DEFAULTS AND RECOVERIES

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DEFAULTS AND RECOVERIES

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Insovencies, fresh start, probability of defaults, bankruptcy ... Their long term sustainability: bearable losses and capacity to increase the equity. ... – PowerPoint PPT presentation

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Title: DEFAULTS AND RECOVERIES


1
DEFAULTS AND RECOVERIES
  • AECM SEMINAR BAD HONNEF, 2006
  • André Douette, AECM

2
DEFAULTS AND RECOVERIES
  • Context of the seminar
  • Is benchmarking possible?
  • Accounting matters.

3
DEFAUTS AND RECOVERY MANAGEMENTI. Context
  • Insovencies, fresh start, probability of
    defaults, bankruptcy proceedings are in the
    forefront of business concerns nowadays.
  • The AECM Seminar sees in it an issue of setting a
    business strategy and establishing sound
    management practices.
  • The seminar is an opportunity to exchange good
    practices and not to settle standards.

4
DEFAUTS AND RECOVERY MANAGEMENTContext
  • Losses are an inevitable by-product of a
    guarantee activity.
  • The question is not how to avoid losses? but
    rather to see to it that the mission of our
    Guarantee Schemes is achieved properly with an
    adequate balance between
  • Their incentive mission in favour of SMEs access
    to finance
  • Their long term sustainability bearable losses
    and capacity to increase the equity.

5
DEFAUTS AND RECOVERY MANAGEMENTII. Benchmarking
?
  • Benchmarking Guarantee Societies accordingly
    their rate of loss is unrealistic and leads to
    erroneous conclusions
  • Their guarantee contract is diversely qualified
  • They pursue different objectives
  • Their creation is recent / ancient,
  • They operate in diverse economic situations
  • They have different kinds of relations with
    partner banks
  • They serve different types of clientele

6
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to guarantee qualification
  • Loss Sharing guarantees the loss is shared
    between lender and guarantor on credit balance
    after recovery of pledged collaterals
  • Joint and several guarantees the proportion of
    the guarantor in the risk is paid on the credit
    balance at the time of credit denunciation.

7
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to guarantee qualification
  • Example
  • Investment credit(purchase machine) 100
  • Collaterals exclusive right on machine
    financial account (20) Guar. Soc ( GS 60)
  • Denunciation 84 (Cap. 75 Int. 9 past due)
  • Recovered 30 (20 account 10 machine)
  • Breakdown of losses
  • Loss sharing Joint
    Several
  • Share GuarSch (84-30)60 32,4 84 60
    50,4
  • Share Bank (84-30)40 21,6
    84-30-50,4 3,6

8
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to additionality objectives
  • Promotion of start-ups financing, of long term
    loans represent virtuous objectives that lead to
    a higher economic additionality of the scheme
  • They potentially involve higher credit risks
  • E.g. Portfolio EU Country1 EU Country2
  • - Start-ups 42
    15
  • - Average maturity 7 years
    3 years
  • - Guar/ Loan 80
    50
  • - Rate of default 4,6
    1,5
  • - Net leverage effect 7x
    6,4 x

9
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to additionality objectives
  • Promotion of High Technology firms bridges a
    serious market gap and is good for the economy
    (relevance and economic additionality)
  • This strategy involves higher credit risks
  • E.g. Portfolio EU Country3
  • - Early Stage Biotech, IT gt 70
  • - Rate of default gt 10

10
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to anciennity of the scheme
  • More ancient schemes have track records and
    statistical materials larger portfolios Thus
    better predictability
  • Ex. Spain, Italy, Germany
  • Recent schemes had a business plan in which the
    expectation of losses was the most unpredictable
    element. They must have careful policies. Nothing
    is worse than a too rapid growth in a launch
    phase.
  • Ex MGS created in 1994. First loss cases 1 in
    1999, 3 in 2000 TIME LAG!

11
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to economic situations
  • UK survey confirmed by Belgian case in the early
    80s loans granted in the peak of the economic
    cycle will results in increased rates of defaults
  • Increasing inflation rates are a factor of risk
    worsening, mainly in countries where the credit
    interest rates are fluctuating and linked with a
    reference rate (e.g. Euribor)
  • Systematic discrepancy between more- and less
    developed regions (South / North Italy Flanders
    / Wallonia in Belgium)

12
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to relationship with banks
  • EU Country MGS its sister Bank
  • A actual partnership a mutual mindset a
    supply also to clients with a real
    creditworthiness
  • Default rate 0,6 p.a.
  • A Anglo-Saxon banking culture
  • Banks apply for a guarantee in cases of extreme
    need, unless either they would grant the loan
    at own risks or they would refuse it.
  • Rate of loss up to

13
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to clients position
  • UK Survey SBS 2004
  • Larger loans are more likely to default than
    smaller transactions
  • Start-ups less than 2 years are much more
    vulnerable than existing Cies.
  • Working capital guarantees increase the rate of
    default insofar the lack of liquidity is not a
    result of growth but of a weaker position

14
DEFAUTS AND RECOVERY MANAGEMENTDefaults related
to clients position
  • Specific risks run by SMEs
  • Business features
  • Under- capitalisation,
  • Weak economic power,
  • Businessman all round man
  • Lack of long term strategy,
  • Poor knowledge of their financial situation
  • Personal risks
  • Desease, divorce, family disputes,
  • Confusion business assets and personal havings,
  • Unprepared transfer, death of the founder,
  • Unwillingness to disclose difficulties

15
DEFAUTS AND RECOVERY MANAGEMENTIS BENCHMARKING
POSSIBLE? IS THE PREMIUM A REGULATION?
  • A benchmark results of a comparison of similar
    situations.
  • Losses cant found a benchmarking analysis !
    Sustainability in a given environment of support
    and in a given strategy of additionality is the
    standard criteria of utility.
  • Can the premium management match the fluctuation
    of losses? SLIGHTLY !
  • Low premium too may weak transactions come into
    the portfolio without a risk reward
  • High premium too few good transactions are
    registered because of the high price.

16
DEFAUTS AND RECOVERY MANAGEMENTIII. Accounting
and statistical methods
  • Confusion possible between
  • Rate of survivability / Rate of default
  • Rate of default (PD) / rate of final loss (PD
    LGD)
  • Gross loss / Net loss
  • Measure instruments
  • Accounts (financial statements)
  • Statistical instruments

17
DEFAUTS AND RECOVERY MANAGEMENTVocabulary
  • Survivability / Default
  • Survivability How many transactions from a
    portfolio generated in year x remain standard
    (alive) in year x1, x2, x3
  • approach for the forming of comprehensive risk
    provisions
  • Defaults How many transactions out of the
    outstanding portfolio of year x have been
    qualified defaulting in that year?
  • measure of PD in the Basel 2 approach

18
DEFAUTS AND RECOVERY MANAGEMENTVocabulary
  • Default
  • Usual meaning claim, amount that the guarantor
    is entitled to pay to the guaranteed lender
  • Basel 2 an event occuring either if the obligor
    is unlaikely to pay its credit obligations in
    full without actions such as realising
    securities, or if the obligor is past due more
    than 90 days on his credit obligations. Thus
    requiring a higher equity to back his risk (150
    of ordinary requirement)
  • Loss
  • Usual meaning the amount that has been disbursed
    to the guaranteed lender accordingly the contract
    signed with him.
  • Basel 2 economic loss, including material
    discount efffect, and material direct and
    indirect costs associated with collecting of the
    instrument.

19
DEFAUTS AND RECOVERY MANAGEMENTVocabulary
  • Gross default / final net loss
  • Gross default total outstanding guarantee
    balance at the occurrence of the event default
  • Net losses total final amount paid by the
    Guarantee Scheme to the lender, resulting of the
    provisional gross amounts paid, the interventions
    received from a counter-guarantor and the amounts
    recovered from debt collection proceedings

20
DEFAUTS AND RECOVERY MANAGEMENTAccounting
principles
  • Accounting toolkit provisions
  • General prescription financial accounts must be
    sincere and accurate.
  • International Accounting Standards (IAS 37)
  • Provisions liabilities of uncertain timing and
    amount.
  • Must be recognised and disclosed when (only when)
  • An enterprise has a present obligation as a
    result of a past event
  • An outflow of resources will probably be required
    to settle the obligation
  • A reliable estimate can be made of the amount of
    the obligation.
  • Must only be used for the expenditure for which
    it was originally recognised

21
DEFAUTS AND RECOVERY MANAGEMENTAccounting
principles
  • Toolkit for measurements accounting
  • What is registered in PL?
  • Mainly provisions, formed when it is likely that
    an outflow of resources will result from the
    substandard situation of a guaranteed loan.
  • What amount? The best estimate of the expenditure
    (present value of the expenditure expected to be
    required to settle the obligation
  • ?Information delivered by PL must be analysed
    with precaution

22
DEFAUTS AND RECOVERY MANAGEMENTAccounting
principles
  • Reporting in Basel 1 (Belgium)
  • Situation Time To
  • Increments in the period
  • - Deduction in the period
  • Situation end of Period T1
  • For each category standard, uncertain and
    unrecoverable

Guarantees
PL Provisions
Bal. Sheet Provisions
23
DEFAUTS AND RECOVERY MANAGEMENTStatistical
methods
  • Toolkit for measurements statistics
  • New methodology based on Basel 2
  • P.D. the probability of default of a counter
    party over a one year period
  • L.G.D. the ratio of the loss on an exposure due
    to the default of a counterparty to the amount
    outstanding at default.
  • Thus new calculations are necessary, in line
  • with Basel 2 through a system of statistics.

24
Thank you for your attention
  • European Mutual Guarantee Association
  • 40, rue Washington, 1050 Brussels
  • info_at_acm.be www.aecm.be
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