The Nonprime Mortgage Report's Default Risk Index for the fall quarter of 2004 is 97 from a revised 98 in the previous quarter. The index has risen by 15 percent since 2001 and more than 25 percent since late 1998, but remains moderate by historical standards. The index measures the risk of default on newly originated non-prime mortgages. That's a key finding of the latest Nonprime Mortgage Report by University Financial Association (UFA) of Ann Arbor, Mich.
"House price appreciation remains well above trend, but the prospects for future increases are eroding. These trends cause the default risk to be moderate," says Dennis Capozza, professor of finance at the University of Michigan and a principal in UFA.
Under current economic conditions, non-prime lenders should expect defaults on loans currently being originated to be significantly higher than the average of loans originated in 1998 to 2003, but three percent less than the average rate on mortgages originated in the 1990s. This quarter's changes reflect the life-of-loan impact of mortgage rates as well as revisions to the housing data, including continuing strength in the collateral markets.
UFA's analysis is based on a "constant quality" loan--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 currently less favorable 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 non-prime 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. The Fed's easing of interest rates has the opposite effect.
The Nonprime Mortgage Report is a unique analysis that has successfully predicted such development as the increased defaults in southern California in the mid-90s. Its predictions are based on an extensive analysis of local economic conditions in each state and the relationship of those conditions to loan profitability. The historical record of millions of mortgage loans is studied each quarter to assess the vulnerability of each state to loan losses and prepayments. The detailed analysis of each state--including best and worst places to lend--appears in the Nonprime Mortgage Report, which is published quarterly by UFA.
For more information, visit www.ufanet.com.