An analysis of the limitations of utilizing the development method for projecting mortgage credit losses and recommended enhancements

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By Kyle Mrotek, Michael C. Schmitz | 30 November 2010

The rise and fall of subprime mortgage securitizations contributed in part to the ensuing credit crisis and financial crisis of 2008. Some participants in the subprime-mortgage-backed securities market relied at least in part on analyses grounded in the loss development factor (LDF) method, and many did not conduct their own credit analyses, relying instead on the work of others such as securities brokers and rating agencies. A new appreciation for the value of independent analysis is clearly a silver lining and an important lesson to be taken from the crisis. This paper examines the LDF method and offers several enhancements that consider both underwriting characteristics of the underlying loans and economic factors.