The Office of Federal Housing Enterprise Oversight announced last Wednesday that any downward revision to the 2007 conforming limits that are due to dropping home prices would be deferred for one year. This means that, contrary to earlier Street projections, the conforming loan limits will remain unchanged next year.

In a press release, OFHEO outlined the procedures for determining the 2007 conforming loan limits, making it evident that the conforming loan limit will hold at $417,000 for now. The GSE governing body also clarified how the October-to-October price change would affect the maximum loan limits.

"If house prices fall, loan limits should reflect that, but we need to ensure an orderly and transparent process for any downward adjustment," OFHEO Director James Lockhart said. "We want to make sure that guidance exists to avoid disrupting the end-of-year pipeline of mortgages or the market for mortgage-backed securities."

Before the announcement, Street analysts were already projecting that these limits would be dropping, basing their projections on home prices that declined over the October 2005 through September 2006 period. Specifically, single-family home prices have declined 3.1% during this time span.

Conforming loan limits for an upcoming year are determined by the October-to-October percentage increase in the average house price as reported by the Federal Housing Finance Board. Based on this and expectations of further deterioration in October home prices, some Street analysts were expecting a decline in the 2007 conforming loan limit to around $404,000 from 2006's $417,000.

This especially seemed likely as OFHEO took over the responsibility of calculating the conforming loan limits beginning in 2004, partly because of the GSE's failure to take into account the home price declines in the mid-1990s.

The OFHEO calculated the limits based on the following criteria. If the average October 2006 price exceeds that of October 2005, the maximum conforming limits will be adjusted upward by the percentage increase in price. If the October-to-October increase is negative, its effect on the maximum conforming limits will be deferred for one year. Furthermore, OFHEO said that the decrease would be netted against any increase next year for determining the 2008 limits. If prices drop again next year, then the maximum loan limit would dip in 2008 by at least this year's percentage decline in average prices.

OFHEO said it would provide more detailed guidance early next year for determining conforming loan limits for 2008 and forward. OFHEO is set to announce the 2007 conforming loan limit on the morning of Nov. 28, following the release of the FHFB October home price survey at 8:30 a.m. on the same day.

Street reaction

In a previous report, Barclays Capital analysts had discussed the potential impact of a reduction in the conforming loan limit, including a likely rush to securitize by yearend December 2006 loans that were slightly below the 2006 limit ($417,000) but above the 2007 limit. They had also estimated that about $2 billion per month of issuance would move to private-label jumbo MBS from agency MBS.

However, based on OFHEO's clarification, it would appear these are no longer issues. Also, the stay in the conforming loan limit should prevent the typical acceleration in jumbo prepayments that occurs in the first few months of a year when those borrowers have been previously presented with the opportunity to refinance into a conforming loan, Barclays analysts added.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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