Delinquency, Default, and Loss Analysis
Nearly every asset class in structured finance is subject to loan obligors not paying. This eventually generates losses. While the concept of an obligor defaulting and causing a loss is not difficult to understand, historical loss reporting, future loss projection, and how a structured transaction model is constructed to handle these are often a cause of confusion. Because there is no standardized method for reporting, projecting, or modeling loss, data is often presented in inconsistent and sometimes misleading formats. The most favored format of understanding historical loss information is the static loss report, which tracks losses for each origination period over time. This format is ideal for building historical loss curves and producing a projected loss curve with severity and timing that is predicated on prior asset performance.
Incorporating loss into a model can also be done a number of ways depending on certain rating agency methodologies and subjective formula techniques. This chapter lays the groundwork for understanding loss and shows one possible method for integrating the concept into a functioning model. Later in this book there are discussions about other methodologies.
DELINQUENCIES VERSUS DEFAULTS VERSUS LOSS
One reason understanding loss can be so confusing is the terminology that is involved in the process leading up to a loss. To be clear prior to any use, the following related terms are defined: