PMI Mortgage Insurance Co., a subsidiary of The PMI Group, Inc. (PMI), has just released its quarterly (winter) 2005 Risk Index, indicating a "decrease in the probability of an overall house price decline," except for the riskiest Metropolitan Statistical Areas (MSAs), nine of which are on the East and West Coasts.

The Risk Index isn't based on what you may think it is -- that too many people are getting loans with PMI. The risk factors instead are broad market indicators such as employment and the economy as a whole, explains Josh Wozman, spokesperson for The PMI Group, Inc.

"It's not about loans -- this is about home price appreciation and depreciation," explains Wozman, "not about risk in our business (underwriting and insuring loans), but this speaks to a number of factors in certain MSAs and those factors are employment data, home price appreciation, etc."

The Group uses the data, says Wozman, to determine which MSAs are more risky to insure loans.

"What jumped out at me," says Wozman, "is the top nine MSAs at risk for price depreciation are coastal -- in California or the Northeast, and these cities increased in their risk index since November."

In other words, in California there is a higher likelihood of home depreciation than other areas. "That tells us that these areas are more sensitive to depreciation," says Wozman, "so we take that into account."

Based on PMI's Risk Index model, as of January 2005, the average risk value of the 50 largest Metropolitan Statistical Areas (MSAs) is 161 -- a 16.1 percent probability of an overall house price decline, as measured within the next two years and across the 50 largest housing markets, says the Risk Index.

The winter 2005 average risk value decreased sequentially, quarter-over-quarter, by 13.4 percent. As of autumn 2004, PMI Risk Index data showed that the average risk value of the 50 largest MSAs was 186, which implied an 18.6 percent probability of an overall house price decline, measured within the next two years and across the 50 largest housing markets.

Analysts at PMI have attributed the average decrease to improving nationwide economic conditions indicated by generally lower regional unemployment rates and increasing (or less negative) job creation. Eight of the nine MSAs ranked at the top of PMI's Risk Index, but did experience a substantial increase in risk. For these markets, another quarter of record home price appreciation has further dented home affordability, even as mortgage rates close to historic lows. As affordability for these MSAs drifts lower, this signals a further misalignment of home prices with long-term economic fundamentals causing the probability of a two-year price decline to escalate.

"Despite the Federal Reserve's gradual increase in its target federal funds rate, the 30-year fixed mortgage rate has slightly declined, thus encouraging consumers to pursue the opportunity to benefit from low mortgage rates. This has contributed to continued strength for U.S. home prices," said Marco Van Akkeren, Director, Economist, PMI Mortgage Insurance Co.

According to the report, the five MSAs least likely to exhibit home price declines over the next two years are Indianapolis, Rochester, NY, Oklahoma City, Buffalo-Niagara Falls, NY, and Pittsburgh.

Rochester and Buffalo are highly affordable housing markets, notes the analysis. For more than ten years, these areas' home prices have appreciated at a much slower pace compared to the national average, and the local economy, with its heavy concentration in manufacturing, has expanded only modestly. Pittsburgh is hampered by chronically weak population trends. Oklahoma City has also trailed the nation in home-price appreciation, but shows positive demographic trends.

Coastal MSAs topped PMI's Risk Index. Three MSAs in the Northeast region and six California MSAs held the top nine spots on the risk index where home price declines are most likely over the next two years. Boston, San Jose-Santa Clara, San Francisco-Oakland, San Diego, and Providence rounded out the five most risky MSAs for price depreciation. New England MSAs have maintained a trend of lower affordability and heightened house-price risk. In the middle, are the MSAs of Detroit-Warren-Livonia, Minneapolis-St. Paul-Bloomington, and Denver-Aurora. On the west coast, labor conditions in Northern California MSAs have improved considerably compared to the previous quarter, but substantial growth in home prices has lowered affordability, pushing up their risk index values.

Does this mean that the coastal cities are higher risks, making loans with private mortgage insurance (PMI) more expensive? Wozman won't say....

"The Index gives our credit risk analysis professionals a sense of where the likelihood of home price depreciation will be in the next two years," he demurs, "so they account for that in their pricing models. It doesn't mean PMI will be more expensive, a lot will depend on what a buyer can put down, whether they need mortgage insurance, if home prices are coming down, then the opposite might happen. We can't project whether we will have more or less people needing PMI, or if insurance would be higher because there are so many variables like employment growth and the economy as a whole."

Published: February 25, 2005

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