With global debt at an all-time high, some commentators are voicing concern over the increased risk of banks’ corporate lending. Nina Brumma, Head of Research and Analytics at Global Credit Data, discusses what happens to corporate debt in the event of default
Following a slow but steady emergence from the global economic crisis at the end of the last decade, alarm bells were raised by the International Monetary Fund (IMF) last month at the news that global debt reached a record-breaking high at the start of 2018. With the total now standing at $237 trillion, the question has been raised as to whether bank lending is becoming an increasingly risky business.
In its latest Global Financial Stability Report, the IMF signalled that “the prolonged period of loose financial conditions in recent years has raised concerns that financial intermediaries and investors in search of yield may have extended too much credit to risky borrowers.”
A warning to both banks and corporates, it raises a vital question – what will happen if corporates start defaulting on this debt? An answer to this question can found by analysing banks’ Loss Given Default (LGD) – a risk metric that measures the percentage of non-recovered funds in the instance of borrower default. With defaulted loans representing just 1% of a given bank’s total loan book, however, data on LGD has historically been in short supply – making it difficult to identify meaningful trends.
The release of Global Credit Data’s recent LGD report – combining statistics from over 50 member banks since 2000– is therefore a timely one. Indeed, it offers some reassuring perspective on the real risks of corporate default – revealing that, on average, banks recover 75% of defaulted corporate debt. And if we factor in that only 1% of corporate debt is actually defaulted on in the first place, this means banks recover a total of 99.75% of all corporate debt – while also generating profit through coupons and interest payments. These considerations should be clear in minds of banks and their detractors when weighing up the risks of continued corporate investment.
Breaking down the figures a little further, we can see that banks recoup almost 100% from the majority of individual defaulted facilities – with only 10% resulting in a loss of 80% or more.
If we consider these figures on a global scale, the statistics are consistent across the regions: Europe and North America sit in the middle of the regional averages – registering very similar figures. Outside this, Africa and the Middle East boast lower levels of LGD, while Asia and South America have slightly higher levels. These slight variations, however, are likely the result of variations in the make-up of data and we cannot be sure whether they represent significant statistical diversity.
For instance, in Africa and the Middle East, data is compiled from a much smaller data set than other regions – a disproportionate amount of which originates from South Africa, where the LGD on average tends to be lower than other countries in the region. Consequently, there is no hard evidence to suggest that African and Middle Eastern debt carry significantly less risk with regard to LGD.
In Asia – which encompasses the Oceania region in its data – it’s a similar story, only it is made up of a much larger and more diverse list of countries. With each country shaped by its own unique legal and economic frameworks, disparities in LGD are inevitable. Australia, New Zealand, South Korea and Japan, for instance, have LGD levels which are more or less in line with Europe and North America’s, but other countries – with higher LGDs – inevitably push up the region’s average.
While regionally, LGD levels do not vary too significantly, the data collected does vary over time – suggesting a relationship between LGD and the state of the global economy. Another Global Credit Data report – the LGD Downturn Report – found, somewhat unsurprisingly, that default rates are proportional to a decline in GDP growth, but the relationship between GDP and LGD is a little more complicated. If we look at data from the period leading up to and inclusive of the global financial crisis, LGD rose well ahead of time, peaking in 2008 and dropping off in the midst of the crisis – before default rates themselves had normalised.
It’s hard to find a specific systemic factor to which we can attribute this correlation, but it appears that there is a link between macroeconomic decline and a rise in LGD. Of course, while we do have LGD data for recent years – which could potentially corroborate the IMF’s fears and indicate another downturn – these records are not yet complete due to the time it takes to resolve defaults (two years on average).
Mitigating risk with seniority and security
The report does, however, provide us with clear evidence as to the factors that determine the costs for banks, and the likelihood of repayment, in the event of a corporate default.
Unsurprisingly, taking collateral has a significant impact on LGD – with an average of 23% LGD for secured debt, versus 28% for all unsecured debt, falling down to 40% for debt that is subordinated and unsecured. Given the concern surrounding the growing levels of global corporate debt, banks with high levels of secured debt can point to these figures as reassurance and vindication for their investment policies.
As we have briefly seen already, seniority also plays a role in determining LGD – with the percentage of senior unsecured debt recovered standing at 73%, compared with just 60% of subordinated unsecured debt.
So despite the climate of concern surrounding rising global debt levels, the industry must keep a level head. Public opinion is easily swayed – “debt” a somewhat loaded term, after all – but these investments ultimately drive the economy forwards. And with both seniority and collateral in place, the evidence suggests banks can continue to invest with confidence.
Global Banking & Finance Review
Why waste money on news and opinions when you can access them for free?
Take advantage of our newsletter subscription and stay informed on the go!
By submitting this form, you are consenting to receive marketing emails from: Global Banking & Finance Review │ Banking │ Finance │ Technology. You can revoke your consent to receive emails at any time by using the SafeUnsubscribe® link, found at the bottom of every email. Emails are serviced by Constant Contact
Business3 days ago
Leverage the customization revolution to promote your brand
Top Stories3 days ago
Reconsidering climate risk: a return to valuation fundamentals
Business3 days ago
Bluprintx strengthens sales and marketing leadership to drive global growth-as-a-service expansion
Top Stories3 days ago
Britain sets out marketing rules for EU investment funds in the UK