Loss Severity
Private Credit & Direct Lending
Definition
Loss severity is the share of a defaulted exposure that is not recovered after collateral sales, guarantees, workouts, or other recoveries. It is the complement of recovery rate.
Why it matters
Default rate tells you how often loans fail; loss severity tells you how bad failures are. A real estate lender can survive elevated defaults if collateral recoveries are strong, but high default frequency plus high severity quickly erodes equity and investor trust.
Common misconceptions
- •Default rate and loss severity are different dimensions.
- •Low LTV does not guarantee low severity if collateral marks are stale or foreclosure costs are high.
- •Severity should be measured after legal costs, taxes, repairs, and sale expenses.
Technical details
Simple formula
Loss severity = (exposure at default - net recovery) / exposure at default.
Example: $250,000 defaulted loan, $190,000 net recovery after sale and costs. Loss severity = 24%.
Recovery rate is 76% in the same example.