Understanding Constant Default Rate (CDR) and Its Calculation

What is Constant Default Rate (CDR)?

Constant Default Rate (CDR) is a key metric used in the analysis of asset-backed securities, particularly mortgage-backed securities (MBS). It measures the rate at which borrowers default on their loans within a given time period.

How is CDR Calculated?

CDR can be calculated by dividing the total principal amount of defaulted loans by the initial principal balance of the loan pool. The result is expressed as a percentage.

Why is CDR Important?

CDR provides valuable insights into the credit quality of a loan pool and helps investors assess the risk associated with investing in asset-backed securities. It is a crucial measure for mortgage servicers, investors, and rating agencies.

Factors Affecting CDR

Several factors can influence the CDR of a loan pool:

• Interest rates: Changes in interest rates can impact borrowers' ability to make timely loan payments.
• Economic conditions: Downturns in the economy can increase the likelihood of loan defaults.
• Borrower demographics: The characteristics of borrowers, such as credit scores and income levels, can influence their default rates.

Calculating CDR: A Step-by-Step Guide

Here's a step-by-step guide to calculating CDR:

1. Gather the necessary data: You'll need information on the principal balance of the loan pool and the amount of defaulted loans.
2. Calculate the default amount: Subtract the current principal balance of the loan pool from the initial principal balance to determine the amount of defaulted loans.
3. Calculate CDR: Divide the default amount by the initial principal balance and multiply by 100 to get the CDR as a percentage.

Example of CDR Calculation

Let's consider an example to better understand CDR calculation:

Initial principal balance of the loan pool: $100,000,000
Defaulted loans: $2,000,000

Default amount = $100,000,000 - $2,000,000 = $98,000,000
CDR = ($98,000,000 / $100,000,000) * 100 = 98%

Using CDR in Investment Decisions

CDR is an essential tool for investors to assess the risk and potential returns associated with investing in mortgage-backed securities. It helps investors make informed decisions by providing insights into the credit quality and default risk of the underlying loans.

Conclusion

Constant Default Rate (CDR) is a crucial metric in the analysis of asset-backed securities, particularly mortgage-backed securities. It provides valuable insights into the credit quality and default risk of loan pools, helping investors make informed investment decisions. By understanding CDR and its calculation, investors can better assess the risk and potential returns associated with investing in mortgage-backed securities.