While the actual pace at which home price appreciation (HPA) dropped in the first quarter can vary depending on the source, nearly all market participants agree that the housing market is cooling off - with first quarter HPA estimates ranging from little more than 3% to 8.1%. And as the potential for continued Federal Reserve tightening threatens to further stifle what has been record growth in the U.S. housing market, many are beginning to wonder when the sluggishness, and uptick in rating agency prudence, might take its toll on the home equity ABS market.
UBS noted last week that year-over-year home price increases might register a zero - or even negative - by this summer, according to quarterly data from the National Association of Realtors. The data, which tracks the average of all sales transactions in a given quarter, indicates progressive slowing; throughout 2004 and 2005, HPA was running at rates of 9% to 10% year-over-year, but since it has consistently slowed - indicating a 3.1% year-over-year HPA rate in April. And, on a quarterly basis, the NAR data has turned negative for the last two quarters, UBS reported.
Meanwhile, data from the Office of Federal Housing Enterprise Oversight, which tracks price fluctuations on repeat sales of the same home, showed slowing in the last three quarters. It also reported a first quarter HPA rate of 5.27% - the slowest rate since the fourth quarter of 2001, when taking into account only homes that were purchased, not simply refinanced.
A number of market participants are not expecting headline risk from the turn in HPA to affect spreads until the figures become more dramatic. Although, certain market technicals in the short-term could do the job.
The release last month by Standard and Poor's of a more stringent update to its methodology for analyzing the probability of home equity loan default and delinquency - which will take effect July 1 - is anticipated to send a glut of issuance through the market this month, as issuers work to slide deals under the belt before they are required to post more credit enhancement for their deals.
If housing prices stabilize near levels reported in the first quarter, the market is likely to remain optimistic about a soft landing, according to Lehman Brothers. Analysts at the investment bank last week said that, "on the other hand, if deceleration continues, we may need to start worrying about how bad things can get." Home equity loans are expected to be the first mortgage-related securities to react to a softening U.S. housing market because of the often financially stretched nature of the borrowers. Futhermore, many have speculated that underwriting criteria has crumbled in light of increasing competition with the subprime lending market.
Even so, spreads on home-equity ABS have remained at or near record tights. For example, three-year, triple-A spreads were recently pegged at three basis points over Libor, seven basis points lower than both the 12-month average and the average since 1998, according to Lehman. What's more, five-year triple-B minus spreads have widened by some 20 basis points from a 12-month tight of 175, but are still more than 100 basis points below the average since 1998. But even though the short-term expected increase in supply could put pressure on spreads, continued demand from various sources across the credit spectrum could keep them in, according to Lehman.
Nomura Securities agreed. "We expect the increased HEL deal supply this month could cause spreads to widen, but this widening could be short-lived due to the resulting smaller July supply calendar," Nomura analysts wrote last week.
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