Title: DEFAULTS AND RECOVERIES
1DEFAULTS AND RECOVERIES
- AECM SEMINAR BAD HONNEF, 2006
- André Douette, AECM
2DEFAULTS AND RECOVERIES
- Context of the seminar
- Is benchmarking possible?
- Accounting matters.
3DEFAUTS 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.
4DEFAUTS 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.
5DEFAUTS 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
6DEFAUTS 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.
7DEFAUTS 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
8DEFAUTS 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
9DEFAUTS 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
10DEFAUTS 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!
11DEFAUTS 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)
12DEFAUTS 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
13DEFAUTS 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
14DEFAUTS 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
15DEFAUTS 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.
16DEFAUTS 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
17DEFAUTS 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
18DEFAUTS 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.
19DEFAUTS 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
20DEFAUTS 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
21DEFAUTS 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
22DEFAUTS 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
23DEFAUTS 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.
24Thank you for your attention
- European Mutual Guarantee Association
- 40, rue Washington, 1050 Brussels
- info_at_acm.be www.aecm.be