Each collateral type in PrecisionLender should have its own specific recovery rate. This rate will reflect the net expected proceeds, after all carrying and selling costs, in the event that liquidation of the collateral is required.
The default recovery rates pre-populated within PrecisionLender are a good starting point for setting recovery factors. If actual recovery factors are available from past liquidation events, you will want to consider their reasonableness for use today. Many clients apply a factor that is a conservative estimate of what any given type of collateral would generate in a liquidation event.
The recovery rate is used in combination with the provided collateral value when pricing to accurately reflect the risk mitigation that particular piece of collateral provides.
A commercial building securing a commercial real estate loan may have a market value of $1,000,000, but costs such as preparation for sale, utilities, property taxes and transactional selling expenses will ensure the net proceeds are much less than that $1,000,000 value, especially if the holding period is longer than hoped. If the Recovery Factor is set at 60%, PrecisionLender will calculate that $600,000 of actual risk mitigation for that Commercial Real Estate loan is provided by its Commercial Real Estate collateral.