Usage Given Default < 1 ?

[JDGutzmann]

Hi there,

I would like to post the question of whether a UGD of less than 100% is plausible in the real world.

So far, in any credit risk modelling that I came across, UGD was assumed to be exactly 100% (leaving aside confusing covenants), because as a debtor moves into default, she will "max out" all remaining commitments in order to avoid a default.

Maybe you can help by referring me to literature elaborating on this matter.

Thank you very much!

Joh. D. Gutzmann

 

[brian.field]

There are countless ways in which this could happen, in my humble opinion. At first thought, it is my understanding that most credit facilities restrict access to funds following a downgrade (or a variety of other ex ante defined events). Consider a company rated Baa3 with. $100 credit facility with $50 drawn. Now assume that funds are only accessible while the Baa3 is retained. If the company is downgraded at a time when only 50% of the facility is used, (I guess you could argue that they would access the funds prior to a downgrade in the hopes of preventing the downgrade itself,) then I could envision a UGD less than 100%.

Another example might be a downgrade straight to default due to some extreme circumstance wherein which the access to the credit facilities would not matter - I am thinking of a company based in the World Trade Center on Sep 11, assuming the company had no other offices and no insurance, etc. this may NOT be plausible, but clearly, is possible.

Hope that helps!

Brian

 

[JDGutzmann]

Thank you, Brian for your help.

 

[brian.field]

You are most welcome!

Brian