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The US Housing Market's Road to Recovery: Slower Speed Limits and Stricter Enforcement

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PIMCO expects housing prices to appreciate 8% to 12% over the next two years.

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Access to Credit and Lending

The ability to get a mortgage at today's historically low rates remains an issue. Figure 7 shows the average FICO scores and loan-to-value ratios of closed and rejected loans in December 2012, as processed by Ellie Mae's database, which encompasses 20% of all US mortgage originations.

We would argue that tight credit is a positive, as lending standards will only become easier. Credit expansion has materialized in both the auto and credit card sectors and should slowly spill over into mortgages. Capacity constraints, higher capital requirements and more regulation will cause this transition to take time but mortgage credit should begin to loosen.

One of the main reasons banks have been unwilling to expand the mortgage credit box is the potential liability of making loans that may eventually become delinquent and default. The Dodd-Frank Act, which has created a "safe harbor" for lenders of "qualified mortgages" − those that it can be reasonably assumed will pay off − will create a safer system but, in our view, will slow the process of easing lending standards.

Conclusion

We remain constructive on the state of the housing market but recognize the road is far from smooth.

On balance, we believe the positives outweigh the negatives and look for housing to appreciate 8% - 12% over the next two years. Housing should have positive influences on consumer confidence and labor mobility.

In terms of investment implications, we believe both agency and non-agency markets offer opportunities to generate excess returns, while active management should be able to add value to structural allocations. Agency mortgage securities offer liquid investments that can be traded against each other as well as against other liquid interest rate markets, specified mortgage pools and, less frequently, structured mortgage products.

Non-agency mortgages continue to offer the best risk-adjusted returns in the sector, but specific security selection will matter much more given their recent high returns. Compared to investing directly in real estate, which requires time to close, lawyers, insurance and transaction costs, non-agency mortgages offer similar returns without the friction. Pairing non-agency mortgages with agency mortgage-backed securities potentially provides an attractive return profile across a wide range of economic outcomes.

This article originally appeared on PIMCO.
No positions in stocks mentioned.
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