As a function of updated housing-market expectations, as well as “actual results from the first of the projection period that were substantially better than projected,” the Federal Housing Finance Administration (F.H.F.A.) released a report last week updating its projections of potential agency draws from the Treasury under conservatorship. The upside adjustment to the projections should be considered in context, however, given limited transparency of the modeling process supporting the new estimates.

Sam Chandan, Ph.D.

Some Better Housing-Market News

Earlier this month, the National Association of Homebuilders reported that its homebuilder confidence index jumped 18 points in September, the largest one-month increase since the short-lived improvements that coincided with the homebuyer tax credit. The overall increase reflects gains in current measures of home sales and homebuyer traffic and a larger rise in expectations of home sales six months from now.

The S.&P. Case-Shiller House Price Index was unchanged in the month of August, and 3.8 percent lower year-on-year, the best over-the-year reading since February. Similarly, the F.H.F.A. House Price Index was 0.1 percent lower in the month of August after posting modest increases in each of the previous four months, ending 4 percent lower year-on-year.

Existing home sales dipped in September, according to data from the National Association of Realtors released week before last. September sales were more than 10 percent higher than a year earlier but are also down by almost 10 percent from January’s high. The inventory of homes for sale has fallen more consistently than sales have picked up, but remains elevated by any historic norm.

New home sales rose 5.7 percent in September with gains in the two largest regions, the South and the West, offsetting a fall in the Midwest. At September’s sales pace, the supply of new homes on the market also tightened to 6.2 months, the lowest level since April 2010. However, house prices continued to fall in the Commerce Department report, with the median sales price for new homes down 3.1 percent in September and 10.4 percent year-on-year.

Implications for the Performance of Fannie Mae and Freddie Mac

In its report from last Thursday, the regulator and conservator of the enterprises updated its projections of Fannie Mae’s and Freddie Mac’s financial draws from the Treasury Department. As of this month, the enterprises have drawn $169 billion under the terms of the Senior Preferred Stock Purchase Agreements, including funds drawn to meet the program’s dividend obligations. In part as a reflection of the updated housing-market outlook and better-than-expected delinquency trends over the past year, the F.H.F.A. now projects that total draws will range between $220 billion and $311 billion by the end of 2014. Given the size of the draws, it is widely understood that the agencies cannot return to profitability as long as the dividend payments are enforced.

While expectations of smaller agency losses are welcome news, the broadsheets’ coverage of the F.H.F.A. update belies the need for scrutiny of the methodologies supporting the conclusions. In particular, the estimates are the result of modeling exercises undertaken by the agencies themselves, incorporating scenarios provided by the F.H.F.A. but using internal models. In light of the failure of the agencies’ risk-management processes during the housing boom, it is altogether unclear that the results of this exercise should be treated as valid. Given the broad implications for public policy and the U.S. taxpayer, the F.H.F.A.’s statement, that credit-related expenses were calculated using “a statistical loan transition model [that] projects the unpaid principal balance (U.P.B.) of loans expected to default over the projection period” as well as other modeling processes, may not pass the litmus test of model transparency. The F.H.F.A. is correct in pointing out that “the projections reported here are not expected outcomes.”

The issue is exacerbated by the F.H.F.A.’s use of house-price scenarios and other inputs from Moody’s. While the scenarios may be valid, the F.H.F.A. does not substantiate the criteria used to evaluate the efficacy or reliability of these projections or the sensitivity of results to alternative projections. Absent a more rigorous disclosure of modeling approaches and assumptions, it is impossible to determine if the tests employed by the agencies 1) capture the risks of individual mortgages or mortgage pools with any degree of accuracy or 2) are unbiased in their assessments of each enterprise’s whole residential mortgage portfolio.

Agencies’ Continuing Role in Financing Apartments

The F.H.F.A.’s assessments of agency health and the related cost to taxpayers matter for the future of housing finance and, by extension, for the apartment sector outlook, which is impacted by the direction of housing-finance reform efforts. The recovery’s cardinal markets, including New York, Washington, D.C., and San Francisco, have seen the agencies’ share of financing diminish as a wider range of lenders have responded to improving fundamentals. Still, a degree of crowding out—where nongovernmental lenders lose deals to preferentially priced agency financing—remains a factor limiting the balance-sheet gains of some banks and life companies. Some of these institutions have turned to financing apartment development as conditions demand greater risk-taking.

Outside of the cardinal markets, where apartment occupancy rates and rents are also generally rising, a range of regulatory and balance-sheet constraints on regional and community banks, combined with an unpredictable C.M.B.S. market that has seen little multifamily conduit activity, have resulted in agency financing’s maintaining its position as the dominant source of mortgages for sales and refinancing. That may remain the case for some time, even as housing-finance reform sees progress in refashioning the governmental role in the apartment sector.

Competition among lenders, and the very low cost of agency capital, has pushed debt yields to historic lows. Some market participants will cite relatively wider cap-rate spreads or positive leverage as mitigating factors in the risk analysis. But these arguments ignore that some recent deals would not be viable if interest rates were even 100 basis points higher. Invariably, cash-flow growth will have to remain strong and sustained to offset the impact of higher borrowing costs at exit. In markets or submarkets where the apartment-supply response is relatively sharp, that cash-flow growth is not assured even if the demand curve continues to shift out along its current trajectory.

dsc@chandan.com

Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.

Instead of yet another bleak housing market report, we would like to share some wonderful post-Cold War news: American home builders visiting St. Petersburg have offered to share their top-secret technology, in exchange for... softwood lumber.

Why the cross-continental bargaining? Because as of next month, our very own Canadian neighbors will be starting "a complex system of border taxes and quotas that will artificially raise lumber prices."

In short, those damn Canadians have forced us to share our precious housing secrets with those damn Russians. Can't a patriarchic global superpower ever catch a break?

Our first press release from SAINT-PETERSBURG is after the jump.

- Max Abelson

U.S. HOME BUILDERS SEEK NEW LUMBER SOURCES IN RUSSIA

SAINT-PETERSBURG, Russia - Oct. 11 - Addressing the International Forestry Forum here, U.S. home builders offered to share American home building technology with their Russian hosts and encouraged them to boost exports of softwood lumber and other wood products to America.

"We support opening up competition in the U.S. lumber market because we know that it will be beneficial for those families in our country who want to buy homes," said Jerry Howard, executive vice president and CEO of the National Association of Home Builders (NAHB). "We also appreciate the benefit it will bring to our home builders, who are seeking a steady supply of affordably priced lumber."

Howard and NAHB Immediate Past President David Wilson, a home builder from Ketchum, Idaho, represented NAHB and the International Housing Association (IHA) at the conference. NAHB serves as the secretariat of the IHA, which was established in 1984 to provide a forum for home builders and related industry groups around the world to share information and discuss issues related to the housing industry.

As a result of environmental and regulatory policies that have greatly reduced timber harvests from public lands, America today does not have the domestic capacity to meet its demand for lumber. Last year, more than 38 percent of the lumber used in the U.S. was imported, with Canada supplying the bulk of that amount.

However, a new softwood lumber accord between the U.S. and Canada that is scheduled to take effect on Nov. 1 will create a complex system of border taxes and quotas that will artificially raise lumber prices during periods of normal or slow demand, and thereby harm housing affordability. The pact is also expected to cause new uncertainties for U.S. builders over the availability and price of Canadian lumber.

"Access to a reliable, steady supply of lumber is the lifeline for any American home builder," said Wilson, who provided conference participants with an overview of light-frame wood construction techniques in the U.S. housing industry. "We believe that lumber trade barriers impose an unreasonable burden on U.S. home buyers and on the industries that depend on adequate, affordable supplies of lumber to provide the housing and other vital goods and services America needs."

While Howard noted that the new trade pact is a misfortune for Canada, he said it represents an opportunity for Russia and the rest of Europe to increase lumber exports to the U.S. over the long term.

"Today, the U.S. is overly reliant on Canadian imports to meet its lumber needs," said Howard. "We are reaching out to you to correct this problem and we are looking to Russia to add equilibrium to our market for this essential commodity for the home building industry.

"The Joint Center for Housing Studies of Harvard University projects 14.6 million household formations over the next 10 years," he added. "In the next 10 years, we conservatively estimate that we will need to construct 18 million new homes. We want to work with you to open up this new trading opportunity."

During their week-long visit to Russia, Howard and Wilson also held productive talks with representatives of the Builders Association of Russia, the Union of Timber Manufacturers and Exporters of Russia, Ilim Pulp Enterprise, BaltRoss, Slavyansky DSK and the Association of Wood Housing.

The meetings come one week after Howard visited Stockholm to discuss with Swedish trade and industry officials ways to secure new import sources of softwood lumber and other wood products and to export American building systems and log homes technology.

NAHB's European visits to seek additional sources of softwood lumber follow the association's September board meeting in Salt Lake City, where policy was instituted to address the pending U.S/Canada trade pact. A resolution was adopted that calls on NAHB to work with the governments and industry of other countries to facilitate softwood lumber imports and encourages the use of alternative building materials wherever practical in order to protect the interests of American home builders and consumers. Pre-existing policy urges the U.S. government to open up additional forest lands for logging.

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ABOUT NAHB: The National Association of Home Builders is a Washington-based trade association representing more than 235,000 members involved in home building, remodeling, multifamily construction, property management, subcontracting, design, housing finance, building product manufacturing and other aspects of residential and light commercial construction. Known as "the voice of the housing industry," NAHB is affiliated with more than 800 state and local home builders associations around the country. NAHB's builder members will construct about 80 percent of the more than 1.93 million new housing units projected for 2006, making housing one of the largest engines of economic growth in the country.