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We find that factors explaining bank loan recovery rates vary depending onthe state of the economic cycle. Our modeling approach incorporates a two-stateMarkov switching mechanism as a proxy for the latent credit cycle, helping toexplain differences in observed recovery rates over time. We are able todemonstrate how the probability of default and certain loan-specific and othervariables hold different explanatory power with respect to recovery rates over`good' and `bad' times in the credit cycle. That is, the relationship betweenrecovery rates and certain loan characteristics, firm characteristics and theprobability of default differs depending on underlying credit marketconditions. This holds important implications for modelling capital retention,particularly in terms of countercyclicality.

The determinants of bank loan recovery rates in good times and bad - new evidence