Steady/ Rising Credit Scores Despite More First-Time Buyers; Narrowing of Buyer Pool

Dan Oppenheim
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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES 

 

Dan Oppenheim , CFA

(415) 889-5617

doppenheim@ssrllc.com

February 28th 2019

Steady/ Rising Credit Scores Despite More First-Time Buyers; Narrowing of the Buyer Pool

Mortgage data reflect affordability concerns and a narrowing of the buyer pool. In general, we’ve seen a trend of homebuyers with flat to rising FICO scores, despite an increasing share of home sales to first-time homebuyers, who would typically have lower FICO scores. We believe that this trend of stable/rising scores, but a greater share of first-time homebuyers is a function of challenged affordability in many markets and the resulting narrowing of the pool of potential buyers. Fortunately, these affordability concerns have eased to some extent with the decline in mortgage rates since mid-November (Exhibit 2). Nonetheless, history suggests that a meaningful upturn in new home sales activity will require increased activity from mid-range consumers.

Horton reporting slight increase in FICO scores, even while shifting to first-time buyers. D. R. Horton’s wide geographic diversity and focus on affordability makes its statistics on FICO scores and first-time buyers especially relevant. The average FICO score for a borrower utilizing D.R. Horton’s mortgage company has risen slightly to 721 in fiscal 2018 (and in 1Q19) from 716 in 2015, despite the increasing share of Horton’s home sales to first-time homebuyers, rising to 47% in 2018 and 50% in 1Q19, up from 41% in 2015 (Exhibit 3). While the improving economy has led to a slight uptick in FICO scores (Exhibit 5), we believe this mix shift (slightly higher average scores, but a rising share of first-time buyers) is larger than the slight rise in FICO scores from the upward movement of the economy.

Mortgage origination data also shows smaller pool of mid-range borrowers. This narrowing of the pool of homebuyers is consistent with what we have seen in mortgage origination data, with the share of mortgage originations to borrowers with FICO scores of 720-759 now at a multi-decade low (Exhibit 4). In 4Q18, borrowers with 720-759 FICO scores represented just 15.4% of mortgage origination volume, at the lowest level in at least the past 15 years and well below the 26.4% average from 2003-2018. We don’t believe this is so much a function of tightening credit, but rather a voluntary pull-back by the consumer in response to affordability issues (see our Feb 15th note “Consumer Credit Trends: Mid-range Consumer not Buying Homes; Tired High-End Consumer”).

Prior homebuilding expansions have been led by greater share of mid-range originations. Typical upturns in the housing market have been accompanied by a rising share of originations to borrowers with credit scores in the range of 720-759. While attention has often been on originations to subprime borrowers (generally FICO scores below 670) and the easing of low-end credit, the 720-759 FICO score segment is a much more significant driver of the housing market. In the early years of the housing rebound in 2012-2013, this FICO score segment represented 27.1% of mortgage originations. Similarly, in 2003-2004, in the years of an expanding market, but prior to the most problematic lending, borrowers with FICO scores of 720-759 represented 33.2% of mortgage origination volume. As the 700-749 FICO score segment represents the middle quintile of scores (Exhibit 5), activity from this segment is essential to see a meaningful increase in new home sales or a rising homeownership rates from 64.4% (as of 3Q18).

Exhibit 1: SSR’s Preferences Among Housing-Related Sectors
Source: SSR analysis

Affordability at historic average nationally, but more stretched in western markets. The decline in mortgage rates since mid-November has helped to reduce the concern about affordability on a national basis, with the mortgage payment on the median priced home representing 19% of household income in 1Q19, consistent with the average over the past 20 years. This is a key part of our expectation for reasonable demand during the spring housing season. However, affordability remains more stretched in many key markets, especially on the west coast. Historically, stretched affordability leads to a smaller pool of potential buyers and we will continue to watch this closely.

Exhibit 2: National Affordability Back to Historic Averages Following Decline in Mortgage Rates
Source: National Association of Realtors, Freddie Mac, and SSR analysis

Horton’s trends show slight upward move in FICO scores, but shift to first-time buyers. The average score of D. R. Horton’s mortgage customers has risen slightly in recent years, up to 721 in fiscal 2018 and fiscal 1Q19 from 716 in fiscal 2015. This slight upward move comes despite Horton selling a greater share of homes to first-time buyers, up to 47% in fiscal 2018 and 50% in fiscal 1Q19 from 41% in fiscal 2015.

Exhibit 3: D.R. Horton’s buyers have had slightly rising FICO scores, despite greater first-time buyers
Source: Company reports

Declining share of borrowers will 720-759 credit scores consistent with builder trends. The share of mortgage origination volume to borrowers with credit scores of 720-759 fell to a record low of 15.4% in 4Q18, well below the 26.4% long-term average. The share of originations to buyers in this credit score range has declined over the past five years (with this share falling from 29.8% in 4Q13), with a corresponding increasing share for those with credit scores 760+ (up to 57.9% in 4Q18 from 47.9% in 4Q13). We believe that this shift is likely due primarily to stretched affordability limiting the ability of these buyers in the 720-759 range to purchase homes and take on mortgage debt along with a slight upward drift in credit scores during the economic expansion (so that borrowers who had been in the 720-759 range moved up into the 760+ range during this time). During the housing upturn in 2003-2004 (below the cycle was far too stretched in 2005-2006), a far greater share of mortgage originations went to mid-range and lower-end consumers. While attention focused on the increased share of subprime borrowers, the greatest difference between that time and the recent past has been the declining activity of the mid-range consumer, which reinforces the importance of affordability.

Exhibit 4: Borrowers with 720-759 credit scores have largely been absent in recent years
Source: New York Fed Consumer Credit Panel/Equifax
Improving economic trends have only resulted in a modest upward rise in the distribution of FICO scores. The percentage of consumers with FICO scores of 750 or higher increased to 42% in April 2018, up 460 basis points from a cycle low of 37.4% in April 2010. On the surface this upward shift should increase the FICO scores of homebuyers and lead to increased homebuying activity. However, it is important to keep in mind that the homeownership rate of 64.4% in 3Q18 means that more than just the highest rated 42% of consumers must purchase homes to even keep the homeownership rate constant. Looking at the next segment of consumers (those with credit scores between 700 and 749), the share increased slightly to 16.2% in April 2018, up from 15.7% April 2010. This is likely the key group to buy homes in order to see a significant rebound in new home sales.

Exhibit 5: Modest Upward Drift in FICO Score Distributions with Improving Economy

Note: FICO Score distributions from 2005-2018 as a percentage of population with credit scores.

Source: FICO

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