The expected value of collateral conditional on default is often far lower than its unconditional expectation.

True: the credit-risk literature or empirical data show that collateral values or recoveries on default are frequently and substantially lower than their unconditional or average values, because collateral value and default are positively correlated ('wrong-way risk', recoveries that fall when default rates rise). Mostly true: the effect is well documented but its size is modest or shows up only in some asset classes, so 'often far less' slightly overstates it. Mixed: the evidence is split, with a material effect in some major settings and a negligible one in others. Mostly false: the effect exists but is generally small or rare, so 'often far less' clearly overstates it. False: the evidence shows that, conditional on default, collateral values are typically no lower than their unconditional expectation.

Set before the research began.

1. E1 Special Comment Moody's Ultimate Recovery Database Moody's Investors Service · April 2007

   “Corporate family and bond recovery rates exhibit considerable cyclicality as measured by their correlation with the US speculative-grade default rate. Loan recovery rates exhibit considerably less cyclicality.”

2. E2 The link between default and recovery rates: effects on the procyclicality of regulatory capital ratios Bank for International Settlements · 1 July 2002

   “our results show a significant increase in both expected an unexpected losses when recovery rates are stochastic and and negatively correlated with default probabilities.”

3. E3 Local Housing Market Cycle and Loss Given Default: Evidence from Sub-Prime Residential Mortgages; by Yanan Zhang, Lu Ji, and Fei Liu; IMF Working Paper 10/167; July 1, 2010 International Monetary Fund · July 2010

   “He finds that the recovery distribution is bimodal, with recoveries lower in recessions than in expansions.”

4. E4 [PDF] Loss-given-default and macroeconomic conditions European Central Bank (Working Paper Series No 2954)

   “banks may be reluctant to liquidate collateral assets during economic downturns. This temporal gap between default and loan resolution suggests that the LGD may not necessarily increase during a recession, particularly in the case of secured loans.”

The BIS working paper (E2) reports a significant increase in expected and unexpected losses when recovery rates are stochastic and negatively correlated with default probabilities. The IMF paper (E3) cites findings that recoveries are lower in recessions. Both support the idea that collateral is worth less in the conditions under which default happens. But Moody's (E1) finds that loan recoveries are much less cyclical than bond recoveries, and the ECB paper (E4) notes that loss-given-default on secured loans may not rise in recessions. So the effect is well documented, but it is weaker for secured loan collateral specifically, and "often far less" somewhat overstates it.