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Economic Commentary

Housing Chartbook: October 2007

Tue, Oct 16 2007, 06:34 GMT
by Adam York, Mark Vitner

Wachovia

Executive Summary

The recent turmoil in the mortgage market and near shutdown of the subprime lending market is further restricting the supply of qualified homebuyers. Recent months have seen the secondary market for subprime and nontraditional mortgages dry-up. It is nearly impossible today to sell subprime loans, stated income loans, interest-only loans, and even high quality jumbo loans into the secondary market. As a result, terms on such loans have tightened considerably.

Tighter lending standards are making it considerably tougher for potential homebuyers to qualify for a mortgage. Banks generally reported falling demand for all types of mortgages, with the sharpest drop occurring in subprime loans. With lending standards remaining tight, we have again lowered our forecast for both new and existing home sales. Sales of new homes are now expected to plunge nearly 22 percent this year, while sales of existing homes should decline 11 percent. While these drops are dramatic, it is important to remember that most of this decline has already occurred. The bulk of the correction in the housing sector is behind us.

The meltdown in the secondary mortgage market makes forecasting home sales particularly difficult. Delinquencies and defaults typically take a while to show up and probably will not top out for several more quarters. Tighter lending standards in recent months mean that credit quality and delinquencies will most likely be the worst for mortgages originated in late 2005 and early 2006. This still means that any noticeable improvement in credit conditions is, at a minimum, a few quarters away.

We have long noted that many of the problems currently plaguing the housing market can be traced back to the huge role speculators played in the housing market back in 2004, 2005 and early 2006. Speculators made demand appear much stronger than it actually was from a fundamental standpoint. The added push from speculators drove prices up to levels that priced out many buyers in California, Arizona, Nevada, the greater Washington D.C. area and areas around New York City. While these markets had the greatest speculative excesses, investors and speculators were active in markets all across the country.

What needs to happen now is for prices of new and existing homes to adjust back to levels where families earning the median household income can once again afford to buy a wide assortment of homes, particularly in Florida, Nevada and California. Price declines in these markets are likely to be fairly significant in coming quarters. For the rest of the country, price adjustments will be far more modest and most areas will simply see price appreciation slow rather than endure outright price declines.

Starts of single-family homes will likely fall sharply in coming months, as builders respond to tighter credit conditions. We still see home construction bottoming in the coming year, however, as sharp adjustments in new construction have already occurred in the parts of the country that face the greatest oversupply. After tumbling 28 percent this year, we expect starts of new single-family homes to fall an additional 11 percent in 2008. More drastic reductions simply are not needed, as most of the reduction in new home construction has been in markets where overbuilding and speculative buying were the worst.

Construction of apartments is actually picking up slightly, which should offset some of the slowing we expect in the condominium market. In total, starts of multi-family projects, which includes apartments, condominiums and town homes, are expected to be unchanged in the coming year.

For the second year in a row, sales of new homes will not fall nearly as much as construction will, which will help eat away at the oversupply of homes on the market. We expect sales of new single-family homes to fall 6.0 percent in 2008, following an 11 percent drop this past year. Sales of existing homes are expected to decline 7.9 percent. Builders will need to clear out their own inventories before inventories of recently built existing homes will begin to clear. From a national standpoint, we expect the supply and demand of housing to be roughly in balance by the end of the year, which should allow for some modest improvement in both sales and new construction in 2009.

Applications Bounce and Level-off

Applications may have received some lift in recent months from tighter lending standards, as many applicants are filling out more applications looking for a willing lender. The increase in multiple application files makes it a bit more difficult to gauge actual demand for mortgages.

Applications for adjustable rate mortgages have cooled off considerably. Part of the decline simply reflects the small gap that currently exists between fixed rate and adjustable rate mortgages. Lenders are also curbing their offerings of adjustable rate products, shedding many of the more exotic mortgage products.

Affordability Hit Hard by Rising Mortgage Rates

Affordability is still stretched in many parts of country. Sales in areas where prices rose the fastest, such as Florida and California, are currently seeing some of the largest declines. Home prices are beginning to correct and job and income growth remain solid. Affordability has risen slightly from its lows. Unfortunately, rising mortgage rates are cutting into this improvement, and tighter lending standards are another problem. The interest rate on jumbo mortgages has also risen, which is compounding the problem in higher priced and second-home markets. The cost and availability of insurance is another limiting issue for many coastal markets.

Starts Fall Further on Credit Woes

Recent credit woes have sent housing on another downswing. The impact on starts will be more muted than some are expecting as most builders are now ramping down production as fast as they can. Inventories are still too high, however, particularly in Florida, northern Virginia, Arizona, Nevada and parts of California. There are also some bright spots, including Houston, Charlotte, Raleigh, Nashville, and Austin in the South, and Seattle and Portland in the West. While we still expect starts to fall further in coming months, we should see a bottom by the middle of next year.

Permits Reach Multi-year Lows

Declines in permits are beginning to show improvements in year-over-year change figures do to lower comps in late 2006. These improvements should give little comfort to investors, except to note permits are approaching a definitive floor in some of the hardest hit markets. Several states have seen extremely large declines. Florida has seen permits tumble 43 percent over the past year and 68 percent from their cyclical peak. In Nevada, permits are down 49 percent year to year and 71.5 percent from their peak. Permits for new homes in California are off 34 percent over the past year and 66 percent from their peak. How much further can they fall?

New Home Sales Retrace Bounce and Then Some

New homes sales reached a new business cycle low in August, as credit concerns and market volatility weighed on the minds of consumers. The drop in sales likely does not capture the extent of how much demand has weakened. The new home sales figures do not take cancellations into account, and cancellations soared in August, as tighter credit conditions made it tougher for would-be homebuyers to qualify for a mortgage. Fortunately, inventories are now falling and should continue to retreat over the next few years, as housing completions are now steadily declining. We expect to see considerable improvement in inventories over the course of 2008.

Existing Home Sales Continue Slide

Since rising early this year, existing home sales haven fallen back almost 18 percent and we would expect these declines to continue for several more months. We do not expect existing home sales to bottom out until late spring at the earliest.

Existing home inventories remain high and part of this glut reflects new homes purchased by speculators that had expected to flip them before construction was completed. Many investors are unable to cut prices much from current levels while builders can cut their prices on competing homes or add amenities, which is one reason existing home inventories remain high and prices remain sticky.

Price Indices Still Show Split Opinion

The OFHEO index, our preferred measure of housing prices, continues to show positive appreciation, year over year. Eighty-percent of the U.S. population, covered by the survey, lives in a metro area where prices are up, year over year. We think this indicates less of a wealth effect on spending than some are forecasting in coming quarters. The S&P/Case-Schiller Index of 20 major markets shows a more severe decline, with overall prices falling 3.9 percent over the past year. With the exception of Detroit, the largest price declines are in markets where prices had previously surged and where investors made up a larger proportion of earlier home purchases.

Delinquencies Continue to Rise

Mortgage delinquency rates have risen in recent months, particularly for adjustablerate subprime loans. We expect delinquency rates for such loans to rise at least through the middle of next year, as many of the subprime loans made after the housing market peaked two years ago have experienced a high level of early payment defaults. Delinquency rates on fixed-rate subprime loans and prime conventional loans have risen far less. ABX spreads have moved largely sideways but remain at extremely wide levels, which means it remains tough for lenders to sell mortgages into the secondary market.

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Published on  Tue, Oct 16 2007, 06:38 GMT

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