Moody's Investors Service highlighted its expanded method of calculating net losses in auto loan pools, in a report issued last week. The calculation Moody's uses is an expansion on the traditional method of calculating cumulative net losses, and involves calculating a new statistic called cumulative net loss to liquidation, which Moody's claims is an indicator of the standard net loss statistic.

Moody's Senior Vice President Kumar Kanthan, suggested that, while loss-to-liquidation is not the only calculation issuers and investors should be using to evaluate auto-loan pools, it is one of the most powerful. "Add it to your toolkit if you are not already using it," he recommended.

Moody's claims that calculating CNLTL provides a better indicator of losses early in the life of a pool than the cumulative net loss statistic and is more accurate at predicting performance of pools containing loans with longer-than-average original terms, because those tend to have more back-ended losses.

The primary difference between loss-to-liquidation and cumulative net loss is that loss-to-liquidation measures net losses, as a percentage, using a variable denominator calculated by subtracting the current pool balance from the original pool balance - leaving the amount of loans that have been liquidated.

By factoring in the amount of loans that are no longer in the pool, the graph of a pool's loss-to-liquidation rises much more steeply than its cumulative net loss graph at the front end of pool's life and then levels out to ultimately reach the same number as the cumulative net loss percentage. The difference in the two curves is dramatic when the pool is young, but converge as the pool matures.

"Any comparison of a longer-term pool to a regular-term pool, based on cumulative net loss performance, would require adjustments for the potential differences in the shape of each pool's loss curve," according to the report. "The use of [loss-to-liquidation] analysis may be preferable in this instance because the [loss-to-liquidation] metric adjusts for the impact of longer terms to some degree as the back-ended, or delayed, losses are offset by the slower amortization or liquidation of such pools," it summed.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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