Household Credit Outlook

Presented by:

Mark M. Zandi,Chief Economist

Presented by:

Mark M. Zandi,Chief Economist

2

In the Sweet Spot of the Credit Cycle...

All household liabilities, 4-qrt MA

7

8

9

10

11

12

13

00 01 02 03 04 05 061.4

1.6

1.8

2.0

Sources: CF.com, FRB

Loan growth (L)

Severe derogatory rate (R)

3

...the Very Sweet Spot

Subprime share of liabilities

20

21

22

23

24

25

26

27

00 01 02 03 04 05 06

Source: CF.com

4

Mortgage Lending Has Soared…

% change year ago, 4 qtr. MA

0

5

10

15

'00 '01 '02 '03 '04 '05 '06

Sources: FRB, Moody's Economy.com

Cards

Installment x cards

Total liabilities

Mortgage

5

…and Quality Has Improved Across the Board

Delinquency rate, 4 qtr. MA

0

1

2

3

4

5

6

'00 '01 '02 '03 '04 '05 '06

Bank card

Total liabilitiesFirst mortgage

HELOCs

Auto bank

Source: CF.com

6

An Unprecedented Housing Market...

Real house price growth

2

4

6

8

10

12

'00 '01 '02 '03 '04 '05 '06

Sources: OFHEO, BEA

7

...and Better Job Market…

Unemployment rate

3.5

4.5

5.5

6.5

'00 '01 '02 '03 '04 '05 '06

Source: BLS

8

…is Evident Across the Country

Severe derogatory rate, all household liabilities, $

Source: CF.com

Weaker qualityAverage qualityBetter quality

9

The Credit Cycle is Set to Turn….

0.4

0.6

0.8

1.0

'00 '01 '02 '03 '04 '05 '06 '077

8

9

10

11

12

Chargeoffrate (L)

Liabilitiesgrowth (R)

4-qrt MA

Source: FRB, MEDC

10

...Particularly for Mortgage Lenders...

3.8

4.2

4.6

5.0

5.4

'00 '01 '02 '03 '04 '05 '06 '078

10

12

14

16

Delinquency rate (L)

Liabilitiesgrowth (R)

4-qrt MA

Source: MBA, MEDC

11

-6

-4

-2

0

2

4

'65 '70 '75 '80 '85 '90 '95 '00 '05

…as Monetary Policy Tightens

Difference between 10 yr. T-yield and Fed Funds Rate

Sources: FRB, MEDC

12

Housing Affordability is Eroding...

100

110

120

130

140

90 95 00 055

6

7

8

9

10

11Affordability index (L)

Sources: Realtors, FHFB

Effectivemortgage rate (R)

13

...in Many Parts of the Country...

50

75

100

125

150

U.S. D.C. Miami Las Vegas Riverside Seattle

01q4 06q1

Source: Moody's Economy.com

Housing affordability index

14

...Despite Very Aggressive Lending

0

5

10

15

20

25

98 99 00 01 02 03 04 05

IO ARM Option ARM

Source: LoanPerformance

Share of non-conforming mortgage originations

15

Housing Appears Increasingly Expensive…

0

5

10

15

99 00 01 02 03 04 05 Current

Yield

S&P 500

Office space

3-mo. T-bill

U.S. housing

10-yr T-bond

D.C. housing

16

...Undermining Investor Demand

Investor share of non-conforming mortgage originations

0

2

4

6

8

10

12

14

16

18

98 99 00 01 02 03 04 05

Investor2nd home buyer

Source: LoanPerformance

17

Metro Areas at Risk

San Diego

Sarasota

Newark, Edison

Riverside

Albany, KingstonSan Francisco-Oakland

Los Angeles-Santa Ana

Chicago

Hagerstown, Baltimore

Minneapolis

Las Vegas

Sacramento Providence

Cape Coral

Tampa

Charleston

Orlando

TucsonPhoenix

Honolulu

Washington - Bethesda

Madison

Palm Bay

Jacksonville

Reading

New York, Nassau

Ocala

Rockford

ChampaignKankakee

Davenport

Waterloo

LexingtonKnoxville

Chattanooga

Sioux Falls

Jackson

Lansing

Mobile

Miami-Fort Lauderdale

DeltonaGainesville

Dover

New Orleans

Gulfport

Milwaukee

Highly overpriced 2 SD above historic averageBased on the NAR median house price, 2006Q1Source: Moody's Economy.com, NAR

18

Real Price Declines in Half of Metro Areas

% MSAs With Price Growth Below Inflation, Next 3 Yrs, OFHEO

0

5

10

15

20

25

30

<= -10% -10% to -5% -5% to 0 0 to 5% 5% to 10%

19

Metro Areas Projected to Experience Lower Prices

10% or more decline Less than 5% decline

Carson City, NV Riverside, CA

Prescott, AZ Edison, NJ

Reno, NV Essex County, MA

Las Vegas, NV St. George, UT

Nassau, NY Atlantic City, NJ

Barnstable Town, MA

Between 5% to 10% decline Santa Ana, CA

Phoenix, AZ Boston, MA

Yuma, AZ Salinas, CA

Washington, VA Los Angeles, CA

Bethesda, MD New York, NY

Miami, FL Fort Lauderdale, FL

Poughkeepsie, NY Worcester, MA

Tucson, AZ Pascagoula, MS

Santa Barbara, CA Merced, CA

Stockton, CA Bakersfield, CA

Gainesville, FL

20

Housing Goes From a Positive to a Negative...

Percentage point contribution to real GDP growth

-0.5

-0.3

0.0

0.3

0.5

0.8

1.0

00 01 02 03 04 05 '06 '07

Wealth effectHomebuilding

Source: MEDC

21

...Particularly in Some Areas

Real estate-related employment as share of total, %

0 2 4 6 8 10 12 14 16

Delaware

Nevada

Arizona

Colorado

Maryland

Florida

Utah

Virginia

Idaho

California

United States06Q1

00Q1

22

Higher Rates, Rising Debt Service, Credit Problems

-2

0

2

4

6

8

10

12

'90 '92 '94 '96 '98 '00 '02 '04 '06 '080.4

0.6

0.8

1.0Debt service growth,lagged 2 years (L)

Chargeoff rate,4-qrt MA (R)

23

Higher Rates Threaten New Homeowners...

Cumulative distribution of homeowners' equity, %

0

10

20

30

40

50

60

<-5% <0% <5% <10% <15% <20% <25%

% Homeowners' equity

FixedARM

Source: First American

24

...Which Could Spook Global Investors

Foreign holdings of U.S. mortgage-backed debt

15

20

25

30

96 97 98 99 00 01 02 03 04 05400

800

1,200

1,600

2,000

2,400

2,800

3,200Source: FRB $ bil (R)

Share of foreignholdings of U.S. financial assets,% (L)

25

Higher Energy Prices are a Threat...

0

1

2

3

4

5

6

7

8

9

10

Lowest 20% Second 20% Middle 20% Fourth 20% Top 20%

Fuel oilElectricityNatural gasGas

% of consumer spending, 2004 Consumer Expenditure Survey

26

...Particularly to Lower Income Households

Share of families with debt burdens greater than 40%

0

5

10

15

20

25

30

Share

<20% 20-40 40-60 60-80 80-90 >90%

Percentile of income

19952004

Source: Federal Reserve SCF

27

Outlook Summary

The credit cycle is at its sweet spot. Loan growth is robust and loan quality is pristine. Behind the stellar conditions are the heretofore roaring housing market and strong job market.

The credit cycle is set to turn with the tightening in monetary policy.

Housing and mortgage markets are weakening. Home sales are falling, unsold inventory is surging, and house prices have gone flat. New construction remains strong, however.

House prices will decline by as much as 10% peak-to-trough throughout much of the Southwest, Florida, and parts of the Northeast. Half dozen markets will experience a crash.

Matters of concern include the job market’s reliance on housing, negative wealth effect, confident builders, even higher rates.

The most substantial threat is that weakening mortgage credit quality will trigger a financial market event, resulting in a more serious decline in housing and economic activity.

Even higher energy prices also remains a threat.