MIF_NPL.pptx

Master International Finance Non Performing Loan Valuation PROFESSOR ROBERTO KNOP...

Master International Finance Non Performing Loan Valuation PROFESSOR ROBERTO KNOP PhD, MRICS, MFIA, CESGA July 2024 1 Page Page Master in International Finance IEB 11  INDEX  INTRODUCTION Definition Regulation Market trends  GENERIC VALUATION MODEL Types Collaterals Credit situation  INTEREST RATE CURVES Interest rate curves Discount function Discounts function with profitability  CASH FLOW MODEL Relevant factors Implementation  VASICEK MODEL Model definition Parameters Pág Page Page Pág Master in International Finance IEB 22  1 Master in International Finance Introduction IEB Page Page 33 Definition Non A non-performing exposure is that one with a 90 days performing past-due (material exposure) or unlikely to be repaid EXPOSURE in full without collateral realization (irrespective of any past-due amount or of the number of days past-due). Impaired or defaulted according to the applicable accounting or regulatory frameworks. Non performing A nonperforming loan (NPL) is a sum of borrowed LOAN money upon which the debtor has not made the scheduled payments for a specified period. Many loans become non-performing after being in default for 90 days, but this can depend on the contract terms. Non-performing risk positions include defaulted and impaired risk positions. The total amount of non-performing risk positions is the sum of non-performing loans and non-performing off-balance sheet items Pág Page Page Pág Master in International Finance IEB 44 Regulatory initiatives to continue to put pressure on banks Priority in EU supervisory agenda EU Action plan to tackle NPL problem for EU banks with special focus on removing impediments for the formation and development of an efficient and active NPL market. Complemented by ECB NPL Guidelines and IFRS 9 accounting rules, which were put in place in 2018. Main effects on banks: 5% NPL ratio threshold NPE management integration in institution´s governance and planning Implementation of a transaction-oriented framework Data infrastructure: high granular analysis and data skills required with special focus on RE collateral Page Page Master in International Finance 5 IEB 55 Regulatory initiatives to continue to put pressure on banks EBA NPL Guidelines Prudential provisioning Enhanced disclosure backstops Extension of ECB requirements: Guidelines. Specification of Framework for the Supply of relevant and sound risk management establishment of mandatory comparable information on practices for credit minimum provisions for new asset quality in bank´s institutions for managing NPLs portfolios NPLs NPL transaction platforms AMC (Asset management companies) Blueprint: EBA NPL Loan tape Proposal for data infrastructure strengthening Common principles for effective Data tape to be used in NPL and setting-up of NPL implementation of national transactions and general AMCs. Clarification of transaction platforms in permissible design, consistent portfolio screening order to stimulate the with the EU legislative secondary markets framework. Asessment of EU insolvency Guidelines on loans Other initiatives for the regimes and enhancement origination: development of secondary protection of secured Sound principles for NPL markets creditors borrower affordability Proposals for removing Benchmarking exercise on assessment: origination, impediments on NPL transfer domestic regimes and monitoring and internal and harmonise servicers and potential regulatory proposal governance. investors requirements Page Page Master in International Finance IEB 66 The new IFRS 9 standard outlines a ‘three-stage’ model based on changes in credit quality since initial recognition Page Page Master in International Finance IEB 77 Spain: most active market in Europe in 2017-2021 period COVID-19 has obviously impacted the NPL market and will be the driving force for next few years. Shortly after the outbreak, the European NPL and REOs market came to an abrupt standstill in March 2020. The total volume of transactions during Q1 2020 barely reached €4 billion, with just one dozen deal completions. Spanish banks’ non-performing loan (NPL) rate have retreated to its lowest since 2009. Page Page Master in International Finance IEB 88 Early signs of stress are beginning to appear in the European banking sector Page Page Master in International Finance IEB 99  Improvement in NPL ratio with growing balances. Deterioration symptoms are observed in the NPL ratios, somewhat more intense in Q1 of 2024. Page Page Master in International Finance IEB 10 10  0,00% 0,50% 1,00% 1,50% 2,00% 2,50% 3,00% 3,50% 4,00% 4,50% 5,00% G re ec Sp e 4,60% a Po in 3,26% Master in International Finance Lu rt u x e ga m 3,20% bo l ur g 3,02% I ta Au ly 2,72% s Sl tria ov 2,55% en F r ia an 2,48% c I re e 2,41% la Be nd 2,03% lg G ium e 1,68% N rma et he ny 1,61% NPL ratios: Q1 2024 rla nd Fi s nl 1,55% an Es d 1,34% to Li nia Southern Europe concentrates highest NPL ratios. th 1,24% ua ni a 1,23% La tv ia 0,54% IEB 11 11 Page Page 2 Generic Valuation model Page Page Master in International Finance IEB 12 12  Generic Model Due to the different profiles of financial assets, mainly loans, their valuation requires appropriate quantitative models and a precise classification of them according to their characteristics. The main features for classification are linked to: 1) Financial terms: Depreciation rate Possibility of disposition Calendar of interest payments 2) Type of loan: cards, consumer, mortgage, corporate, credit lines, etc. 3) Credit standing Performing Non Performing Failed Pág Page Page Pág Master in International Finance IEB 13 13  Generic Model The contractual definition of financial assets establishes loan flows in the absence of credit events, amortisation/extraordinary disposals or changes in market conditions. Most loans in the Spanish market generate cash flows with a constant share of principal and interest, a constant share of principal or payment of principal at maturity. In addition, many allow partial or full repayment on each loan repayment date. I I II Constant share of principal and interest P P P Constant share of principal P P P P Principal payment at maturity Pág Page Page Pág Master in International Finance IEB 14 14  Generic Model Many of the interest rates on loans are referenced to FLOATING rates and the payments depend on the situation: -Market Types -Spread -Caps (roof clauses) -Floors of the contract. In addition, most loans have the possibility of early repayment which has to be considered in a probabilistic way to calculate the flows of the contract. Similarly, credit lines where the borrower can make withdrawals should be treated. Pág Page Page Pág Master in International Finance IEB 15 15  Generic Model. Type The different types of debtors and the existence or not of additional guarantees to them are the main variables that influence the characterization of a loan. The valuation of unsecured loans has a lot to do with the amount, homogeneity and solvency of the debtor. In general, many loans can be valued using: A) Statistical approach (similar to the actuarial one), without they are of little amount and similar atributes B) Modelling of the loan and debtor (similar to those with collateral) if they are of greater amount and more specific characteristics. Pág Page Page Pág Master in International Finance IEB 16 16  Generic Model. Collaterals Loans with additional guarantees to the debtor's solvency are the majority financial assets in the Spanish retail market. Its valuation is marked by The value The quality of the guarantee (mainly financial or real estate) and its treatment. The accuracy of the valuation of a financial asset is proportional to that of the debtor's equity analysis. This analysis requires is the study of your updated financial statements and the establishment of those assets to which there could be recourse in the event of a credit event. Financial Statements ANALYSIS Assets with resource Page Page Master in International Finance IEB 17 17  Generic Model. Credit Situation. The credit situation of a loan conditions its valuation and affects both the forecast of future flows and its possible classification within a sale portfolio. Without the occurrence of any credit event, all loans originate as performing and it is for that state that most valuation models (especially discounted flows) are designed. However, and especially at low times of the cycle and credit crisis, there is a significant number of non-performing loans (NPL) that need to be valued. PERFORMING Discount flows with corresponding rates NO PERFORMING Discount flows with corresponding rates Page Page Master in International Finance IEB 18 18  Generic Model. Credit Situation. Within NPLs, it is usually distinguished by the time since the credit event occurred: Unpaid Doubtful: less than 3 months from the event Failed: more than 3 months and less than 12, 18 and 24, depending on the agreement to define the failed. These classifications usually refer to a credit event where there is no default on the full principal. The valuation for NPLs is based fundamentally on the recoverability of the loan given by the existence of real guarantees or, in the last case, by the net asset value of the debtor. Pág Page Page Pág Master in International Finance IEB 19 19  Generic Model. Credit Situation. DISCOUNT CASH FLOW MODEL PERFORMING Contractual cash flows Appropiate interest rate. cash flows Value Discount rate NON PERFORMING STOCHASTIC MODEL Collateral Collateral (VASICEK) Collateral value Collateral volatility default time to Appropiate interest rate. possession Value Discount rate Pág Page Page Pág Master in International Finance IEB 20 20  Generic Model. Credit Situation. The valuation of financial assets, especially NPLs, is affected by the costs of their maintenance, management and legal processes related to legal events. In the latter case, the recovery process times are also very significant. Collateral Collateral default time to possesion All these expenses and terms, contractual flows, loan typologies (including credit standing), debtors and guarantees linked to financial expenses and market/investor capital structure are the parameters to be imputed in the different valuation models in order to be able to obtain a price for a loan. Pág Page Page Pág Master in International Finance IEB 21 21  Generic Model. Credit Situation. Concession Life Expiration PERFORMING SITUATION PERFORMING NO PERFORMING PL Discount of flows with Discount of flows with corresponding interest corresponding interest rate. MODEL rate. NPL APPRAISAL Recoverability based on collateral valuation, creditworthiness of borrowers and guarantors PL SPREAD ACCORDING SPREAD ACCORDING SPREAD ACCORDING For cash flow ESTIMATED QUALITY ESTIMATED QUALITY EVOLUTION NPL discounting TYPE OF purposes only. INTEREST RISK-FREE RATE RISK-FREE RATE Pág Page Page Pág Master in International Finance IEB 22 22  3 Master in International Finance Interest rate curves and discount function IEB Page Page 23 23  Introduction The valuation of a financial asset in general is the present value of the cash flow or flows it generates over time. In their determination they are relevant: 1. Location of the flow/s in time RELATIONSHIP CLOSE 2. Flow Magnitude/s 3. Probability of occurrence 4. Interest rate/discount to know its present value. Location Magnitude Valuation Probability Discount of flows with corresponding interest rate. Today Page Page Master in International Finance IEB 24 24  Curve with risk Interest rate curves are usually profiled as follows: Interest rate Interest rate Corporate with high risk Corporate with risk > interbank Interbank  Risk, PD High quality sovereign Risk-free interest rate: Sovereign of the highest quality Maturity Maturity The differences between them are due to the incremental differences in the probability of default, due to greater credit risk. Page Page Master in International Finance IEB 25 25  Curve with risk The interest rate curves of the Spanish Treasury, the German Treasury and the interbank curve in Euros are in place: Treasury Interbank Treasury Germany EUR Interbank: Spain Page Page Master in International Finance IEB 26 26  The discount function The construction of a zero coupon interest rate curve is carried out from various financial instruments. If quotes are available for instruments whose interest becomes effective at the maturity of the transaction (zero coupon rates), such as interest rates on interbank deposits, the calculation of the corresponding discount factors is immediate. A discount factor is no more than the present value of a future currency unit. 1 DF = 𝑓𝑜𝑟 𝑠𝑖𝑚𝑝𝑙𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 (1+𝑖 × 𝑦𝑓 ) 1 DF = 𝑦𝑓 𝑓𝑜𝑟 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 (1+𝑖) Page Page Master in International Finance IEB 27 27  4 Master in International Finance Cash flow model IEB Page Page 28 28 Flows (Distressed Market) The credit market in general is linked to those loans that have suffered credit events (NPLs) and therefore the flows to model have a distressed approach. Generally speaking, in order to apply a flow estimation model, it is key to determine the recipient: Originator/Owner of loans Investor Profile and Strategy Servicer The access to information and parameters applied by each of them is very different, as well as the time horizon given their return on investment requirements. Source: PWC. NPL. September 2017 29 Page Page Master in International Finance IEB 29 29 Flows (different strategies) Renegotiation Unsecured Unsecured Secured Secured Loans Loans Loans Loans Recovery Sale Active Enforcement Guarantee / Delivery Development / Sale L/P Holdings Investment Pág Page Page Pág Master in International Finance IEB 30 30  Flows (different strategies) STRATEGY DEBTOR STRATEGY Minimum Maximum Months to sale 9 18 1.Third party sale Discount 20% 20% DEBTOR Minimum Maximum 2.Discount pay out Months to agree. 18 36 Discount 20% 30% Minimum Maximum Months to agree. 24 36 3. Friendly sale (collateral) STRATEGY ASSET STRATEGY Discount 5% 5% 4. Dation in payment Depends on asset scoring ASSET 5. Asset execution Pág Page Page Pág Master in International Finance IEB 31 31 Flows (Relevant factors per investor) ECONOMIC CYCLE CASH GENERATED BY PORTFOLIO TIME HORIZON RETURN INVESTMENT OTHER FACTORS (FUTURE PORTFOLIO FLOW, COSTS AND ACCESS TO VENDOR FINANCING, SERVICING STRUCTURING) Page Page Master in International Finance IEB 32 32 Flows (relevant factors information) With regard to the access to information that allows flows to be estimated, different situations can be determined, depending on the position and process for portfolio analysis: – Availability of complete, granular, consistent, complete and accurate information – Availability of information summary (data tape) – Availability of a summary and access to complete information from a sample of files (data room) – Format and accessibility of information Page Page Master in International Finance IEB 33 33 Flows (Statistical estimations) Recovery curves Std unsecured Annual recovery rate Specialized unsecured Std secured (Example) Specialized secured Page Page Master in International Finance IEB 34 34 Flows (Portfolios of Individual – Unsecured loans) KEY VALUATION FACTORS INFORMATION SOURCES Statistical estimation by portfolio Internal portfolio management data - behaviour recoveries, age, deadlines, costs, Segmentation and classification of efficiency and guidelines by type and clients by resilience area Portfolio ageing and non-payment External accredited information - index ageing register, credit bureau, vendor CIRBE rating, debtor.... postal code -. Origination and subsequent management of non-payments, state of Internal or external contact details judicialization Existence or not of guarantors Individualized analysis of major exposures and tasting for calibration Pág Page Page Pág Master in International Finance IEB 35 35 Flows (Portfolios of Individual- Mortgage) KEY VALUATION FACTORS INFORMATION SOURCES Valuation of collaterals and typology / Portfolio Information geographical distribution -province, square Market tokens for collateral valuation size, census district-- External sources of valuation -AVM, Value Periods of execution and possession and Opinion, Appraisal..... - period of sale Information on forecasts of price evolution by Expected or potential evolution in asset value asset category Costs of recovery, management, maintenance Legal and fiscal costs by typology and sale Deadlines for execution and commercialisation - Existence of other guarantees - guarantor,.... - judicial statistics, real estate broker information,...- The debtor's expected future ability to pay - Real estate management and marketing costs - restructuring alternatives -. internal data or market benchmark-. Conditions of the loans -spread, term,.... - in Index registers, CIRBE and credit bureau for the case of performing loans debtor solvency analysis - restructurings, Status of the implementation process performing,.... - Protection of the debtor Characteristics of debtor protection - possible brake to execution / possession -- Pág Page Page Pág Master in International Finance IEB 36 36 Flows (Portfolios of Legal Entities - Unsecured) KEY VALUATION FACTORS INFORMATION SOURCES Net equity (accounting and economic) of Financial information of the debtors - debtor companies, recognised assets internal, external, Mercantile Registry, and liabilities and priority (EEFF or Report of the Insolvency Administrator-. bankruptcy report) Credit bureau, credit history, CIRBE - Flow generation capacity internal or external-. Existence of guarantors or guarantees Indicators or proxies of capacity to pay / Historical recovery in portfolio incidences - judicial bases,..... - Portfolio recovery curves or similar Sectoral and geographical analysis of operations portfolios provided by servicers / Portfolio data transacted or under State of the claim - specialized recovery, management judicialization, bankruptcy.... phase -- Pág Page Page Pág Master in International Finance IEB 37 37 Flows (Portfolios of Legal Entities - Secured) KEY VALUATION FACTORS INFORMATION SOURCES Valuation of collaterals and typology / Portfolio Information geographical distribution -province, square Market tokens for collateral assessment -zone, size, census district-- type,...- Periods of execution and possession and External sources of valuation -AVM, Value period of sale Opinion, Appraisal..... - Expected or potential evolution in asset value Information on forecasts of price evolution by Costs of recovery, management, maintenance asset category and sale Deadlines for execution and commercialization Existence of other guarantees - securities, - judicial statistics, real estate brokers pledges.... - information,...- Expected future payment capacity of the Real estate management and marketing costs debtor, financial analysis - restructuring -internal data or market benchmark-. alternatives -. Registers of indices, CIRBE, EEFF, Insolvency Conditions of the loans -spread, term,.... - in report and credit bureau for debtor solvency the case of performing loans analysis - restructuring, performing, Reversion risk recoverability additional to collateral. Status of the implementation process Data on portfolios under management or transacted in the market Pág Page Page Pág Master in International Finance IEB 38 38 Flows and discount models As we have seen, while the flows of a performing loan are in their greatest weighting unique and given by a contract, a defaulted loan can generate very different flows depending on the strategy assigned for its recovery and its management. This choice of strategy is usually linked to the scenario that maximizes the value for the investor by intervening in maximizing not only the flows, but their discount. Therefore, there is feedback between flows and discounts within the world of credit portfolios (especially distressed) and it is necessary to pose the model that combines both and then develop different approaches to discount. Pág Page Page Pág Master in International Finance IEB 39 39 Discounted Cash Flow Model The simplest and most common discount flow model for the simplest performing financial products in a quantitative approach (investment grade bonds) and in corporate and distressed valuation models, consists of associating to each flow a discount weighting it from each to a final value. This discount is usually associated with a target YTM or a comparable type of products traded on the market. flows cash flows D Debt Debt For cash CF: cash flows from principal or interest (fixed or variable; Euribor according to the implicit forwards in the corresponding curve or recovery in NPL) DF: discount factor For Page Page Master in International Finance IEB 40 40 Generic Model and by Cash Flows 𝐷=𝑃𝑉 (𝐷¿¿𝑇 −𝑄)¿ of aa Value of D: debt loan loan PV: present value Value T: maturity of debt Q: price of the potential loss. If we assume that the return on the asset is equal to the risk- free interest rate, it is equal to the Expected Loss. 𝑃𝑉 ¿ ¿ cash Using cash flows flows CF: cash flows from principal or interest (fixed or variable; Euribor according to the implicit Using forwards in the corresponding curve) FD: discount factor yf: accrual year fraction of cash flow in the case of interest The main problems are the calculations of the potential loss (Q) and the incorporation of the price-adjusted valuation and profitability of the future value of the collateral in the loan. Page Page Master in International Finance IEB 41 41  Cash Flows Model The market value of a loan is the present value discounted at the risk-free rate of the expected cash flows multiplied by the probability of collection. To this will be added the present value of the collateral adjusted in time and price by the probability of default. D Relevant variables to be estimated: PD, AJ Relevant variables to be estimated: PD, AJ D: debt PV: present value T: maturity of debt CF: cash flows from principal or interest (fixed or variable; Euribor according to the implicit forwards in the corresponding curve) CO: collateral value DFi: discount factor for risk-free rates DFL: discount factor at collateral settlement date yf: cash flow accrual year fraction PD: probability of default AJ: adjustment factor that incorporates the profitability of the collateral corrected in price until its liquidation. Page Page Master in International Finance IEB 42 42 Cash Flows Model This model requires at the same time the development of two models for: o Calculation of default probabilities based on hypotheses about:  Borrower's credit quality: rating, scoring….. o Calculation of collateral adjustment based on hypotheses about:  Yield during the investment  Time to settlement  Adjustment of the value to the settlement time Rating Rating SOLUTIONS type Collateral type A PD (or FD) curve stops: -Normal Status Maturity Maturity -Substandard status Collateral PD PD -Doubtful Status AJ PDA A PDB B -Default Status updated AJ according to market references (loans, bonds, CDS....) This forces a scoring to calibrate PD Page Page Master in International Finance IEB 43 43 Cash Flows Model Alternatively, you can replace the PDs with corresponding discount functions according to the credit quality of the loans - calculate present value of the expected cash flows. To this shall be added the present value of the expected loss covered by collateral. 𝑛 𝑃𝑉 (𝐷𝑇 ) ∑ [ ( 𝐶𝐹 𝑖 × 𝐷 𝐹𝑅 𝑖 × 𝑦𝑓 𝑖 ) −(𝐸𝐿× 𝐷 𝐹𝑅𝑖 )] 𝑖=1 Relevant variables to be estimated: DFR, EL Relevant variables to be estimated: DFR, EL D: debt PV: present value T: maturity of debt CF: cash flows from principal or interest (fixed or variable; Euribor according to the implicit in the corresponding curve) DFRi: discount factor corresponding to the rates with the corresponding credit risk yf: cash flow accrual year fraction EL: expected loss PD: probability of default AJ: adjustment factor that incorporates the profitability of the collateral, corrected in price, until its liquidation. Page Page Master in International Finance IEB 44 44  5 Master in International Finance Vasicek Model IEB Page Page 45 45 Vasicek Model It is based on the theory of options and assumes normality in the variations of the prices of the assets (collateral) and liabilities of a company... Requires estimation of asset or collateral price volatility. Part of the premise the price of an asset satisfies the following equation 𝑑𝐴=𝜇 𝐴 𝑑𝑡 +𝜎 𝐴 𝑑𝑊 𝜇:𝑎𝑠𝑠𝑒𝑡 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑒𝑡𝑢𝑟𝑛 𝜎 :𝑎𝑠𝑠𝑒𝑡 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 The total value of a company's assets is A: asset C: liabilities with higher priority than debt D: value of debt B: value of bonds issued S: equity value Page Page Master in International Finance IEB 46 46  Vasicek Model D: debt − 𝑟𝑡 𝐷=( 𝐷 𝑇 − 𝑄) 𝑒 T: maturity of debt Q: price of the potential loss. Expected Loss if collateral return = risk- free rate F: interest (not paid on the debt) and/or dividends Debt+ Liabilities in t VP(Assets-divid. or Liabilities in VP(Assets - divid. or int.) int.) t 𝑁 ( 𝑑1 ) 𝑖𝑠 𝑡h𝑒 𝑃𝐷 Page Page Master in International Finance IEB 47 47 Vasicek Model This model requires the estimation of different types of parameters Certain:  Debt  Interest rate  Interest rate on arrears  Risk-free interest rate  Deadline  Collateral value. Uncertain:  Collateral yield during your tenure  Collateral volatility (in the absence of implicitly quoted, historical). Use some research available Page Page Master in International Finance IEB 48 48  Vasicek model (parameters) There are some useful market indicators to calculate historical volatility in the Spanish real estate market: Type Source: Frequency Format Property Start date Base Year Description Ministry of Information obtained from the association of Development Web/Bloomberg Quarterly Excel/Excel Housing 2004 2005/100 appraisers (weighted no. of transactions) Ministry of Development Web/Bloomberg Quarterly Excel/Excel Soil 2004 Euro/m2 Information obtained from the Register Information obtained from the company's valuations Tinsa Bloomberg Monthly Excel Housing 2001 2001/1000 (by province and number of valuations) Information obtained from the association of notaries (weighted no. of transactions, only natural INE Web/Bloomberg Monthly Excel/Excel Housing 2007 2007/100 persons) Information obtained from the offer prices of the PHOTO HOUSE Web Quarterly PDF Housing 2005 2005/1000 web (weighted nº transactions Information obtained from web offer prices (GDP- Idealist Web Quarterly PDF Housing 2002 2002/100 weighted index) In addition, some assumptions are necessary regarding the returns (expert criteria approaches, implicit market rates or macro analysis) of the assets and the recovery terms of the default scenarios (linked to execution times and bankruptcy terms). Page Page Master in International Finance IEB 49 49 Vasicek model (solvency parameters) There are multiple definitions and approaches to measuring or defining a company's creditworthiness. Solvency should be assessed as the value of a company, i.e. the value of a company on the basis of its assets and liabilities at the time of valuation. Detailed information on a company's assets and liabilities is not always accessible, so it is usually necessary to make approximations from its annual accounts, focusing both on the key items on the balance sheet and on the company's profits and losses. In addition to this information or in the absence of it, it is advisable to consult other information on credit risk which, although they hinder (or force new assumptions) the quantitative calculation of solvency, give signs of non-payment or different payment situations. We mention some of them, although many others can be contemplated, including more heterogeneous ones (public profiles on the Internet, etc). CIRBE: Bank of Spain Information Centre. RAI: Defaults of legal entities with bank debts. Reports and judicial status Page Page Master in International Finance IEB 50 50 Vasicek Model (liquidity and capital parameters) Loan buying and selling markets, especially distressed markets, are illiquid with operators with very different capital costs, liquidity needs and objectives. Usually, these differences are much more marked between sellers and buyers so there are large differences between the bid (buy) and ask (sell) values of the market. The increase in depth and liquidity of a market can be seen by the narrowing of these values which could somehow resemble wholesale versus retail prices. Broadly speaking, we can classify market operators in two: Distressed funds with high financing costs (double digits, +/-15%, all capital), market regulation and on the buyer side. Loan generators, with much lower financing costs, financial regulation and usually on the selling side. The crossover in market operations between the two is often marked by the strategic, regulatory (such as capital charges) or liquidity needs of financial institutions to get rid of loans considered unprofitable or non core at appropriate prices to match the returns required by distressed funds. Page Page Master in International Finance IEB 51 51 Vasicek Model (stochastics parameters: volatility) Volatility has been estimated using a GARCH(1.1) model. It is a statistical model used to predict volatility where the underlying variable may exhibit a reversal of the average. GARCH is the acronym for generalized self-regressive conditional heteroscedasticity. They are characterized by assuming Self-regressivity: volatility depends on past volatility Contagion: contexts of high or very low volatility are surrounded by similar episodes Asymmetry: ascents are less volatile than descents of variables. We will estimate the volatility for the future moment and depend on some parameters: 2 2 𝜎 𝑖 +1 =𝜔 +𝛼 𝑅 𝑖 + 𝛽 𝜎 𝑖 The maximum likelihood estimation is carried out for the parameters 𝜔,𝛼, 𝛽 Page Page Master in International Finance IEB 52 52 Vasicek Model (stochastics parameters: volatility) Province Volatility Speed Population Province Volatility Speed Population (% / total) (% / total) TERUEL 8,29% 84,31% 0,29% ZAMORA 6,33% 89,98% 0,38% HUESCA 7,98% 90,87% 0,47% SORIA 7,93% 99,55% 0,19% TOLEDO 6,31% 91,96% 1,47% OURENSE 7,91% 97,02% 0,67% TARRAGONA 6,29% 90,90% 1,70% LUGO 7,82% 99,79% 0,72% SALAMANCA 6,19% 99,82% 0,72% SEGOVIA 7,49% 99,69% 0,33% ALAVA 6,17% 90,63% 0,70% CUENCA 7,38% 61,34% 0,43% CORDOBA 6,15% 90,73% 1,69% ALBACETE 6,88% 90,08% 0,84% HUELVA 6,13% 91,84% 1,11% GUADALAJARA 6,85% 84,43% 0,54% CORUÑA, A 6,10% 93,96% 2,41% MALAGA 6,84% 99,79% 3,50% RIOJA, LA 6,03% 99,82% 0,68% BURGOS 6,75% 79,18% 0,77% LEON 6,02% 99,79% 1,01% PALENCIA 6,72% 99,70% 0,35% VALLADOLID 5,97% 81,32% 1,12% ALMERIA 6,63% 90,27% 1,52% ALICANTE 5,88% 92,79% 3,92% CEUTA 6,58% 98,37% 0,18% CANTABRIA 5,88% 91,51% 1,25% CASTELLON 6,56% 88,23% 1,24% PONTEVEDRA 5,83% 99,79% 2,02% MELILLA 6,51% 99,22% 0,18% CIUDAD REAL 5,77% 90,73% 1,08% ZARAGOZA 6,41% 95,04% 2,05% MURCIA 5,71% 99,79% 3,16% AVILA 6,37% 89,65% 0,35% SEVILLA 5,66% 99,82% 4,16% Province Volatility Speed Population (% / total) NAVARRA 5,59% 99,79% 1,38% GRANADA 5,54% 90,26% 1,96% CACERES 5,53% 84,51% 0,86% CADIZ 5,48% 91,51% 2,66% LLEIDA 5,48% 99,79% 0,93% GUIPUZCOA 5,46% 82,74% 1,54% JAEN 5,29% 93,29% 1,38% SANTA CRUZ DE TENERIFE5,26% 99,82% 2,16% BALEARES 5,21% 76,53% 2,40% GIRONA 5,12% 90,26% 1,62% MADRID 5,12% 93,02% 13,97% VIZCAYA 5,08% 97,80% 2,47% PALMAS, LAS 5,00% 99,79% 2,36% VALENCIA 5,00% 92,65% 5,46% ASTURIAS 4,81% 88,53% 2,22% BADAJOZ 4,77% 85,60% 1,46% BARCELONA 4,33% 90,08% 11,97% Page Page Master in International Finance IEB 53 53 Vasicek Model (stochastics parameters: volatility) 9% 8% 7% Volatility 6% 5% 4% Ball size =population of the province 3% 60% 70% 80% 90% 100% 110% Average mean reversion speed Page Page Master in International Finance IEB 54 54 Vasicek Model (stochastics parameters: volatility) The location of the real estate guarantees of the financing operations managed by the financial entities are given. However, it is up to them to discriminate positively in prices and to become more competitive in those cases in which favourable circumstances exist. In the process of evacuating secured loans from the bank balance sheets in which the sector is currently immersed, the optimisation of the portfolios that institutions can maintain involves identifying those that have the collateral located in the "good quadrant"; less volatility and a high reversion to its "structural" volatility. Together with the solvency analysis of the borrowers, the analysis of real estate guarantees is one of the levers of competitiveness that banks can promote even for price discrimination. Page Page Master in International Finance IEB 55 55  Thank you! [email protected] 📨 [email protected] www www.knop.es www.linkedin.com/in/RobertoKnop Page Page Master in International Finance IEB 56 56