What is Loss Severity (LGD)?
Loss Severity, also called Loss Given Default (LGD), is the percentage of a defaulted loan's outstanding balance that the investor ultimately loses after all recovery efforts, including collateral liquidation, mortgage insurance claims, and deficiency judgments. It is the complement of the recovery rate: if a lender recovers 60 cents on the dollar from a foreclosed property, the loss severity is 40%. Loss severity depends on property type, LTV at default, local real estate market conditions, foreclosure timeline, and loan characteristics.
Formula
Loss Severity = 1 - Recovery Rate Expected Loss = PD x LGD x EAD Where PD = Probability of Default, LGD = Loss Given Default, EAD = Exposure at Default
How LoanBook Uses Loss Severity
LoanBook uses the Severity Model v3, which states severity as a percentage of the loan balance at the time of default. Residential severity is read from a realized Fannie Mae loss table with the property marked to its value at the time of default; other sectors use LTV, property type, state foreclosure timelines and home price inputs. The model integrates with the Default Model for CECL lifetime loss calculations and feeds into OAS pricing.
Frequently Asked Questions
What is a typical loss severity for residential loans?
Residential first lien mortgages typically have 25-45% loss severity. Higher LTV loans, judicial foreclosure states, and declining markets push severity higher. Second liens and unsecured consumer loans can see 80-100% severity.
How does LTV affect loss severity?
Higher LTV at default means less equity cushion, leading to higher severity. A loan at 60% LTV has significant equity protection (severity may be 15-25%), while a loan at 95% LTV has minimal cushion (severity may be 45-65%).
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