UFA: Default Tsunami May Be Receding

According to Michigan-based ""University Financial Associates"":http://www.ufanet.com (UFA), the risk of default for nonprime mortgages during the first quarter of 2009 is down from Q4 2008. The company's Default Risk Index for the first three month's of 2009 fell to 201 from last quarter’s revised index of 209.
UFA said this marks the second quarter of decline in a row -- a hopeful sign that the tsunami of foreclosures may be cresting. Still, the company said, the elevated level of the index reflects rapidly eroding economic conditions, as well as a revision to include a recession scenario in 2009 which ""optimistically assumes that the Obama policy initiatives will be able to stem this wave of defaults.""
In the last 4 years, the UFA Default Risk Index for nonprime mortgages has doubled. Under current economic conditions, UFA said, the first quarter index of 201 means investors and lenders should expect the risk of default on nonprime loans originated today to be 101 percent higher than the average of loans originated in the 1990s.
Dennis Capozza, professor of finance with the Ross School of Business at the University of Michigan and a founding principal of UFA, commented, ""All the recent data show signs of shipwreck, as the tsunami generated by the mortgage crisis travels in waves through the world economy.""
Capozza explained, ""In the fourth quarter of 2008, consumer and business spending collapsed, causing unemployment to rise steeply. The severe damage to balance sheets from falling asset prices is taking its toll. Until this storm stops raging, we won’t be able to assess the extent of the damage.""
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. And according to UFA, most important are worsening economic conditions.
The company explained that a recession, such as we're seeing today, 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 Federal Reserve's easing of interest rates has the opposite effect, UFA said.
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. Analysis from the company's quarterly ""UFA Mortgage Report"":http://www.ufanet.com/nmr.htm successfully predicted such developments as the increased defaults in Southern California in the mid-90s and the current increases in defaults nationwide. The company's predictions are based on an extensive analysis of local economic conditions in each state and the relationship of those conditions to loan profitability.