Factors affecting the loss given default (LGD) rate

Since the size of the LGD is not only affected by the factors of the borrowing enterprise, but also closely related to the specific design of the loan program, the factors affecting the LGD are more numerous and complex than those affecting the PD. Specifically, the factors affecting LGD include the following four main areas. This category of factors is directly related to the specific design of the loan program, reflecting the project-related nature of LGD and the bank's efforts to manage and mitigate credit risk through the design of the transaction in the specific transaction. Such factors specifically include liquidation priority (Seniority), collateral, etc.

Solvency priority is an important characteristic of the claims owned by creditors under the debt contract, which refers to the order of priority of creditors relative to other creditors and shareholders of a debtor enterprise in obtaining satisfaction from the residual value of the enterprise in the event of its bankruptcy and liquidation. In the United States and other developed market economy countries, the development of the financial market for many years has formed a series of enterprise bankruptcy liquidation of the liquidation of different order of financial products, including from the mortgage to common stock, and the formation of the relevant legal norms. The "Absolute Priority Rule" (APR) in the United States bankruptcy law provides that the value of the bankrupt enterprise shall be distributed to different capital suppliers according to the order of priority of liquidation, and that higher creditors shall be fully satisfied before lower creditors are given any distribution, and all creditors are equally satisfied. and that all creditors should likewise be fully satisfied before any distribution is made to the shareholders.

Obviously, the requirement in the loan contract that the borrowing enterprise provide specific collateral makes it possible to increase the priority of repayment of mortgages, and in the event that the borrowing enterprise goes into bankruptcy and liquidation, it is possible for the bank to increase the rate of recovery and to reduce the LGD. of course, the prerequisite for the use of mortgages to reduce the LGD is that the bank should manage the collateral effectively, and the state should have an effective judicial system to guarantee the bank's access to, realization and realization of the collateral. acquisition, realization and value recovery of collateral. In addition, besides traditional collateral, banks are also developing other methods of preventing or passing on losses after corporate defaults through financial innovation, such as credit derivatives. These techniques are referred to as risk mitigation techniques by the New Basel Capital Accord and are being incorporated into the new capital regulatory framework by subjecting them to different LGD data. Macroeconomic cyclicality is an important factor affecting LGD.Frye's research using bond data from Moody's Ratings shows that debt recovery rates are one-third lower during recessions than during expansions.Studies by Altman,, Brady, Resti and Sironi, as well as Hu and Perraudin's research, show that the economic system's The overall default rate (representing cyclical variations in the economy) is negatively correlated with the recovery rate.

The above four factors*** together determine the level of LGD and its variations, but the extent to which they each affect LGD varies. According to the information disclosed by Moody's in 2002 in the technical paper of its LGD prediction model LossCalc, it shows that item factors such as solvency priority have the highest contribution to the impact of LGD, which is about 37%; followed by macroeconomic environment factors, which is about 26%; then industry-specific factors, which is about 21%; and lastly, corporate capital structure factors, which is about 16%.