When Loans Go Rogue – How Investors Read the Risk in Securitisations

If you’ve ever wondered what keeps structured credit analysts awake at night, it isn’t the copious cups of coffee they’ve downed that day – it’s two deceptively dull numbers that decide whether a deal sinks or swims.

The first is default frequency – how often the borrowers behind a securitisation are expected to miss their payments. The second is loss severity – how much value disappears when they do. Together, they form the heartbeat of every securitisation model, quietly dictating the pecking order of who gets paid, who doesn’t, and who ends up explaining themselves to the credit committee.

Get those numbers wrong, and what looked like a calm pool of loans can turn into a splashy mess. Get them right, and you’re the one who saw the storm approaching while everyone else was still admiring the prospectus.

So, what do default frequency and loss severity actually tell us about risk? And how do investors work out when loans are about to misbehave? Time to meet the first troublemaker: default frequency.