Delinquency, Default, and Loss Analysis 75
therefore have percentages of loss taken out. However, it may seem unusual when
using a loan level style of amortization because a percentage of loss is taken out of
an individual loan. In reality a loan will either default or not. There is no concept
of part of a loan defaulting. In modeling, however, a loss curve will be applied to
each loan and the results aggregated. This concept becomes more important when
thinking about seasoning and default timing.
The Effects of Seasoning and Default Timing
When a loan has begun to amortize or is seasoned, the expected loss amount will
change because a seasoned loan is on a different part of the loss curve than a new
loan. For example, a loan that is brand new with a final maturity of 24 months
might have a loss curve that is 24 periods in length. By month 24 the loan will have
taken 100 percent of its expected loss. Imagine that the loan was already 10 months
old when it was sold into the transaction. This means that 10 months of loss should
be expected to already have taken place. Figure 4.12 shows the difference of two
loans with different seasoning and their expected remaining loss.
FIGURE 4.12 A new loan will be expected to
take a full 7.01 percent of loss, while a loan
seasoned 10 months is assumed to have already
taken 2.31 percent loss, leaving the expectation
of 4.70 percent of loss to be incurred.
