SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet 6

SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet...

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3/17/11 Loan Rates Example: Computing LGD LGD = Loss Given Default Once default has occurred, LGD includes Loss of Principal Interest Income not received Workout Expenses (collections costs, legal fees, etc.) LGD can also be expressed as [ 1 – (RCV/EAD)], where (RCV/EAD) is the Recovery Rate on the credit. The Recovery Rate is net of costs and will be dependent on whether there are loan guarantees, collateral (loan is secured),
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3/17/11 LGD 22 Another way of expressing LGD is ( 29 RCVR - 1 LGD or , EAD costs of net recoveries all EAD EAD LGD since EAD costs of net recoveries all EAD LGD = - = - =
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3/17/11 LGD Many banks will use the LGD computed by the ratings agency for the risk class of the bond to which the loan is mapped In our example, a loan with a risk rating of 8 is equivalent to an unsecured bond with a PD= 1.75% LGD = 50% 33
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LGD The rating agencies determine PD by using their vast data on bonds to compute how many bond issues of each rating default within 1, 2, 3,…., n years The ratings agencies compute the average of losses on these defaulted bonds by averaging the discounts on the bond’s price following default.
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This note was uploaded on 03/16/2011 for the course FIN 4324 taught by Professor Clark during the Spring '11 term at FSU.

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SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet...

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