Credit Union Times: Why will it take five years to return to pre-bubble default levels?

Dennis Capozza: Default levels are heavily dependent on local and national economic conditions. Credit crises like the current episode take a long time to revolve, sometimes decades as in Japan. The current data signal that more time is needed.

CU Times: Some observers say people simply do not have the sense of shame or concern they had years ago when they default on a mortgage. It used to be a very safe loan for a lender to make. Now there seems to be a feeling that if the borrower can find a way to "strike back," it's okay. Any feel for that?

Capozza: It has always been the case that homeowners respond to incentives. When a borrower is 20% or more underwater on a mortgage, there is a huge incentive to default. With 10% of mortgages delinquent, most borrowers have friends in default. Certainly some of the stigma disappears when default is as common as it is.

CU Times: Despite this, default rates have improved. Do you think lenders are going to be more willing to write mortgages, or will they remain cautious for a long time?

Capozza: Default rates are improving partly because the worst vintages are "burning out." Lenders should remain cautious since default risks remain elevated. At the same time, mortgage rates are low in response to regulatory policies so that the returns on lending on housing collateral are unfavorable. Profitability can improve if mortgage rates rise or default risks fall-that is, when appreciation rates turn positive.

CU Times: Suppose you were the CEO or a board member of a credit union. What would all this mean to you? What should the credit union do?

Capozza: Every credit union faces a different local economic situation. My understanding is that most credit unions sell the mortgages they originate to the agencies and do not hold the loans as assets. This business model is not very sensitive to default rates.

CU Times: You mentioned that local economic situations vary. Does that translate into a lot of geographic variation in default rates and what will happen over the next few years?

Capozza: Yes, and the most problematic locations are beginning to migrate from California, Florida, Arizona and Nevada to other states.

CU Times: Based on your research, what points would you want to stress to credit unions?

Capozza: Both auto loans, which are often more important to credit unions than mortgage loans, and mortgages are very sensitive to local economic conditions. In our experience, the lenders who run into problems almost always face unfavorable local economic conditions. Because loans are long-term contracts that can extend into the distant future, it is essential that credit unions be aware of future prospects for their local area. Our UFA default risk indices, which assess these future risks at the ZIP code level for loans originated today, are an example of information credit unions can use to reduce risk and serve their members better.

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