Current Collateral and Guarantee Guidance

2019 Collateral and Net Recovery Rate Study Results

PrecisionLender studied net recovery rates in use by collateral type across its client base in Q3 2019. We found over 1 million possible combinations of collateral types and net recovery rates. From this foundation, we distilled the source data into 18 common collateral types - and the range of net recovery rates in use for these common types - across the PrecisionLender Platform.

We present the results here for the purpose of quantifying the range of net recovery rates in use for a given collateral type. This information may assist administrators in evaluating their bank’s net recovery rate assumptions.

 

 

We have organized the data into 2 levels of detail:

General Collateral Types

• Real Estate
• Non-Real Estate
• Municipal—represents about 4% of usage. We chose to isolate this, as recovery rates are among
  the highest employed.
• Unsecured—rarely employed at 1% of usage. We chose to isolate this special case of lending
  due to wide variance in net recovery rates employed.

 

Collateral Sub-Categories

These add detail to the Real Estate and Non-Real Estate groups as follows:

Real Estate sub-categories are listed below, with brief description of the types of collateral included.

• Construction - includes both commercial and residential construction types
• Hospitality - includes hotel, motel, casinos, restaurants, and other hospitality
• Industrial Real Estate - includes industrial, warehouse, certain processing facilities
• Land - includes raw land, undeveloped lots, developed lots, farmland, and ranch land
• Multi-Family Real Estate - includes 5+ and apartments
• Office - includes single and multi-tenant offices, both owner occupied and non- owner occupied
• Real Estate all types (other/Misc.) - includes a variety of specialty types such as: schools, dormitories, nursing homes, medical, car wash, and others
• Residential Real Estate - includes 1-4 family and single-family residences
• Retail - includes retail properties, both single and multi-tenant
  

Non-Real Estate sub-categories are listed below, with a brief description of the types of collateral included.

• Accounts Receivable - denotes assets that will generate revenue for the borrower
• Agriculture - includes inventory, equipment, and some facilities associated with agricultural concerns
• Assignment - includes the assignment of various business assets as collateral
• Blanket Filing - includes UCC filings and liens
• Equipment - includes commercial equipment, rolling stock, marine equipment, and vehicles
• Inventory - includes non-commodity and non-agricultural inventory as commodity and agricultural are mapped to “Agriculture”
• Liquid collateral - includes cash, cash equivalents, and marketable securities

 

Key Findings

• On the PrecisionLender platform, lenders use real estate collateral 52% of the time, vs 43% for non-real estate, across opportunities. The remaining 5% is split between municipal and unsecured.
• Within real estate types, construction and land represent 40% of the concentration.
• For non-real estate, equipment and liquid collateral comprise 37% of the activity.
• Both real-estate and non-real estate types carry an average recovery rate of approximately 53%

The chart below demonstrates the range of average recovery rates for these sub-category types.

 

 

Updated Guidance for Collateral and Guarantees

Based on information gathered from surveying PrecisionLender clients and on reviewing specific collateral types and net recovery rates in use across the platform, we have developed updated guidance for collateral and guarantees that may be used in whole or in conjunction with any given client’s loss experience.

Note that the scope of this guidance is limited to Collateral and Guarantee Types as they relate to their corresponding net recovery rates and suggested default LTV rates - as applicable - for commercial loan products priced within the PrecisionLender platform. It does not address other credit capital, annual loss, costs or other assumptions.

Note: PrecisionLender provides this guidance for your consideration as a reasonable starting point for your particular assumption set. The assumptions you choose for your bank are yours to own.

 

Why should you care?

Affects ROE - Collateral and Guarantees can be used to reduce the credit risk associated with an opportunity, thereby increasing profitability and return.

Both collateral and guarantees, their types, values, and net recovery rates, directly affect the annual loss and credit capital assignments for all commercial loans priced, where these credit risk mitigants are part of the economic capital methodology.

Collateral and guarantees are credit risk mitigants and offer protection to the lending institution in two ways: 1) quantity and 2) quality. Quantity in that greater amounts of collateral and guarantees reduce potential loss given default (LGD). Quality in that higher quality collateral and/or stronger guarantors reduce potential LGD.

The extent of the protection varies and is based upon input assumptions with respect to net recovery rates. So, there is a direct connection between net recovery rate assumptions, annual loss and credit capital assignments, and the expected return (or ROE) on priced loan opportunities. This information is also used in supporting the credit capital assignment for on-balance-sheet (booked) loan accounts in the event the bank does not have data to connect collateral values individually to the underlying loan. Net recovery rates are typically based on a bank’s actual experience, management’s estimates or by using PrecisionLender industry data.

 

Best Practices

• Consider granular Collateral Types—avoid bundling collateral such as “accounts receivable, inventory and blanket lien” into a single category; the key is to think about how quickly and how
  much deviation from the original value the collateral will bring when setting up categories. For example, cash and non-marketable securities will not have the same characteristics when they are liquidated.
• Consider customizing collateral selection by product when distinct business lines are present.
• Always select a default Collateral Type for each product. This selection can act as a prompt to relationship managers when they are pricing an opportunity—they will update the default information with the specific details for the opportunity being priced.
• For clients using the Relationship Awareness module, make certain that all your actual valid Collateral Types are either referenced or mapped to a referenced Collateral Type. The LTV% and net recovery rates will fill in any data gaps from your core system(s) and will support an accurate credit capital assignment and profit calculation.
• Consider refining net recovery rates by both guarantee type and relative strength of guarantor.

 

Approach to Net Recovery Values for Collateral

PrecisionLender employs a conservative approach to net recovery values. We consider how long it is expected to take to liquidate the collateral, measured from the time interest stops being paid per loan terms until the liquidation. We begin with a nominal recovery rate based on the expected liquidation value of the collateral and the full cost of its maintenance. We employ a 15% discount rate to bring the nominal recovery rate down to the economic net recovery rate. In this approach, the point of view is that liquidation options are limited, and the overall tone is one of difficult economic conditions with respect to liquidation speed and value. 

 

Collateral Type Table

The table below shows the standard PrecisionLender Collateral Types with corresponding nominal
and net recovery rates. In addition, the LTV% is shown for use in cases where the actual collateral
value is not known at the time of pricing or profitability measurement. This Collateral Type list, net
recovery rate, and LTV information is available within your instance of PrecisionLender.

 

 

Guarantee Type Table

For 2019, PrecisionLender maintained our recommendations introduced last year. The revisions made in 2018 provided additional clarity and simplicity for relationship managers when pricing in the solution. This lineup attempts to define the degree to which a guarantor may be able to “make good” on an opportunity or obligation for which they are legally obligated to repay if the obligor defaults. Similar to the approach described above for collateral net recovery rates, a 15% discount rate is employed against the guarantee nominal recovery rate to arrive at the guarantee net recovery rate. Related Entity refers to an ongoing business enterprise that is affiliated with the borrowing entity generally through common ownership—for example: a parent or sister company.

 

 

For more insight into the impact recovery rates can have on their economics of a loan, check out this article. And if you need any assistance updating your Collateral or Guarantee Types, check out these Collateral and Guarantee articles.