Key Takeaways
- Our assessment of overvaluation in the U.S. remained at approximately 20% as home price gains tempered in the third-quarter 2022.
- Despite the steady national-level assessment of overvaluation in the U.S., there is some regional variation with almost 15% of states showing home price depreciation.
- We believe the credit impact of home price dynamics and overvaluation on U.S. RMBS will depend on the geographic distribution of the mortgage pools and the valuation dates of the properties backing the loans in the underlying collateral pools.
Recent U.S. home price appreciation (HPA) stalled as the non-seasonally adjusted Federal Housing Finance Agency's (FHFA) all-transactions House Price Index (HPI) data showed a gain of only 1.7% between the second and third quarters of 2022 and the Purchase-Only Index was slightly negative. Depending on the trajectory of mortgage rates, more downward price pressure could be in store.
S&P Global Ratings views home prices as overvalued or undervalued based on how much the price-to-income (PTI) ratio for a specified region (e.g., metropolitan statistical area [MSA] or state) is above or below its long-term average. Our regional inputs are the FHFA's HPI and income per capita. Based on these values, we compare the current PTI ratio to the 20-year average to assess over/undervaluation. With per capita income growth in line with home price increases, the national level of overvaluation is largely unchanged at roughly 20%. At a regional level, the proportion of overvalued metropolitan statistical areas or divisions (which we refer to broadly as MSAs) is still over the 90% mark, although some regional variance exists compared to the second-quarter 2022. For our previous overvaluation assessment, see "Housing Overvaluation May Be Peaking: How It Affects U.S. RMBS," published Oct. 17, 2022.
The third-quarter 2022 FHFA's HPI update reinforces the notion (which we outlined in our prior update) that overvaluation may be peaking. While 1.7% home-price growth (as indicated by the all-transactions index) was still positive, some of the monthly data from the Purchase-Only Index showed month-over-month depreciation within the quarter. Chart 1 shows that about 15% of states experienced home price depreciation between second- and third-quarter 2022, with those along the West Coast all posting declines.
Chart 1
On Feb. 17, 2023, we updated our over/undervaluation measures, as well as the FHFA index inputs using third-quarter 2022 data. We use these values because they relate to certain U.S. residential mortgage-backed securities (RMBS) 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. Depending on the pool diversification and location of the underlying mortgaged properties, overvaluation means our loss severity assumptions will tend to be higher (because a greater correction in home prices could occur under adverse scenarios) than if there is less overvaluation, or if the market is in equilibrium or undervalued. However, because our property value index now reflects third-quarter 2022 FHFA data, the indexed valuation will generally be somewhat higher, depending on when the valuation was performed and given the HPA between the second and third quarters of 2022.
Housing Is Still Roughly 20% Overvalued Nationwide
While we believe housing is still about 20% overvalued across the U.S., there is some degree of regional variation, and there continues to be a significant skew in terms of the number of overvalued MSAs and the extent of the overvaluation (see chart 2). Compared to our last assessment, some of the areas that exhibited a higher variance included the Austin, Texas and Seattle MSAs, which had respective declines in overvaluation of roughly 6% and 7% absolute (i.e., a drop of roughly 600 and 700 basis points from the prior reading); these MSAs also posted 2022 second- to third-quarter HPI declines of 1.5% and 3.0%, respectively. On the other hand, the Jacksonville, Fla. MSA posted an increase in overvaluation of roughly 6% absolute, and a corresponding increase in HPI of 5.9%. Chart 3 shows regional differences in home price changes. The degree of price declines across the nation will depend on a combination of factors, including the trajectory of the 30-year fixed-rate mortgage, local housing market and economic fundamentals, and, to some extent, the magnitude of the expected recession in 2023.
Chart 2
Chart 3
The Most Over/Undervalued MSAs
Certain MSAs have overvaluations that are still much higher than the 20% national average. Chart 4 shows the 10 most overvalued and undervalued MSAs, and the distribution of over/undervaluation for 399 MSAs (based on our latest assessment) for use in evaluating mortgage pools and corresponding U.S. RMBS. Previously, we assessed 93% of MSAs across the country as being overvalued. That portion has increased to roughly 94%. Idaho contains two of the top 10 overvalued MSAs, with the Boise region having the highest overvaluation level at 67%, down from our prior reading of 75%. Texas also has two MSAs in the top 10, while Florida has five.
Chart 4
The Impact On Residential Mortgage Pools
Our over/undervaluation measure provides information about affordability in terms of deviations from a long-term average. Assuming the long-term average represents a steady state, overvaluation could influence how much property prices decline under certain scenarios. To account for this when rating certain U.S. RMBS, our assessment of over/undervaluation applies to our market value decline (MVD) assumptions when calculating the loss severity on a loan, based on our criteria (see "Methodology And Assumptions For Rating U.S. RMBS Issued 2009 And Later," published Feb. 22, 2018).
Under a 'AAA' rating stress, we assume that (for a given region) 50% of the overvaluation amount of a mortgaged property will factor into the MVD, with a corresponding value of 20% at a 'B' rating level. At the national level (assuming a 20% overvaluation), our 'AAA' MVD assumption is approximately 55%. This assumes that under a 'AAA' rating stress, the additional decline in a property's value would reduce the liquidation proceeds by approximately 10% (compared to a market at equilibrium), and correspondingly, increase the loss severity assumed for a given loan.
The current update to our overvaluation assessment (and the FHFA index we use for properties with valuation dates before third-quarter 2022) was motivated by regional changes in home prices and per capita income. When indexing property values, we apply 50% of cumulative upward movements and 100% of cumulative downward movements, based on our criteria. Higher property values resulting from this indexation could reduce the probability of defaults and temper loss severities. Overall, we believe the credit impact of HPI changes and overvaluation levels on U.S. RMBS will depend on the geographic distribution of the mortgage pools, as well as the valuation dates of the properties backing the loans in the pools.
This report does not constitute a rating action.
| Primary Credit Analyst: | Jeremy Schneider, New York + 1 (212) 438 5230; jeremy.schneider@spglobal.com |
| Secondary Contacts: | Sujoy Saha, New York + 1 (212) 438 3902; sujoy.saha@spglobal.com |
| Adam J Odland, Englewood + 1 (303) 721 4664; adam.odland@spglobal.com | |
| Research Contact: | Tom Schopflocher, New York + 1 (212) 438 6722; tom.schopflocher@spglobal.com |
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