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Bryan Hughes, VP
Capital Markets Group
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At the time of our last update a few months back there was some optimism that the rate of home price decline was slowing in a few areas but particularly in California. When we revisit this trend it appears that California is seeing minimal slow down in decline compared to other parts of the country and we investigate the degree to which unemployment trends are effecting local housing markets.
The following charts graph the recent monthly index changes grouped by low or high unemployment and by index provider of S&P/Case Shiller or OFHEO. The figure 1 chart shows the recent change in the S&P/Case Shiller indices that cover areas of low unemployment. The figure 3 chart shows the OFHEO low unemployment areas while figures 2 and 4 show the high unemployment areas for each index provider. Notice that the left side scaling on this figure 1 chart includes both positive and negative numbers as opposed to Figures 2 and 4 which detail the high unemployment areas and do not have any positive readings. It is clear here that the indexes in figure 1 are all reporting reduced levels of monthly depreciation in the last month. In figure 2 we mostly see the opposite where the trend is bending lower depicting higher depreciation, except for FL-Miami and FL-Tampa which are both showing very slight retracements. In addition to these trends in monthly change, note the absolute levels of decline with the low unemployment at -0.5 to -1% while the high unemployment ranges from -1% to -4%.
Figures 3 and 4 show low and high unemployment area groups but as calculated with OFHEO indexes.
As expected, the OFHEO indices show lower absolute levels of recent decline. This is expected due to the difference in composition of included loan types in the OFHEO index, also because the most recent seasonally adjusted S&P/Case-Shiller Composite-20 Index shows a year over year decline of 18.05% while the OFHEO U.S. National index only shows a 7.45% decline. The compositional difference referenced above is that the OFHEO only includes sales pair transactions of government purchased loans. The OFHEO indices do not report on non-government agency financed transactions and by excluding these sales pairs, index results do not depict the illiquidity of credit in the sector that has had the most impact on depreciating home values. For this reason it is expected that the OFHEO will depict a stronger housing environment than the S&P/Case Shiller. In figure 3 below the OFHEO is reporting the mountain census division to have a 0.6% increase at the end of October which is contrary to the 1% decrease for CO-Denver reported in figure 1 by S&P/Case Shiller. Another difference between the two indices leading to contrasting directional results at the same low unemployment grouping is the OFHEO’s inclusion of non-purchase transactions. Where the S&P/Case Shiller is showing reduced declines at each area in figure 1 the OFHEO is showing increased declines in West South Central and Middle-Atlantic in figure 3 which is partially due to borrowers refinancing to take advantage of lower interest rates. Taking the differences between the two indices into consideration, the trait of unemployment still appears to be evident in comparing these recent index reports.
Another relationship can be made between the areas that had the largest run-up in home prices during the peak, also had more volatile employment levels and are experiencing higher change in unemployment and home depreciation as a result. Areas such as Arizona, California, Florida and Nevada had large run-ups in prices and strong employment but have been hit the hardest in the downturn. The MSAs in these regions currently have large inventory overhangs and the rising unemployment levels creates a compounding effect where the loss of home equity triggers the increase in job loss. Many entrepreneurial type business start-ups were fueled from tapping home equity so while home prices have dropped to the point of eliminating that funding, businesses have failed. The areas with the larger excess price appreciation and then depreciation can certainly be linked to the more challenging of unemployment situations.
The importance going forward is to properly model loan level loss expectation with adequate consideration to the unemployment trends and their effects on home depreciation. Some areas of growing unemployment can have lower relative default risk if the area did not experience large property value swings making the borrowers less likely to have purchased homes at excessive prices. These borrowers may be less exposed to negative equity situations and will find a way to make payments to protect their investment. A loss modeler should be cognizant of the varying dynamics between unemployment and property value relationships in today’s challenging loan valuation environment.