despite the recovery ratings being in relative terms, Fitch also provides recovery bands in terms of securities that have characteristics in line with securities historically recovering current principal and related interest.
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