Perhaps more important, initial projections for 2009 are for further slippage in starts and new home sales. The three specters: poor buyer psychology, easing pricing, and excessive inventories, are likely to mitigate other modestly to moderately positive developments. Tightened credit standards should continue to largely offset improving affordability.
Fitch concludes that operational and financial pressures will persist and, possibly, intensify for the public homebuilders during 2008 and into next year. The new ratings for the homebuilders reflect the most likely macro perspective for the balance of 2008 and 2009 as well as company-specific performance to this point in the cyclical downturn. As Fitch has noted in the past, a homebuilder's approach to land and development spending, inventory management, free cash flow generation, and management and debt reduction are considered in its ratings in the midst of a housing downturn as are other factors such as credit metrics, ability to satisfy covenants, liquidity, size, geographic and product diversification, margins, and frequency of real estate writedowns and option write-offs, etc.
[b]Current Environment[/]b
Typically, there are positives and negatives relating to the housing sector at any point in time, but negatives continue to dominate.
The economy grew only 0.6% in the first quarter of 2007 (1Q07). The economy expanded 3.8% in the second quarter and advanced 4.9% in the third quarter. The economy then slowed again, registering 0.6% improvement in Q4'07. The advance estimate of real GDP growth for the 1Q08 was also 0.6%, but then subsequently raised to a still anemic 0.9%. The employment situation has been soft so far in 2008 with non-farm payroll employment averaging 64,800 per month in declines for the first five months of the year and job losses of 49,000 in May. The unemployment rate has been rising and reached 5.5% in May, although it is still below the 30-year average of 6.1%.
Consumer confidence, as measured by the Conference Board's broadest measurement of consumer confidence, has been generally deteriorating since August 2007, decreasing from 111.2 in July 2007 to 90.6 in December 2007 and 57.2 in May 2008. The index stands at a 16-year low. (The University of Michigan's consumer confidence index for May fell to the lowest level in 28 years.) The Conference Board indicated that 'weakening business and job conditions coupled with growing pessimism about the short-term future have further depleted consumers' confidence in the overall state of the economy.
Consumers' inflation expectations, fueled by increasing prices at the pump, are now at an all-time high and are likely to rise further in the months ahead. As for the short-term outlook, the expectations index suggests little likelihood of a turnaround in the immediate months ahead.'
Thirty-year fixed mortgage rates, which were as low as 5.48% in late January of this year, averaged 6.09% most recently and were 44 basis points below a year ago. Of course, the current rates are low by historical standards. Adjustable-rate mortgages (ARMs) represented only 6% of conventional mortgage loans in April 2008, a percentage that has been steadily declining during the past few years and reflects tightened mortgage standards. In recent weeks, the Mortgage Bankers Association's Weekly Mortgage Applications Survey's unadjusted index has noticeably weakened compared to preceding weeks and the same weeks one year earlier. The market for subprime loans is essentially non-existent, and within Alt-A, only a limited number of prime-like Alt-A loans are currently being originated.
Total housing starts for the January through April 2008 period fell 29.8% and were off 31.9% in the month of April (1.032 million seasonally adjusted annual rate [SAAR]). Single-family starts were even weaker: down 39.4% year to date and 42.8% lower in April. Multi-family volume for the first four months of 2008 rose 11.3%. April multi-family starts improved 18.6%. Total building permits fell 35.2% year to date and were off 32.0% in April (978,000 SAAR). Housing unit completions decreased 27.9% so far this year and plummeted 35.2% in April (1 million SAAR).
Single-family new home sales in April (526,000 SAAR) dropped 43.4%. Year to date new home sales fell 36.3% as compared to a year ago. Existing home sales declined 15.7% in April (4.89 million SAAR). Existing home sales for the first four months of 2008 are 20% lower than in 2007. Pending (existing) home sales were surprisingly robust in April, up 6.3% vs. March, although off 13.1% on a year-over-year basis. The NAR indicated that sharp price reductions in certain markets apparently had stimulated interest by bargain hunters who may be a combination of investors and owner-occupants.
The average new home price increased 3% to $321,000 in April 2008. The median new home price edged up 1.5% to $246,100. These prices are not adjusted for mix or selling incentives. The average existing home price was $248,300 in April, down 7.4%, while the medium existing home price of $202,300 fell 8.0%. The Case-Schiller home-price 20-city index tumbled 14.1% - the largest decline in the series history - and the lowest reading since 2Q'04.
The Case-Schiller index dropped 14.4% in the month of March, with particular softness in Miami, Las Vegas and Phoenix (among the strongest markets driving the peak in the upside of the cycle). The OFHEO 1Q'08 seasonally adjusted purchase-only house price index, which is much broader than the Case-Schiller index, was 1.7% lower than 4Q'07 and fell 3.1% over the past year, the largest drop in the purchase-only index's 17-year history. The OFHEO and Case-Schiller indexes are, of course, weighted to existing home sales.
Perhaps the most challenging issue for housing, both new and existing, is excess inventory. The new houses for sale statistic reached in excess of 500,000 during each of the 25 months ending November 2007, a level that has often presaged major industry downturns. And, of course, a downturn clearly has been under way. Since the peak in inventory (570,000 in August 2007), monthly statistics have worked down to 454,000 (456,000 SAAR) in April.
The month's supply at the current sales rate was 10.6 months (SAAR) and 9.6 months (unadjusted). The existing homes inventory was 4.522 million which represents 11.2 months' supply. These new and existing home inventory statistics remain quite high by historical standards. It is generally believed that 5.5-6.0 months of supply would represent a rough equilibrium of supply relative to demand for new and existing home inventories.
According to First American CoreLogic, lenders and investors in mortgages owned about 660,000 foreclosed homes in April 2008, up from 493,000 in January and 231,000 in January 2007. Through cutting prices, lenders have managed to increase sales of such homes sharply in recent months in certain cities such as Las Vegas, Detroit and Sacramento. However, lenders have not yet managed to catch up with the inflow of foreclosed homes. Mark Zandi of Moody's Economy.com forecasts that the inventory of REO (real estate owned) homes will not peak before the end of 2009.
The Mortgage Markets and Pending Housing Legislation: The mortgage markets continue to be challenged. Subprime loans, which accounted for 20% of total originations at the peak of the cycle in 2005, are not being done. Only a limited number of prime-like, Alt-A loans are being generated. (Alt-A loans accounted for 12.2% of all originations in 2005 and 13.4% in 2006.) Few jumbo loans were originated after the mortgage market disruptions in August 2007, as the spread versus conventional loans expanded significantly.
With the enactment of the Stimulus Act in early 2008 raising the loan limits for high-cost areas, and the subsequent acceptance of jumbo loans by the GSEs (Fannie Mae and Freddie Mac), agency jumbo mortgage rates are now approximately one percentage point less than other jumbos and about 20 basis points above non-jumbos. But the heart of the mortgage market today is the conventional conforming market, and the GSEs guaranteed about 80% of all newly originated conventional conforming mortgage debt in 1Q'08, up from only 39% two years ago. Almost every mortgage lender, including the GSEs, has tightened credit standards and raised prices to better reflect the risks of lending mortgage money.
The turnaround in the labor market provides the clearest indication yet that the activity slowdown since early 2006-until late last year - driven almost entirely by the housing market - is in the process of spreading to the wider economy. Last fall, private-sector employment was growing at about 80,500 per month but recent releases (and revisions to earlier data) have seen this shift to an average decline of 64,800 in the past five months. In the post-World War II period, declining employment has been associated exclusively with U.S. recessions as identified by the National Bureau of Economic Research (although employment has occasionally declined without two consecutive quarters of negative GDP growth).
Moreover, the ongoing turmoil in credit markets and the process of widespread deleveraging by the financial sector are resulting in a significant deterioration in credit availability and costs for private sector borrowers.
For the year as a whole, real GDP should advance 1% with consumption (plus 0.7%) and exports (plus 1.6%) providing the positive impetus. Inflation (as represented by the Consumer Price Index [CPI]) is expected to accelerate from 2.9% in 2007 to 3.8% in 2008. Interest rates should average roughly a half percentage point lower this year.
Fitch's forecast for the housing sector in 2008 has become more bearish. The soft economy, very depressed consumer sentiment, and unaccommodating mortgage market suggest that housing starts and new home sales comparisons will be sharply negative at least throughout 2008 and, should mortgage rates rise, new mortgage underwriting standards will mean a more expensive mortgage or the inability to qualify for a mortgage, depending on one's financial position and credit history.
Of course, most potential homebuyers, absent any real urgency to buy, are deferring the purchase decision, concerned that selling their existing home at a fair price may be challenging, and fearing that real home prices might decline further as builders increase the level of incentives being offered to the advantage of those who wait to buy.
Total housing starts are forecast to be 0.96 million in 2008, 29.4% lower than in 2006. Single-family starts are expected to be 0.68 million, down 35.2% as compared to a year ago. Multi-family starts should improve 3.6% to 280,000. New single-family home sales should fall 26.1% to 573,000, while existing home sales decrease 14.5% to 4.835 million.
The average single-family new home price is expected to drop 4.5% in 2008 while the median new home price slips 3.5%.
The 'real' price reductions surely are larger than shown by transaction prices (and Fitch's forecasts), as sales incentives are not included. However, this year a greater portion of the 'real' price reduction likely will be overt sales price decreases. Unfortunately, home prices have not yet reached market-clearing levels in most places. Home prices (especially existing home prices) definitely have been 'sticky' on the down side. This pattern is similar to price behavior exhibited in earlier major housing corrections.
Fitch is tentatively forecasting a stronger economy in 2009, although still noticeably below the historical trend line. Real GDP is forecast to grow 1.7% in 2009 in the first scenario, but grow only 1.0% in the second and more likely scenario. However, it would be wrong to interpret this seemingly V-shaped recovery as a rapid bounce-back.
The pick-up in growth in 2009, the first scenario, is accounted for almost entirely by the expectation that residential investment will stabilize from late 2008. Consumer spending growth is expected to remain anemic as households continue to retrench, and Fitch forecasts domestic demand excluding residential investment to expand by just 1.2% in both 2008 and 2009. Compared with previous U.S. recessions, the forecast depicts a path less severe than in 1991, when GDP and domestic demand declined by 0.2% and 0.7%, respectively. While the GDP growth forecast is similar to that seen in 2001, domestic demand is forecast to be weaker, emphasizing the positive role currently played by net trade.
