Understanding the Annualised Constant Default Rate: Definition, Calculation, and Importance

Welcome to our blog post on the annualised constant default rate (CDR). In this article, we will delve into the definition, calculation, and importance of the CDR, a key metric used in mortgage finance. Whether you're an investor, lender, or simply curious about the world of mortgages, this guide will provide you with valuable insights.

What Is the Constant Default Rate (CDR)?

The constant default rate (CDR) is a percentage that represents the proportion of mortgages within a pool of loans on which the borrowers have fallen more than 90 days behind in making payments to their lender. It is a vital measure for assessing the credit risk associated with mortgage-backed securities (MBS).

Understanding the Constant Default Rate (CDR)

Now that we've defined the CDR, let's dive deeper into its significance. The CDR allows investors and lenders to evaluate the credit quality and potential risks of a pool of mortgages. By analyzing the CDR, they can make informed decisions regarding investment strategies and risk mitigation.

Constant Default Rate Formula & Calculation

The CDR is calculated by dividing the number of loans that are 90 days or more delinquent by the total number of outstanding loans in a given pool. It is expressed as a percentage. The formula for calculating the CDR is:

CDR = (Number of Delinquent Loans / Total Number of Outstanding Loans) * 100

For example, if a mortgage pool has 1,000 loans and 20 of them are delinquent for more than 90 days, the CDR would be:

CDR = (20 / 1000) * 100 = 2%

Examples Using the Constant Default Rate

Let's illustrate the concept of CDR with a couple of examples. Imagine you're an investor considering investing in a mortgage-backed security (MBS). By analyzing the CDR of the underlying mortgages, you can assess the level of credit risk associated with the investment. A higher CDR indicates a higher likelihood of default and, consequently, a greater risk for investors.

Special Considerations

While the CDR is an essential metric, it's important to consider some additional factors when interpreting its significance. One such factor is the duration of the mortgage pool. CDRs for longer-term mortgage pools may be influenced by economic conditions and interest rate fluctuations.

Is Constant Default Rate the Same as Conditional Default Rate?

No, the constant default rate (CDR) is not the same as the conditional default rate (CDR). The CDR measures the overall proportion of delinquent loans in a pool, regardless of the occurrence of any specific event. On the other hand, the conditional default rate (CDR) focuses on the probability of default given a specific event, such as a decline in property values.

What is the Constant Prepayment Rate (CPR)?

While we're on the topic of mortgage-related metrics, it's worth mentioning the constant prepayment rate (CPR). The CPR is a measure of the rate at which borrowers are expected to prepay their mortgage loans. It is an important consideration for investors in mortgage-backed securities, as prepayments can affect the expected cash flows and returns.

What Is Single Month Mortality (SMM)?

The single month mortality (SMM) is another metric used in mortgage finance. It represents the proportion of loans within a pool that are expected to prepay in a given month. The SMM is closely related to the CPR and helps investors and lenders assess the prepayment risk associated with mortgage-backed securities.

Key Takeaways

• The annualised constant default rate (CDR) measures the proportion of delinquent mortgages in a pool of loans.
• Investors and lenders use the CDR to assess credit risk and make informed investment decisions.
• The CDR is calculated by dividing the number of delinquent loans by the total number of outstanding loans in a pool.
• Special considerations, such as the duration of the mortgage pool, should be taken into account when interpreting the CDR.
• The CDR is not the same as the conditional default rate (CDR), which focuses on the probability of default given a specific event.
• Other related metrics in mortgage finance include the constant prepayment rate (CPR) and single month mortality (SMM).