Thursday, April 5, 2007

Default Rates and Recovery Rates

There is a well-recognized financial principle that credit bubble lenders are going to experience soon: default rates and recovery rates are inversely correlated.

This is from a Moody's report [pdf] on corporate bonds, but it will apply to residential lending also.

Moody's offers two reasons for this: "One, higher default rates increase the supply of defaulted debt and thereby decrease its price. Two, when the market price for distressed debt is low, distressed companies find it more difficult to obtain financing and default more frequently as a result."


Anonymous said...

The x-axis shows the default rate, which is the number of bonds as a percentage of all bonds that default in a given year.

In their study, default is defined as a missed interest or principal payment, filing for bankruptcy, or consummation of a distressed exchange.

Note from my previous post that alt-a IO ARMs already have a delinquency rate above 3%.


Unknown said...

Any analysis on one-year or two-year lags?
Let's say there was a default in 1999, how long would it take to recover? The point I am making is that recovery may not happen in the same year as default.