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UFA Default Risk Index finds wave of default risk beginning to subside

May 24, 2010

The University Financial Associates (UFA) Default Risk Index for the second quarter of 2010 has dropped to 182, half the peak level of 362 set in 2007. 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. If, as some observers expect, inflation spikes due to excessive monetary ease, nominal house prices will be higher and defaults will be lower. Under current economic conditions, investors and lenders should expect defaults on loans currently being originated to be 82 percent higher than the average of loans originated in the 1990s, but much less than the worst vintages of this cycle (2006-2008). That’s a key finding of the latest UFA Mortgage Report by University Financial Associates of Ann Arbor, Mich. Figure 1: The UFA Default Risk Index stands at 182, estimating the risk of default on newly originated mortgages (both prime and non-prime) at 82 percent higher than the average of the 1990s, but much less than the worst vintages of this cycle (2006-2008). “Although default risks remain elevated, the index is steadily returning to pre-bubble levels,” said Dennis Capozza, who is the Dykema Professor of Business Administration in the Ross School of Business at the University of Michigan, and a founding principal of UFA. “The worst vintages of this mortgage cycle are behind us. However, a return of the default risk index to pre-bubble levels is still several years away.” The UFA Default Risk Index measures the risk of default on newly originated prime and 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. For more information, visit www.ufanet.com/nmr.htm or www.ufanet.com/FSLocation.htm.
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