Rating Models and Validation - Oesterreichische Nationalbank

Rating Models and Validation
precisely in this context, it may be advisable to consider segmentation based on
the historical volatility of securities as well as market liquidity.
The recovery rates for physical collateral implicitly contain the individual
components (collateral value at time of default, realization period, realization
costs and markdown on market price for illiquid markets). In order to improve
discriminatory power with regard to the recovery rate for each segment, it is
advisable to perform further segmentation based on these components. The
definition of segments should be analogous to the selection of segmentation criteria
for bankruptcy recovery rates based on statistical analyses wherever possible.
If a meaningful statistical analysis is not feasible, the segmentation criteria
can be selected on the basis of justified expert decisions.
As an alternative, it is possible to estimate the value of components individually,
especially in the case of physical collateral. This is especially common
practice in the case of large objects (real estate, ships, aircraft, etc.). Capital
equipment is generally valuated using business criteria in such a way that the
collateralÕs value depends on the income it is expected to generate (present
value of cash flow). In such cases, suitable methods include cash flow models,
which can be coupled with econometric models for the purpose of estimating
rent developments and occupancy rates, for example. Instead of cash flow simulation,
the present value and appropriate markdowns can form the basis for
estimates of the collateral value at default, which is calculated by means of
expert valuation for real estate and large movable property (e.g. ships). Private
consumer goods such as passenger vehicles can be valuated using the secondary
market prices of goods with comparable characteristics. In contrast, saleability
is uncertain in the case of physical collateral for which liquid and established
secondary markets do not exist; this should be taken into account accordingly.
It is then necessary to adjust the resulting present value conservatively using
any applicable markdowns (e.g. due to neglected maintenance activities) and
miscellaneous market developments up to the time of default. In addition to
the realization period, the specific realization costs (expert opinions, auctioneersÕ
commissions) and any markdowns on the market price due to the realization
marketÕs liquidity also deserve special attention. As these costs generally
remain within known ranges, it is advisable to use expert estimates for these
components. In this process, the aspects covered and the valuation should be
comprehensible and clearly defined.
Interest Loss
The basis for calculating interest loss is the interest payment streams lost due to
the default. As a rule, the agreed interest rate implicitly includes refinancing
costs, process and overhead costs, premiums for expected and unexpected loss,
as well as the calculated profit. The present value calculated by discounting the
interest payment stream with the risk-free term structure of interest rates represents
the realized interest loss. For a more detailed analysis, it is possible to
use contribution margin analyses to deduct the cost components which are no
longer incurred due to the default from the agreed interest rate.
In addition, it is possible to include an increased equity portion for the
amount for which no loan loss provisions were created or which was written
off. This higher equity portion results from uncertainty about the recoveries
156 Guidelines on Credit Risk Management