Despite Freddie Mac reporting a slowdown in home price growth in the fourth quarter of last year, market observers said that the results are not as bad as expected. Further, home price growth remains strong, although not as high as recent experience, and is expected to level off to a more historically normal rate this year.

"The period between mid-2000 to mid-2001 is when we saw the fastest national average house price growth across the U.S.," said Frank Nothaft, chief economist at Freddie. "What we've seen since then is a gradual deceleration in the rate of house price growth. And that continued with the fourth quarter 2002 data that we've just released."

He stated that for this year, Freddie is projecting a continued deceleration of house prices to a rate somewhere between a 3 to 5 percent annual growth rate nationwide. This does not mean that the country would be experiencing a housing bubble. In fact, Frank said "A 3 to 5 percent growth rate means the average home will still be appreciating in real terms, specifically relative to consumer price inflation, even though home prices experienced a slower rate of growth than what we've enjoyed the last few years."

Last week, Freddie Mac said that home values only grew at the rate of 3.9% in the 4Q of 2002. This is versus the 5.3% growth rate in the third quarter that was prompted by the decrease in interest rates. The annual home price appreciation rate was 6.6% year over year.

Meanwhile, the Office of Federal Housing Enterprise Oversight (OFHEO) reported home prices increased by 6.89% in the fourth quarter of last year from the same period a year ago. Home prices went up by just less than 1% from the third quarter. This would make it the smallest quarter-to-quarter increase since the second quarter of 1998.

Nothaft also expects that the amount of home equity to be liquefied this year will be less than in 2003. It is estimated to drop by approximately one-third from the level seen in 2000. "Dropping by one-third from the record volume seen previously, that would still be a pretty hefty number," he said. For this year, the estimated net amount of home equity to be liquefied as part of a refinancing of conventional prime mortgages (such as those that Freddie would buy) is $60 billion net of paying back any second mortgage.

This is in contrast to $90 billion of home equity that was converted into cash in 2002.

This may have some effect in terms of reducing the growth rate in home improvements as well as in overall consumer spending generally. But Nothaft said, putting this in context, even though this number is one-third less than what was seen in 2002, $60 billion is still significant, especially if seen in light of it being the third highest ever.

Effect on prepayments

Prepayment analysts said that the biggest impact of the overall growth in home prices would be on how moderately seasoned mortgages prepay. It is clear that speeds on 1998 and 1999 production 6s and 6.5s are faster than those on more recent production, a phenomenon caused by cash-out refinancings. They said that these fast speeds are expected to continue for a while yet.

A single quarter during which home price growth rates fall to 1% has very minimal impact on how fast these vintages prepay, analysts stated. Borrowers who bought their houses in 1998 and 1999 still have very nice opportunities to take out equity, and this is going to keep speeds on 1998 and 1999 production 6s and 6.5 quite fast. This is in addition to low interest rates keeping speeds on these vintages fast.

Better than expected

"Although equity appreciation is currently much slower than the 1.9%/quarter typical over the last few years (excepting the most recent two quarters), the home price appreciation outlook is much stronger now than it was prior to the FHLMC report," wrote Glenn Boyd, prepayment analyst from UBS Warburg about the FHLMC repeat-sales home price indices.

He said that based on the new numbers, the firm's econometric model of existing home sales projects a rise of 5% in the first quarter of this year, which would be followed by another 2.5% increase in the second quarter if rates are unchanged through March.

Before the repeat sales reports, the analysts expected the downturn in home sales in the first quarter of 2003, which represents a considerable shift in terms of the firm's projections. He said though that day counts in February and March would suggest 2% decreases in home sales per month, which offsets the fundamental 5% increases, so UBS's overall prognosis for the next two months is actually flat.

In the near term - which means about six months - he said that home sales, and therefore base turnover speeds, would probably not decline unless rates sell off significantly.

"Of course, turnover is not a major focus when the entire market is a premium," wrote Boyd. "In a 100 basis point sell-off, our model suggests only a 3% decline in home sales, unless home-price appreciation slows further, as well. If equity growth zeros out in such a sell-off, a decline of about 10% in home sales should induce a slowdown of 1.5 to 2 CPR in discount speeds."

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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