In its most recent Mortgage Strategist, UBS examined potential mortgage market losses, looking specifically at such drivers as foreclosure and loss severity. In the study, analysts focused on subprime loans as the sector is more sensitive to housing market swings. Also, the sample size for subprime losses is much greater compared to prime and Alt-A mortgages, particularly in the strong coastal housing markets. Analysts used the same method for determining losses on prime and Alt-A collateral, and results were in line with the subprime data.
Cumulative losses could be influenced by probability of default and loss severity - two factors derived from certain rating agency methodology of modeling expected losses. Analysts defined a default as a loan that reaches foreclosure status or worse, adding that a consistent measure of loss severity that corresponds to the probability of default should include all those loans that have reached foreclosure and not only mortgages with positive losses, noting that including only mortgages with positive losses would tend to produce much higher loss severities. This becomes even more pronounced when a higher percentage of loans reach foreclosure but actually produce no losses, which has been true of coastal housing markets in the past several years.