Real Estate – Part Three:

With consumer agencies and reporting services under pressure to tell it like it is, Standard & Poor’s released a report on Monday that puts the recent National Association of Realtors (NAR) monthly housing report in proper perspective.  Standard & Poor’s raised its projections regarding losses expected to result from risky loans backing U.S. mortgage securities.  The new S & P report indicates that as many of 40% of these loans will fail.

The increased projection for subprime and Alt-A Residential mortgages arrives at a time when the real estate market is reeling from more than 30% value losses and when the market is oversupplied with short sale and distressed inventory.  S & P expects their report to have a significant impact on bonds originally carrying AAA ratings.  Many bonds are now valued based only upon the remaining interest payments and are trading for cents on the dollar.

For investors who are already feeling the pinch from 30-40% investment portfolio losses, the biggest decline in the housing market since the 1930′s has pointed out the fragile composition of the recovery.

The S & P report included the following projections for subprime and Alt-A mortgages: 

• Subprimes originated in 2005 – 14% from 10.5%
• Subprimes originated in 2006 – 32% from 25%
• Subprimes originated in 2007 – 40% from 31%
• Alt – A originated in 2005 – 10% from 7.75%
• Alt – A originated in 2006 – 22.5% from 17.3%
• Alt – A originated in 2007 – 27% from 21%

Loss severities include foreclosure costs, liquidation costs, carrying costs and declines in property values.  Standard & Poor’s projects loss severities for subprime mortgages originated in 2006 and 2007 will be 70%.  For Alt – A bonds issued in the same years, loss severities are projected to be 60%.  S & P reported that loss severities have exceeded 100% in many cases.

The report included a summary that highlights the depth of the housing decline.  “We have observed increases in loss severities and we expect them to continue to rise until we reach the trough of the market value decline, which we believe will be in the first half of 2010.” 

Seven Crippling Factors

The Standard & Poor’s July 6^th release includes forecasts that subprime defaults for loans originated in 2005 will top 11%, as 2006 subprime defaults are expected at a 30% rate while 2007 subprime defaults will exceed 49%. 

The startling report comes at a time when homeowner’s balance sheets have been devastated.  The subprime lending policies are a leading cause of the recession and have come under fire by the Obama Administration.  The Standard and Poor’s report seems to underscore the Administration’s initiative for the creation of a new Consumer Protection Agency.  While the new agency may prevent similar lending practices in the future, the housing market’s recovery will need support from seven key components.  

• Unemployment – Last week’s unexpected rise in unemployment put a lid on the recovery. With unemployment rates expected to exceed 10.6% by 2010 and with real unemployment projected at more than 15% in certain U.S. urban areas, the full depth of the housing crunch may yet be felt. Predictions are that employment will be the last economic component to recover.

• Tight Credit – Under close scrutiny and unsure of true housing values, banks are playing it close to the vest on mortgage lending policies. With the recent increase in defaults from prime borrowers, caution continues to be the word in mortgage lending.

• Consumer Confidence - While overall consumer confidence suffered in the wake of the newest unemployment report, Standard & Poor’s indicates that consumers see the current market as one with opportunity. However, the prevailing mood is that the market has yet to bottom.

• Price Pressure – “Move up buyers” are critical to the housing recovery. Burdened with homes that are undervalued and in some cases underwater, meaning that the value is below the financing level, “move up buyers” are out of the market. A current bill before Congress offering all homebuyers, not merely first homebuyers, a $15,000 tax credit may help offset equity losses and bring this necessary element back to the market.

• Short & Foreclosure Sales – The NAR reports increases in Pending Sales and Closed transactions but the majority of transactions are short and foreclosed properties. Additionally, many pending short sales do not actually close. Most of these transactions are from investors, not homeowners. As investors are “buy and sell” opportunists, these transactions are likely to negatively impact housing prices until inventories are recycled.

• Appraisal Revisions – The National Association of Realtors has asked the New York State Attorney General to investigate new changes in the Home Valuation Code of Ethics (HVCC). On May 1^st, Freddie Mac has insisted on strict compliance with these new policies that are negatively impacting home valuations and driving the market to new lows. The NAR reports that the automated appraisal process is causing many appraisals to fall below agreed purchase prices and causing contractual failures.

• Interest Rates – While rates remain favorable, they are rising. In a market filled with negatives, the new interest increase is just one more draining component. If rates go higher, sale will decline further.

A housing recovery will not occur until all these components show positive trends.  In the meantime, there are no quick fixes on the horizon.  The housing adds fuel to the Obama Administration’s push for an increased stimulus package.

Tags: 2009 Stimulus Package, Bailout, depression, Economy, housing, interest rates, nfp, recession, Stimulus Plan, unemployment, US Dollar, US GDP, US NonFarm Payrolls, US Retail Sales, US Unemployment

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