Many global markets experienced a roller coaster ride in 2020 as COVID-19 gripped the world, with U.S. housing remaining a bright spot. Now that vaccines are being rolled out, 2021 could mark a fresh start, with a recovery already underway and residential housing continuing to underpin the U.S. economy. The combination of demographic trends and household formation rates, limited inventory, and historically low mortgage rates will continue to support residential real estate fundamentals. Moreover, the desire for more living space to accommodate work-from-home setups means that the demand for single-family housing will continue to grow. At the same time, although the election is behind us, uncertainty remains as to if/when the government-sponsored enterprises (GSEs) will exit conservatorship. Lastly, the final rule recently issued by the Consumer Financial Protection Bureau (CFPB) regarding qualified mortgages takes effect in the summer and could alter the landscape of mortgage financing in the country.

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

The Stage Is Set For 2021

The U.S. economy, which had been performing well for the past several years, contracted when the pandemic hit last spring. The U.S. housing market, however, has performed well even as the labor and other markets have struggled. In an effort to stimulate the economy, the Federal Reserve lowered the overnight benchmark rate to near zero, and mortgage rates have also settled near historical lows well below 3%. This has boosted affordability and encouraged buyers who might have previously been on the sidelines.

The impact of COVID-19 (and efforts to contain it) upon the labor market has been severe, with national unemployment reaching double digits in the spring and summer. The result was a surge in forbearance plans, which, although high, did not hit the levels some had expected in early- and mid-2020 when the pandemic was at its initial peak. Chart 1 illustrates the current situation, with historically low mortgage rates, strong home price appreciation (HPA), delinquency levels that are slowly improving, and an unemployment rate that, after years of historical lows, increased sharply and then showed signs of recovering (S&P Global Ratings economists predict it will not settle back down to pre-COVID levels until the second quarter of 2024). Our projections for 2021 include a national unemployment rate of 6.4%, a 30-year fixed mortgage rate of 3.0%, and a 3.0% rate of annual growth for the Case-Shiller Index.

Chart 1

Tap the brakes, but keep rolling

The expected 3% annual growth in the Case-Shiller Index represents a slower rebound than we saw in 2020, when the index was up roughly 8% year over year as of October. According to Fannie Mae's January 2021 housing forecast, the Federal Housing Finance Agency's (FHFA) Purchase-Only Index will be up 4.2% in 2021. The lingering effects of the pandemic, including a desire for more functional floor plans, will persist in 2021. This should be supportive of already strong fundamentals, such as limited supply, robust household formation among Millennials, low rates, and strong demand for single-family housing. Despite these fundamentals, we expect a slowdown in HPA.

There is anecdotal evidence that demand for housing outside urban areas is propelling HPA. While it's likely that there has been increased movement toward the suburbs, it's also possible that some homeowners bought second homes outside of the city. Moreover, many renters probably decided to enter the purchase market, encouraged by the low mortgage rates and a desire for square footage. We considered two urban areas, Seattle and New York City, and examined the HPA for both the city/metropolitan statistical area (MSA) and surrounding MSA/core-based statistical areas (CBSAs), sorted by 2020 House Price Index (HPI) numbers (see chart 2). The findings suggest an uptick in urban-to-suburban movement within these two regions during 2020 relative to 2019, as measured by the quarterly (second to third quarter) change in the FHFA HPI. While the drivers of this increased HPA are unclear, temporary COVID-19-related anomalies likely played a role. In any case, we expect demand at both urban and suburban levels to continue into 2021.

Chart 2

The demand for housing probably got an additional boost when renters, on the fence as to whether to buy, realized that dwellings would need to become both offices and schools in addition to residences. It's too early to be certain, but it's possible that the fundamental changes to the office work environment since the onset of the pandemic will be long lasting. Working remotely is now viewed not only as feasible, but as a system that can save money if office spaces in expensive cities are not needed to the same extent. For this reason, it's possible that the effects of COVID-19 could divert demand away from the multifamily sector and into single-family housing in 2021. However, it is also possible that office space in cities could be converted to residential apartments, keeping supply up.

Chart 3 shows the 2020 year-over-year growth in homeownership. The pickup in the South and Midwest is consistent with the increased levels of demand and with our state-level over-/under-valuation metric (more on this in the section below). Furthermore, according to the U.S. Census Bureau, the largest jump in homeownership was in the 35 and younger age bucket, supporting the view that there is strong pent-up demand from Millennials, which is finally being realized.

Chart 3

Current Trends Will Likely Continue Through The Year

The resurgence in single-family housing starts, which several market institutions are projecting to surpass one million units in 2021 and realign with historical norms, reinforces some of the pullback in multifamily starts. However, we don't believe that the strong single-family demand and HPA are precursors for unsustainable price growth and a corresponding housing bubble. To test the idea, we analyzed the 404 U.S. CBSAs across the country to assess affordability. When comparing home price-to-income ratios to their long-term averages, the U.S. is roughly at equilibrium, with some CBSAs showing overvaluation and others undervaluation. The state-level analysis is comparable to what we have seen over the past several years, with states such as Colorado, Idaho, and Texas showing overvaluation, primarily due to population growth and job migrations into relatively inexpensive city centers, resulting in increased demand for housing. Conversely, the Northeast continues to be undervalued as the population migrates out of the region--perhaps to taxation-friendly Florida or to the previously mentioned states. (See chart 4.)

Chart 4

Our assessment of over-/under-valuation contemplates the ratio of home prices to income per capita relative to the 15-year average. In this light, the U.S. as a whole is roughly at equilibrium (i.e., near 0%) and has moved up from a level of undervaluation that occurred once home prices reached a trough in 2012, a few years after the Great Financial Crisis. With low mortgage rates expected to persist in 2021 and HPA slower but positive, we expect the ratio to continue hovering around equilibrium, assuming wage growth continues. About 30% of the states are overvalued (see chart 5), with some of the most overvalued CBSAs focused in Idaho, Texas, and Colorado. Relative to the East Coast, these states offer more available land for housing. Considering the pandemic-fueled desire for larger functional layouts and backyards, we expect migration into these states to continue in 2021.

Chart 5

Mortgage Originations Projected To Surpass $3 Trillion

Residential mortgage originations pierced $4 trillion in 2020, and forecasts for 2021 from Fannie Mae, Freddie Mac, and the Mortgage Bankers Association all exceed $3 trillion, driven by the low prevailing mortgage rates. The increase in the conforming loan limit is expected to continue favoring a mortgage market that is largely financed by the GSEs, and the move toward privatization of the GSEs will likely lose momentum this year in light of the shift in national politics. Nonetheless, some of the GSEs' market share could be ceded if certain administrative actions are taken to reduce agency deliverable loans (e.g., tighter controls on cash-out loans and investor property loans).

Perhaps the most significant new development concerning housing finance was the December announcement by the CFPB of the final QM rule amending the general qualified mortgage definition. The rule, which has a mandatory compliance date of July 1, 2021, adopts price limits over the prior debt-to-income (DTI) ratio cap of 43% and eliminates Appendix Q (the current template for calculation of income and debts). A mortgage with an annual percentage rate (APR) of less than 225 basis points (bps) over the average prime offer rate (APOR) for a comparable transaction meets the threshold for a QM loan. Existing product feature restrictions and point/fee limitations still apply. And although DTI ratio has been topical over the past several years as it relates to QM (and will continue to be so), the new rule's impact on income and debt calculations and the underwriting methods that can be employed to meet QM (whether safe harbor or rebuttable presumption) are perhaps the more interesting topics of this year.

Loans sold to the GSEs are subject to the general QM definition after June 30, 2021, upon expiration of the GSE patch (which currently provides GSE loans with temporary QM status). Elimination of the DTI ratio threshold addresses the concern that the expiration of the GSE patch could result in reduced mortgage credit availability because the GSEs lend to qualifying borrowers with DTI ratios as high as 50%, and some of these loans with DTI ratios over 43% may have APRs below the APOR + 225 bps threshold. These loans would retain QM status upon a transition of Fannie Mae and Freddie Mac to the new general QM definition.

The final rule could lead to an expansion of private mortgage credit as well. Mortgages currently labeled as non-QM due to the DTI ratio cap would potentially qualify for lender protections under the amended definition. Reduced liability for lenders and subsequent assignees could lower financing costs and expand funding options for these borrowers.

Another development to keep an eye on in 2021 is the increased use and adoption of technology to aid in mortgage appraisals and mortgage underwriting. This could make the origination process more efficient and reduce costs. The FHFA has already issued a request for information seeking input on hybrid appraisals.

Mortgage Credit--Forbearance Resolution A Key Factor

Under the CARES Act, it was common to use six- and 12-month forbearance plans for agency loans, and shorter duration plans for non-agency loans. The declines in delinquencies and forbearance are good news. But the question remains: What will become of borrowers in forbearance once they hit the one-year mark? For now, because credit bureaus are not required to report borrowers on COVID-19-related forbearance plans, FICOs may be higher than they otherwise would be. However, it remains to be seen how qualifying requirements will be adjusted for new mortgages when the borrower has been subject to forbearance. From a credit perspective, this is meaningful because it will have an impact on prepayment speeds, which have been high.

Delinquency levels in mortgage cohorts have generally continued to drop, but at a lower trajectory (see chart 6).

Chart 6

Although we will continue to see bond write-downs applied for certain securitizations as COVID-19 forbearance ends, the sensitivity will depend on the resolutions (see "U.S. RMBS--After The Credit Risk Transfer Forbearance Plateau," Oct. 23, 2020). While early forbearance exits during the summer showed large reinstatement rates via either full repayment or no missed payments at all in forbearance, we expect that share to fall in 2021. The good news is that the levels are low in some cohorts. Forbearance resolution type and servicer advance reimbursements are two credit themes to pay attention to in early 2021 (see "Can COVID-19 Cause A Cash Crunch For Certain U.S. RMBS?," Aug. 21, 2020). Some forbearances are also resolved via full loan prepayment, which is positive from a credit perspective. For 2021, with low projected interest rates and still-strong (albeit slowing) HPA, we could continue to observe this as equity-rich homeowners with permanent income curtailment/loss end up selling their properties and satisfying the forbearance terms.

Private-Label RMBS Issuance Poised To Exceed 2019 Levels

Last year there was an annual decline of roughly 10% in non-agency residential mortgage-backed securities (RMBS) issuance volume (finishing at $115 billion in 2020 versus $125 billion in 2019) due to COVID-19 and related economic factors. We expect renewed issuance activity in 2021, with approximately $130 billion of volume (see chart 7).

Chart 7

The non-QM sector experienced the biggest shock in the spring of 2020 as originations and securitizations largely halted and non-QM issuance fell relative to 2019. However, we feel that non-QM issuance volumes will return to 2019 levels this year, reaching an estimated $25 billion, due to a strong purchase loan market and slowing agency refinancing activity. We also think that older non-QM securitization clean-up calls could contribute to additional new securitization collateral in the low interest rate environment.

We expect modest growth in credit risk transfer (CRT) transactions due to the high expected mortgage origination volumes (albeit lower than 2020), but reduced clarity in terms of the consistent issuance activity seen in years prior (largely a result of the recent Capital Rule). As a by-product of CRT and agency mortgage originations, mortgage insurance CRT is expected to contribute several billion dollars to issuance projections, as high loan-to-value purchase loan activity should be elevated and these loans typically carry mortgage insurance.

The greatest RMBS issuance growth is projected to be in the prime/conforming space, which by our categorization includes both prime jumbo mortgages and agency-eligible loans delivered into private-label securitizations. There is a compounding effect when agency-eligible loans flow into private-label securitizations. Typically, the loan balances are equivalent to the issued security amount in the private-label space, whereas if an agency-eligible loan collateralizes a CRT transaction, then only a small percentage of the loan balance is represented in the issued security amount. Moreover, recently announced QM rule changes could contribute to a boost in non-agency issuance. In any case, low mortgage rates should create jumbo origination volumes that may continue into 2021 while agency refinance activity fades.

For the "other" category (including reperforming, nonperforming, servicer advance, single-family rental, and reverse mortgage), we are projecting similar issuance levels as in 2020. This is largely due to growth in terms of COVID-19-related delinquencies/forbearances that end up in a reperforming or nonperforming status.