The Worst Is Over in Mortgage Default Risk?

Mortgage default risk is adjusting to precrisis levels. Almost.

The UFA Default Risk Index for the second quarter of 2012 increased slightly to 120 from last quarter’s revised 119 that was based on the UFA baseline macro scenario.

UFA has revised all recent vintages lower by almost 10 index points.

According to the University Financial Associates of Ann Arbor, Mich., solely due to the local and national changes in the economic environment this spring the level of mortgage default risk is only 20% higher than the normal of the 1990s.

In 2012 default risk has decreased to levels that are comparable to the risk on loans originated between 2004 and 2005.

The index measures the risk of default on newly originated prime and nonprime mortgages. It indicates that under current economic conditions, investors and lenders should expect defaults on loans currently being originated to be 20% higher than the average of similar loans originated in the 1990s.

At 120 the UFA Default Risk Index indicates the estimated risk of default on newly originated prime and nonprime mortgages is 20% higher than the average of the 1990s, but much less than the worst vintage loans originated between 2006 and 2008.

If mortgage lenders and servicers were to take the word of Dennis Capozza, professor of business administration in the Ross School of Business at the University of Michigan and a founding principal of UFA, mortgage banks “can comfortably loosen credit for newly originated loans,” because the worst “is clearly over.”

UFA analyzes mortgages with the same borrower, loan and collateral characteristics during the review period, or how “constant quality loans” are affected by current and expected changes in economic conditions at the local and national level.

Favorable factors include low mortgage rates, the Federal Reserve’s loose monetary policy, and house prices “at or below fundamental values in many locations.”

Nonetheless index findings suggest current economic conditions are much less favorable than in prior years.