Transcript Maximising Value of Non-Performing Assets Performance and Resolution of Non-Performing Assets: the Importance of Hard Evidence by P.

Maximising Value of
Non-Performing Assets
Performance and Resolution of
Non-Performing Assets:
the Importance of Hard Evidence
by P. Grippa, S. Iannotti, F. Leandri (Bank of Italy)
Seoul - 11/11/2003
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Measuring recovery rates of bank loans is
relevant:



to assess the performance of workout procedures
to feed internal portfolio models and the Basle II
Advanced-IRB ‘regulatory function’ (LGDs)
to correctly determine the value of loans
transferred through securitization
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Recovery rates can be measured by:



using the market prices on defaulted bonds or marketable
loans soon after default (“market method”)
discounting the future cash flows resulting from workout
from the date of default to the end of the recovery
process (“workout method”)
extracting the recovery rate from non-defaulted risky
bond prices by means of an asset pricing model
(“implicit method”)
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 The workout method is particularly relevant since
portfolios of banks consist mainly of nonmarketable loans

Calculating workout recovery rates requires
discounting methodology of the cash flows
discounting
a
Final cash flow
t0
1° recovery
cash flow
t1
2° recovery
cash flow
t2
time
T
default
close-out
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks



In the years 2000-2001 the Bank of Italy conducted a
survey on workout procedures and recovery rates in
the Italian banking system
It addressed commercial banks (foreign bank
subsidiaries and mutual banks excluded): around 250
banks, representing > 90% of total loans as of
December 1999
It collected data on bad loans “closed” in 1999
(loans for which a specific event or board decision
has determined their cancellation from the bank’s
FAIR III – Session V
books)
BANK OF ITALY
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Structure of the quantitative survey

Province

Type of obligor (household, company, public entity, etc.)

Economic sector

Default date (when classified as ‘bad loan’ for the 1st time)

Exposure at default (with evidence on collateral & guarantees)

Legal expenses

Cancellation date

Total amount of recoveries (capitalized at cancellation date)
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 A vast majority of banks was able to respond to the
quantitative part of the questionnaire …
 … but by different degrees of detail
 After controlling for data quality, the database showed the
following figures:
BANKS
TOTAL
Banks with detail on collateral
Banks with detail on guarantees
Banks with detail on legal expenses
BANK OF ITALY
211
108
59
139
N° POSITIONS
86,670
3,713
1,074
28,276
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Time length of workout procedures

in years
PROCEDURE
Recovery of pledged securities
Foreclosure
Legal compositions
Bankruptcy proceedings
Private settlements
NORTH
WEST
NORTH
EAST
CENTER
2.8
5.8
7.4
6.4
2.3
2.3
5.3
6.0
6.0
2.0
2.6
6.6
6.2
7.3
2.4
BANK OF ITALY
SOUTH
AND
ISLANDS
3.1
7.1
5.4
7.3
2.3
ITALY
2.8
6.3
6.2
6.8
2.1
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 % of utilization and mean recovery rates by
procedure
PROCEDURE
Recovery of pledged securities
Foreclosure
Legal compositions
Bankruptcy proceedings
Private settlements
PERCENTAGE OF
UTILIZATION
MEAN RECOVERY
RATE
3%
10%
5%
21%
42%
44%
57%
36%
27%
68%
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Average time to recovery, by province

in years
(the darker the color,
the lengthier the
time to recovery)
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Evidence on costs of workout procedures



Labour costs plus external services costs in 1999
amounted, on average, to 2.3% of each bank’s
total operating expenses
These costs varied with the location of the bank
(northern banks seem to be more efficient)
Weighted average total costs of workout
procedures in 1999 amounted to 1.2% of bad
loans
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Considerations

The nature of data required was considered a
compromise between:




the high detail required by advanced risk measurement
methodologies and future regulatory rules (Basle II)
and
the current state of the art of workout databases (critical, as
for most banking systems)
Even so, the degree of detail required proved to be
too demanding for many banks
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Considerations


The survey was useful, but could not, by itself,
address the basic problem of delays in the way the
banks address the workout function
… but things, at least in Italy, are changing:


some banking groups have created legal entities devoted to
restructuring and workout procedures on the loans
originated by other intermediaries within the group ...
… other groups have created internally workout divisions
which are assigned a budget and are assessed as profitcenters
FAIR III – Session V
BANK OF ITALY
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Considerations



Overall, it seems that the attention on workout
procedures has increased
This should prompt better internal data collection at
banks in the next future
On its side, the Bank of Italy is planning to realize a
centralized national database to foster the collection
of data at banks and to provide, as a feedback, a
national benchmark for recovery rates
BANK OF ITALY
FAIR III – Session V
The Importance of Hard Evidence:
Results from a Survey on Workout
Procedures in Italian Banks
 Considerations



The degree of detail needs to be much higher than
the one adopted for the 2000 survey
This represents a challenging task for many banks,
but it looks as the only way to collect sensible data
on recovery rates and on the length and costs of
workout procedures
It could help banks wishing to move towards the
Advanced IRB approach under Basle II
BANK OF ITALY
FAIR III – Session V