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Roy Park , VP
Capital Markets Group
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Housing Market Outlook
Wednesday, April 13th, 2011
The housing market continues to be the focus of attention for investors in the credit sectors. Its impact on performance of residential mortgages and mortgage-backed securities is self-evident. Its importance to the health of the broader economy is undeniable. Many of the economic policies by the US Federal government have centered on sustaining the health of the housing markets. Over the last year, home prices in the United States have stayed within a range. Although monthly home-price changes have showed great volatility, the index levels have stayed within a pretty tight range relative to what we experienced over the several years prior to the crisis. There is broad consensus that the probability of a catastrophic tail-risk event is low. However, due to new concerns over foreclosure procedures as well as remaining concerns over the large inventory of distressed assets, the likelihood of further modest declines in housing markets and the amount of time before a significant rebound in home prices occurs may be greater than initially thought.
Review of Home Price Movements
Since the spring of 2009 when home prices reached the bottom, home prices measured by these three indices began to rebound. Since the spring of 2009, they reached their peaks in the summer of last year. However, home prices have begun to decline again. In fact, the current level of the Loan Performance Home Price Index is actually lower than the lowest level it reached during the months immediately following the Lehman collapse – 134.94 in December 2010 versus 137.18 in March of 2009.
Table 1: Home Price Indices
Source: Case-Shiller, LoanPerformance
Table 2: Home Price Appreciation
Source: Case-Shiller, LoanPerformance
The annualized home-appreciation numbers tend to be more volatile Beginning in early 2010, after almost three years of consecutive monthly negative prints, the YoY change in home prices as measured by these three indices saw positive movement. However, they moved into negative territory after several months and as early as August of 2010 for the Loan Performance HPI Index. All three indexes have been in negative territory for the past two months. Considering that we’re entering the weakest part of the year for the housing market, this trend should continue at least for the next couple of months.
Many believed that we had reached bottom during the spring of 2009 and the possibility of home prices going lower was remote. The thought among many was that since the housing market had suffered such a steep decline during the recession home prices had nowhere to go but up; for awhile, that seemed to be the case. However, the housing market price declines left many borrowers with negative-equity positions in their homes. Even as the economy began to improve, those without any equity in their homes continued to default on their mortgages. As a result, large supplies of distressed inventories still exist all across the country and they should continue to weigh on the housing markets in the foreseeable future as evidenced by the recent price declines.
Housing Market Outlook
As we move forward, we should continue to examine some of the factors that the Deutsche Bank’s home price model considers as the most important to the path of home prices. They include:
- Price Momentum – home prices are auto-correlated and in a market that depends so much on “comparables,” price momentum is a big driver in future home values.
- Availability of Credit – the number of potential buyers who can find financing to purchase homes will have a direct impact on the amount of demand for homes.
- The state of the economy – low home prices and record-low interest rates are not enough to compel potential homebuyers if they are unemployed, underemployed, or fear becoming either. Economic conditions and the path of home prices are intricately linked.
- Supply of distressed assets – the number of homes that go through the liquidation process adds to the supply of housing. Increased supply will increase pressure on home prices and in all likelihood will prevent a meaningful rebound in the housing mark.
Examining these four areas, it is hard to argue that any factor is currently experiencing an outright positive trend. The only factor moving in a positive direction is the state of the economy, as the unemployment rate has dropped significantly since reaching its high in late 2009. As we’ll discuss later, even this assertion can be debated as the official unemployment rate can mask the true conditions of the job market. It is understood that once spring housing activity picks up, absent an unexpected negative exogenous macro-economic event, prices should move back to positive if seasonal patterns hold. However, seasonal patterns may not be enough to offset the negative situation.
The first factor that we’ll examine is price momentum. As Table 1 shows, for the most part, all three indices have stayed within a tight range over about the last two years. However, the trajectories of the indices have turned sharply since reaching last summer’s highs since 2009. In fact, the Loan Performance Index is down 8.2%, contributing to the thoughts that the US is already in the midst of the double-dip housing recession. The other two have declined less sharply: the Case-Shiller 10-MSA and 20-MSA indices have declined 3.7% and 4.3% respectively. While the long-term trend seems to indicate that housing markets have stabilized, in the short term, we may experience a few more months of price declines because winter is typically the weakest season for the housing market.
Credit in the residential sector continues to tighten. It has been at least a couple of years since affordability products such as IOs, 40-year amortization loans, and 80/20 lending have been offered on a large scale. Additionally, even in the prime sector, underwriting guidelines continue to become more restrictive. One example of this recent increase is the loan-level price adjustments for agency deliveries that will increase in April of 2011. Most of the increases were made for loans with higher LTVs, lower FICO scores, or both.
Table 3: Case-Shiller Index versus the Unemployment Rate
Source: Bloomberg, Case-Shiller
Recently, we’ve seen some positive signs in the economy. Specifically, GDP growth continues to be positive and the unemployment rate has dropped to 8.9% since reaching a high of 10.1% in late 2009. As is commonly known, the unemployment rate understates the severity of the current job market. If the underemployed and those who have quit looking for work are included, the rate of those unemployed and underemployed would be close to 17%. Despite the flaws in the unemployment rate as a measure of strength of the job market, a declining unemployment rate is a positive sign. However, the job market is not as strong as many had hoped.
Table 4: Loans in the Foreclosure Process
Source: Bloomberg, Mortgage Bankers Association
The supply of distressed assets continues to be at or near all-time highs. When using the percentage of outstanding residential mortgages that are past due 90 days or more as a measure of distressed assets, the supply has decreased to 8.57% in December 2010 from a high of 9.67% in December 2009. However, that is still about 4 times greater than the levels seen from 2004 to 2006. When using the percentage of outstanding residential mortgages that are in the foreclosure process, the most recent supply reading in December 2010 matched the all-time of high 4.63% observed in March 2010. Therefore, although the supply seems to have stabilized over the past few quarters, this is probably the only positive observation one can make, since these levels are at or near all-time highs.
Due to these factors, the housing market should feel some pressure in the near future. Rates continue to creep upwards after reaching late last year lows. The lack of demand-inducing government programs such as tax credits should reduce the purchasing power of many potential homebuyers. Additionally, the levels of distressed inventory continue to be at or near all-time highs no matter what measure is used, adding to the supply of housing that should add further pressure to the markets. Finally, while the economy has improved since the height of the financial crisis, the fragility of the housing market does not bode well for a sustained recovery. The outlook for the housing market in the near term continues to be dubious. The overhang of distressed properties will continue to prevent any significant recovery for an extended period of time. Due to the large housing supply and the slowdown in the foreclosure process, the unwinding of distressed housing should take a very long time and continue to keep in check any sharp, meaningful recovery in the housing markets.
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