fair iii – session v bank of italy maximising value of non-performing assets performance and...
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BANK OF ITALYFAIR III – Session V
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 ITALYFAIR 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 ITALYFAIR 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 ITALYFAIR 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 non-marketable loans
Calculating workout recovery rates requires a discounting methodology of the cash flows
default
close-out
time
t0
t1 t2 T
2° recoverycash flow
discounting
1° recoverycash flow
Final cash flow
BANK OF ITALYFAIR 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 books)
BANK OF ITALYFAIR III – Session V
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 ITALYFAIR 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 N° POSITIONS
TOTAL 211 86,670 Banks with detail on collateral 108 3,713 Banks with detail on guarantees 59 1,074 Banks with detail on legal expenses 139 28,276
BANK OF ITALYFAIR 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
PROCEDURENORTH WEST
NORTH EAST
CENTERSOUTH
AND ISLANDS
ITALY
Recovery of pledged securities 2.8 2.3 2.6 3.1 2.8 Foreclosure 5.8 5.3 6.6 7.1 6.3 Legal compositions 7.4 6.0 6.2 5.4 6.2 Bankruptcy proceedings 6.4 6.0 7.3 7.3 6.8 Private settlements 2.3 2.0 2.4 2.3 2.1
BANK OF ITALYFAIR 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
PROCEDUREPERCENTAGE OF
UTILIZATIONMEAN RECOVERY
RATE
Recovery of pledged securities 3% 44%Foreclosure 10% 57%Legal compositions 5% 36%Bankruptcy proceedings 21% 27%Private settlements 42% 68%
BANK OF ITALYFAIR 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 ITALYFAIR 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 ITALYFAIR 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 ITALYFAIR 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 profit-centers
BANK OF ITALYFAIR III – Session V
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 ITALYFAIR 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