Michigan Company Provides Tool to Crack the Credit Risk Code

Dr. Dennis Capozza, founder of Ann Arbor, Michigan-based ""University Financial Associates"":http://www.ufanet.com (UFA), has spent the last 30 years predicting cycles in the mortgage industry. Dr. Capozza’s research and experience have been automated in a scoring system called ForeScore for more than a decade, and last week, UFA announced that lenders, investors, and regulators can now access the ""ForeScore system"":http://www.ufanet.com/Product.htm and supporting analytics via an integrated Web services platform.
The company explained that compared to traditional backward-looking models, UFA’s ForeScore is up to 80 percent more accurate when it comes to predicting loan performance. UFA says this is because ForeScore assesses not only borrower credit, but also collateral performance and local economic conditions. The company claims that ForeScore predicted increased loan defaults in the late 1980s, 2006, 2007, and 2008, years in advance.
To illustrate the system's potential, UFA quoted a former executive at a now bankrupt lender as saying, ""There is no question that if our company had applied UFA ForeScore best practices, our company would have been profitable even in the turbulent times. It took us too long to embrace change. We were entrenched with traditional underwriting and history-based risk management approaches.""
The company also said that after evaluating ForeScore’s predictions of loan default rates and profitability, a major bond rating firm began employing the predictive risk scoring system in 2006 to enhance its credit risk rating products.
Now, ""UFA's ForeScore"":http://www.ufanet.com/Product.htm is available via web subscription or Software as a Service (SaaS) on a pay-per-click basis. The company said lenders, investors, and regulators in the prime, non-prime, and subprime markets can improve underwriting and portfolio management with the new tool. Using ForeScore, UFA said, allows firms to ""avoid the damage of credit cycle fluctuations and position themselves properly during recovery periods,"" such as the nation finds itself in right now.
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. The company's Default Risk Index measures the risk of default on newly originated non-prime mortgages, and is based on a ""constant-quality"" loan, meaning a loan with the same borrower, loan, and collateral characteristics.
The ""UFA Default Risk Index"":http://www.ufanet.com/Latest_Indices.asp for the second quarter of 2009 fell to 251 from last quarter’s revised 270, and is 10 percent below the peak reading two quarters earlier. This figure means that under current economic conditions, non-prime investors and lenders should expect defaults on loans currently originated to be 151 percent higher than the average of loans originated in the 1990s (the average index reading between 1990 and 2000 was 100, and is used by UFA as a primary reference point in explaining the likelihood of mortgage defaults).
UFA explained that the second quarter’s changes reflect the life-of-loan impact of mortgage rates, recession conditions, and collateral markets in precipitous decline. The company added that unprecedented house price declines in many parts of the country have brought prices closer to fundamental value, placing a floor under the borrower’s equity position and lessening the probability of default.
According to Dr. Capozza, who is also a professor of finance with the Ross School of Business at the University of Michigan, ""The welcome news is that expected defaults on constant quality loans currently being originated has declined significantly. Of course, lenders have greatly tightened credit standards in recent quarters, so the rate of foreclosures in the serviced portfolio (all outstanding loans) should be declining soon as well.""