RECOVERIES

Having credit enhancements attached to the credit exposures investors can precisely estimate the net exposure, and thus losses, after the default event. Indeed, credit exposure is not always fully covered by the credit enhancements.

The degree of the expected recovery, after the credit enhancements, is mainly dependent on the seniority of the exposure. Thus, senior debts are paid out first and have a higher probability and amount of payment whereas subordinate and junior debts have rather lower probability (see Figure 8.6). The recovery rates are mainly defined by applying statistical analysis but also some qualitative assumption and mapped as a recovery rate pattern. Institutions define the recovery rates for mapping both the amount and the time in which the corresponding recovery cash-flows are expected. The recovery pattern describes how this amount is to be regained over time.

There are several parameters that need to be considered in recovery behavior analysis including the seniority class, the net and gross exposures, the expected amount of recovery, and the expected recovery pattern.

Portfolio loans constructed in marketplace lending are uncollateralized; thus interest income and recoveries may be the only sources of covering the credit losses. Defaulted borrowers may decide to recover part of the outstanding obligation for avoiding further down­grading and loss of reputation. Nevertheless, recoveries in marketplace lending are a rare occurrence, for example,¹¹ when a loan no longer has a reasonable expectation of further payments, it earns “charged off” status. The platform may sell such loans to a third party, and if the third party recovers the outstanding capital fully or partially, investors receive a pro rata

FIGURE 8.6 Expected recovery rates for senior, subordinate and junior debts

share of the sales proceeds or recovered capital. One marketplace lending platform admits that recoveries on previously charged-off loans are infrequent.¹²

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