With the recent release of a new loss-severity analysis model, Credit Suisse First Boston finds that within the subprime home-equity sector the Darwinian theory of "survival of the fittest" has clearly been demonstrated among lenders, separating the proverbial wheat from the chaff. Researchers Rod Dubitsky and Kumar Neelakantan also find current, rather than initial loan-to-value ratios, a much more significant indicator of loss severity.

What makes this analysis so groundbreaking is the fact that CSFB looks not only at active lenders in the sector but those who have tried - and failed - to survive within the sector. This shows, according to Dubitsky, that "those still operating are doing things right."

Cited in the study are the top-tier issuers within the sector, Saxon Mortgage, Option One, Countrywide, Centex and GMAC-RFC in particular, which, not surprisingly, all have loss severities under 40%. By contrast, defunct issuers Equicredit, The Money Store and even GE Capital Mortgage all top 55% in the loss severity department.

This raises the question of whether the issuer tiering is based on identifiable loan characteristics or is simply a function of business practices. What CSFB found is that loan characteristics and issuer specific servicing practices are significant factors in determining loss severity.

For example, when ranked by observed loss severity, Centex was ranked seventh. CSFB's analysis revealed that Centex's higher loss severity was partly explained by the lower average loan balance of their portfolio compared to other lenders. CSFB's loss severity model adjusts for such important factors in predicting loss severity. When issuers were ranked using CSFB's model, which adjusts for loan characteristics, Centex's ranking improved to third place.

The data suggests that when adjusted for other factors, loans with the higher current LTV at payoff experience a higher loss severity. Dubitsky credited the fact that low original LTV loans tend to prepay in full out of delinquency as one of the reasons for the lack of significance of original LTV in explaining loss severity.

In summation, CSFB says: "Other things equal, pools with lower average current loan balance, greater seasoning, increased percentage of REO, greater non-owner occupied concentration and higher current LTV loans would be expected to have higher loss severity."

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