UFA Default Risk Index: Spinning Out of Control?
The UFA Default Risk Index for the first quarter of 2022 is 113, eleven points above last quarter’s revised 102 in our baseline scenario. Under current economic conditions, investors and lenders should expect defaults on loans currently being originated to be 13% higher than the average of similar loans originated in the 1990s, due solely to the local and national economic environment. That’s a key finding of the latest UFA Mortgage Report by University Financial Associates of Ann Arbor, Michigan.
“With very limited supply of existing homes, a shortage of labor, and only modest new construction, the scene is set for another fast seller's market this year with large increases in house prices,” said Dennis Capozza, who is Professor Emeritus of Finance in the Ross School of Business at the University of Michigan, and a founding principal of UFA. “Our house price forecasts have become more optimistic in the short run (1-2 years forward) but more pessimistic 3-5 years out. One consequence of a large increase in house prices is an increase in home equity for recent home buyers. Existing mortgage loans become less risky in the short term with lower expected defaults but with increased expected defaults longer term. The Federal Reserve has fallen well behind the ballooning inflation, and risks being forced to inflict considerable damage on housing and mortgage markets to regain control.”
The UFA Default Risk Index measures the risk of default on newly originated 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 less favorable currently 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 nonprime 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. Fed easing of interest rates has the opposite effect.
UFA’s pioneering mortgage analysis has successfully predicted problems in the mortgage market well in advance including the increased defaults in Southern California in the mid-90s and the recent national mortgage crisis. Its predictions are based on an extensive analysis of local economic conditions in each state and the relationship of those conditions to loan performance. 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 – is available in the UFA Mortgage Report, published on a quarterly basis.