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Do Economic Downturns Have an Impact on the Loss Given Default of Mobile Lease Contracts? An Empirical Study for the German Leasing Market

by Thomas Hartmann-Wendels of the University of Cologne, and
Martin Honal of the University of Cologne

December 2006

Abstract: This paper investigates the impact of the economic cycle on the loss given default (LGD) of mobile leases. Our data set, which was provided by two major German leasing companies, contains 53,944 defaulted contracts and covers the period between 1993 and 2004. The underlying assets are segmented into three classes: vehicles, ICT equipment, and machinery. Using regression techniques, we first analyse the relationship between several macroeconomic variables and the aggregated LGD according to its different components. Our results show that the LGD based on the return from asset resale at the secondary market is more sensitive to economic conditions than the LGD resulting from other recovery sources such as late rentals. Especially in the vehicle segment, where the overall LGD is strongly driven by the resale returns, we observe that the LGD tends to increase a lot during downturn periods. Based on our estimation results, we point out how leasing companies can estimate a downturn LGD which is in line with the requirements of the Basel II regulatory capital framework. Furthermore, we introduce the concept of the "resurrection rate" which measures the extent of resurrections due to a withdrawal of the default event. This study provides useful insights for leasing companies that have decided to adopt the Advanced IRB Approach of Basel II to their lease portfolios.

JEL Classification: G21, G28.

Keywords: Credit Risk, Leasing, Loss Given Default.

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