The UFA Default Risk Index for the fourth quarter of 2009 continued its slow retracement from the peak, falling to 256 from last quarter’s revised 264. The Index illustrates the important role that local economic conditions have played in this credit cycle since loan, borrower and collateral characteristics are held constant over time in the Index. Our baseline scenario for the economy this quarter now has GDP growing at close to trend rates over the next two years.
Under current economic conditions, non-prime investors and lenders should expect defaults on loans currently being originated to be 156 percent higher than the average of loans originated in the 1990s. That’s a key finding of the latest UFA Mortgage Report™ by University Financial Associates of Ann Arbor, Mich.
“Even as house prices move toward sustainable values, and house price depreciation slows, we continue to see high unemployment extending the period of elevated foreclosures,” said Dennis Capozza, professor of finance with the Ross School of Business at the University of Michigan and a founding principal of UFA. “The economic data this quarter paint a picture of an incipient and balanced recovery from a severe recession. Particularly for the mortgage industry, this is a recovery that is being hampered by the lagging indicator, high unemployment.”
The UFA Default Risk Index measures the risk of default on newly originated non-prime mortgages. UFA’s analysis is based on a “constant-quality” loan, that is, a loan with the same borrower, loan and collateral characteristics. The Index reflects only the changes in current and expected future economic conditions, which are much less favorable currently than in prior years.
Each quarter UFA evaluates economic conditions in the United States and assesses how these conditions will impact expected future defaults, prepayments, loss recoveries and loan values for nonprime loans. A number of factors affect the expected defaults on a constant-quality loan. Most important are worsening economic conditions. A recession causes an erosion of both borrower and collateral performance. Borrowers are more likely to be subjected to a financial shock such as unemployment, and if shocked, will be less able to withstand the shock. Fed easing of interest rates has the opposite effect.
For more information, visit www.ufanet.com/nmr.htm.