Key Takeaways
- U.S. home prices have made significant gains recently. We have therefore updated the home value assessments we use when evaluating mortgage pools backing certain residential mortgage-backed securities (RMBS).
- Nationwide, we estimate that housing is about 5% overvalued. However, the picture varies at the state level and by core-based statistical area (CBSA). That is, some states and CBSAs are overvalued while others are undervalued.
- The impact of home values on a residential mortgage pool is based on the specific CBSAs and their geographic representation in that pool.
It's no surprise that U.S. home prices have experienced gains over the past several years. Contributing factors include low mortgage rates, limited new home supply, and a growing share of the population in their homebuying years (mostly millennials). What comes as a surprise are the significant gains seen during the past 15 months. The COVID-19 pandemic has driven demand for housing as remote working and schooling became the norm. This intensified the need for greater square footage. Meanwhile, dense city dwellings overweight in multifamily rentals became less desirable. High home price appreciation (HPA) continues to erode affordability, as housing demand drives prices up and wage growth lags. Because of the strong house price gains, our assessment of over/undervaluation for U.S. housing and the corresponding CBSAs has shifted toward overvaluation.
On Oct. 8, 2021, we updated the over/undervaluation measures as well as Federal Housing Finance Agency (FHFA) index values using second-quarter 2021 information. We use these values in our loan evaluation and estimate of loss system (LEVELS) model (see "LEVELS Model For U.S. Residential Mortgage Loans," published Aug. 5, 2019), which provides loan- and pool-level calculations of default likelihood (foreclosure frequency), loss given default (loss severity), and loss coverage (the product of foreclosure frequency, loss severity, and any pool-level adjustments).
How does the shift toward overvaluation affect our assessment of RMBS? Here we provide a snapshot of our over/undervaluation assessments and discuss how they pertain to our evaluation of residential mortgage pools that back certain U.S. RMBS.
Nationwide, Housing Is Roughly 5% Overvalued
To assess over/undervaluation, our analysis compares the price-to-income ratio (PTI) to a long-term average PTI for a given CBSA, state, or the nation. When doing so, we use the FHFA price index as well as the income per capita to compute the PTI based on a point in time. We compare this ratio to the 15-year average PTI to determine whether the single PTI calculated based on the more recent period is above or below the long-term average PTI. This will then provide an assessment of the relative degree of affordability for a CBSA (or state/national level). We have provided periodic commentary on our over/undervaluation analysis in recent years. Chart 1 provides our latest assessment at the state level.
Chart 1
This state-level assessment of over/undervaluation is consistent with what we have observed over the past several years, with major trends persisting. States such as Idaho, Colorado, and Texas remain overvalued, while Illinois and much of the Northeast remain undervalued. Our assessment (for purposes of analyzing certain mortgage pools) for the U.S. points to an overvaluation of roughly +5%, up from an undervaluation of –3% in our prior assessment. This suggests that, despite a recent upward trend in wage growth, home affordability has been dominated by HPA, especially over the past 18 months.
The Most Overvalued And Undervalued CBSAs
At the CBSA level, certain pockets of the country have much higher overvaluations compared with the national level. The Boise CBSA has the highest overvaluation at approximately 50%. Texas also has a host of CBSAs with high overvaluation assessments. The Austin, Dallas, and Houston CBSAs are roughly 29%, 18%, and 15% overvalued, respectively, based on our calculation. Population migration has played a large part, as an increasing number of certain industries--and correspondingly, the workers they employ--have moved to the states that have become overvalued, such as Texas, Colorado, and Idaho. Migration to some of these states and their CBSAs has been driven by changing demographics and financial considerations. For instance, Florida entices retirees and others with its warm weather and tax advantages. Chart 2 shows the distribution of over/undervaluation for 399 of the CBSAs based on our latest assessment for evaluating certain mortgage pools and corresponding U.S. RMBS. It also shows the 10 most overvalued and undervalued CBSAs.
Chart 2
U.S. mortgage pools may have only limited exposure to the top-10 most overvalued or undervalued CBSAs. Non-agency RMBS have heavy concentrations of mortgages to borrowers in New York-Jersey City-White Plains, Miami-Miami Beach-Kendall, Los Angeles-Long Beach-Glendale, Seattle-Bellevue-Kent, and San Francisco-San Mateo-Redwood City. These CBSAs have respective over/undervaluations of –7%, +7%, +3%, +12%, and –18%.
The Impact On Residential Mortgage Pools
By definition, over/undervaluation provides information about affordability compared to a long-term average. Therefore, it could influence how much property prices could fall under certain scenarios. One would expect a greater correction in property prices in an overvalued market compared with an undervalued one.
In our criteria for rating certain U.S. RMBS (see "Methodology And Assumptions For Rating U.S. RMBS Issued 2009 And Later"), our assessment of over/undervaluation applies to our market value decline (MVD) assumptions when calculating the loss severity for each loan under the criteria. When doing so, up to 50% of the overvaluation amount is added to the MVD, while 20% of the undervaluation is subtracted from the MVD. For example, if a loan were in a CBSA that we assess as being 15% overvalued, and the standard MVD assumption for a certain rating scenario level is 30%, then the MVD would be 37.5% (30% + (15%*0.5)), assuming 50% of the overvaluation amount were applied. Conversely, for a CBSA undervalued by 15%, the MVD assumption for that same rating scenario would be 27% (30% – (15%*0.20)).
Therefore, at the national level our MVD assumptions are now 2.5% higher than the standard MVD assumptions at the 'AAA' rating level, assuming equilibrium (not overvalued or undervalued). This is because when analyzing certain mortgage pools, we assess the U.S. broadly as 5% overvalued. Before this update, this assessment for the U.S. was roughly 3% undervalued, resulting in standard MVD assumptions less than 1% lower. However, the real impact on a mortgage pool will be based on the specific CBSAs and their geographic representation in the pool.
Because we use the long-term average in our computation, variability over the time series in the corresponding results is either limited or displays volatility that we think could be temporary. These and other factors may influence how frequently we update our over/undervaluation assessment and the FHFA index value as it pertains to our credit modeling.
In addition to an increase in our general overvaluation assessment, significant HPA has resulted in an update to the FHFA index values we use for property values with dates preceding the second-quarter 2021 update. As explained in our criteria, when indexing such loans we apply 50% of upward movements and 100% of downward movements. Although HPA has recently been high and overvaluation has generally been more apparent, the overall impact on a mortgage pool will depend on the geographic distribution and valuation age of the properties backing the loans in the pool.
Related Research
- LEVELS Model For U.S. Residential Mortgage Loans, Aug. 5, 2019
- Will The Froth In U.S. Housing Bubble Over Again? We Think Not, Feb. 22, 2019
This report does not constitute a rating action.
| Analytical Contacts: | Jeremy Schneider, New York + 1 (212) 438 5230; jeremy.schneider@spglobal.com |
| Julian He, CFA, New York + 1 (212) 438 8154; julian.he@spglobal.com | |
| Research Contact: | Tom Schopflocher, New York + 1 (212) 438 6722; tom.schopflocher@spglobal.com |
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