Housing Collapse Erased in Bonds of Homebuilders: Credit Markets

Photographer: Daniel Acker/Bloomberg

Townhomes under construction at the Toll Brothers Inc. Bowes Creek Country Club development in Elgin, Illinois. Close

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Photographer: Daniel Acker/Bloomberg

Townhomes under construction at the Toll Brothers Inc. Bowes Creek Country Club development in Elgin, Illinois.

Another bubble may be forming in the U.S. housing market, this time in the bonds of homebuilders.

Not since July 2007, before the subprime mortgage market collapsed and credit markets froze, have investors accepted relative yields as low as they are now for debt of the nation’s biggest homebuilders. So-called spreads at 4.82 percentage points on debt of borrowers from D.R. Horton Inc. (DHI), the largest U.S. homebuilder by volume, to Toll Brothers Inc. (TOL) have tightened nine times faster than the overall high-yield market since February, Bank of America Merrill Lynch index show.

While recent signs show a housing rebound, new home sales remain 75 percent below the 2005 peak with unemployment stuck above 8 percent for a 42nd straight month. The economic recovery will continue at a “modest” pace with real GDP growth at an annual rate of 2.25 percent in the second half of this year, the Congressional Budget Office said yesterday.

“The market is pricing in a spectacular recovery, quickly, and I don’t see that in the cards,” Vicki Bryan, an analyst at research firm Gimme Credit LLC, said in a telephone interview from New York. “There’s limited, if any, upside from here, even if investors are right.”

Debt of homebuilders has returned 17.4 percent this year, following a loss of 0.34 percent in 2011, according to the Bank of America Merrill Lynch U.S. High Yield, Homebuilders/Real Estate index. That compares with a return of 10.1 percent for the bank’s broader U.S. High Yield Master II index, after a 4.38 percent gain last year.

Limited Room

“I don’t see a lot of room to rally,” Sabur Moini, who manages about $2.5 billion of high-yield assets at Los Angeles- based Payden & Rygel, said in a telephone interview. “It’s tough to see how much tighter it could get. You’re pretty much capped.”

Elsewhere in credit markets, Royal Bank of Scotland Group Plc said a derivative index linked to commercial-mortgage backed securities may have “rallied too far too fast” in the past three months. Aetna Inc. obtained a $2 billion bridge loan to finance its planned acquisition of Coventry Health Care Inc. Belize’s government aims to restructure its debt through negotiations with bondholders and will consider any proposal presented.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 1.53 basis points to 19.22 basis points, the lowest level since June 1, 2011. The measure narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Default Swaps

In London, the Markit iTraxx Europe Index of 125 investment-grade companies, a credit-default swaps benchmark that investors use to hedge against losses or bet on credit quality, rose for the second day, adding 1 basis point to a mid- price of 142.5, according to prices compiled by Bloomberg.

The Markit CDX North America Investment Grade Index closed 0.8 basis point higher to 99.4 basis points in New York yesterday, prices compiled by Bloomberg show.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Rally Questioned

Investors may want to cut bullish bets on Markit Group Ltd.’s CMBX index, which tracks commercial-property loans and has risen to the highest in almost a year, as a lull in Europe’s debt crisis and speculation that policy makers will step in spur gains, RBS analysts led by Richard Hill in Stamford, Connecticut, wrote in a report yesterday.

“While we have been bullish on the market since early July, we are now questioning if CMBS has rallied too far too fast,” they wrote. “A spike in volatility driven by renewed global macro concerns may temper the recent rally.”

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index rose 0.02 cent to 95.12 cents on the dollar, the highest level since June 1, 2011. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has climbed from 91.8 on June 5, the lowest since Jan. 6.

Leveraged loans and high-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

Aetna Loan

Aetna hired Goldman Sachs Group Inc. and UBS AG to arrange the 364-day financing, the Hartford, Connecticut-based health- care benefits provider said in a regulatory filing yesterday. Aetna will pay interest on the debt tied to ratings from Moody’s, S&P and Fitch. The rate increases by 0.25 percentage point if the grades deteriorate.

Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, were the most actively traded dollar-denominated corporate securities by dealers, with 89 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

In emerging markets, relative yields widened 6 basis points to 319 basis points, or 3.19 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The measure has averaged 370 basis points this year.

‘Debt Sustainability’

Belize has worked in “good faith” with its creditors and is willing to discuss alternative restructuring scenarios, Prime Minister Dean Barrow told reporters in Belize City yesterday.

“Debt sustainability is the whole and entire object of this exercise,” Barrow said. “It is clear that serious good faith, face-to-face negotiations are the only root to a consensual solution.”

The last time relative yields were this low on homebuilder bonds was in July 2007, two weeks before BNP Paribas SA marked the start of the worst financial crisis since the Great Depression by halting withdrawals from three investment funds that owned subprime mortgage securities. Spreads reached 478 basis points on Aug. 21 before rising to 482 yesterday, Bank of America Merrill Lynch index data show.

Homebuilders, along with lenders, real-estate firms and investment banks that bundled into securities the mortgages made to the least creditworthy borrowers, contributed to a run-up in housing prices that peaked in July 2006. Prices plummeted 35 percent from then until the market low in February, according to the S&P/Case-Shiller index.

‘Too Far’

Relative yields, which reached a record 2,534 basis points on Dec. 4, 2008, have tightened by 123 basis points since Feb. 28, the last time the spread exceeded the broader high-yield market, Bank of America Merrill Lynch index data show. That compares with a 13 basis-point decline since the end of February on the U.S. High Yield Master II index to 588.

“It’s gone too far too fast and that you’re not currently being compensated for the balance-sheet leverage in the sector,” said Jennifer Machan, a senior high-yield analyst in Des Moines, Iowa, at Principal Global Investors.

Speculative-grade U.S. homebuilders have an average debt to earnings before interest, taxes, depreciation and amortization, or EBITDA, of 9.78 times versus 3.64 for all U.S. junk-rated companies, Bloomberg-compiled data show.

Fort Worth, Texas-based DR Horton’s $350 million of 4.75 percent notes issued in April and due in May 2017, rated three levels below investment grade by S&P at BB-, traded yesterday at 105.9 cents on the dollar to yield 3.39 percent, Trace data show. That compares with an average yield of 3.35 percent on a Bank of America Merrill Lynch index of BBB rated debt maturing in five to seven years.

‘Better Value’

“That’s an investment-grade kind of yield, that’s spectacular credit quality,” Gimme Credit’s Bryan said. “There’s better value in many more sectors than the homebuilding sector.”

Jessica Hansen, a spokeswoman for DR Horton, didn’t immediately respond to a telephone call to her office and an e- mail seeking comment.

Concern that the potential for a greater homebuilder rally is limited comes as U.S. economic growth is forecasted by 78 economists surveyed by Bloomberg to slow to 2.1 percent in 2013 from 2.15 percent this year.

The U.S. will probably tip into recession next year if lawmakers can’t break an impasse over the federal budget, according to the nonpartisan Congressional Budget Office’s report. Economic output would shrink next year by 0.5 percent, joblessness would climb to about 9 percent with “economic conditions in 2013 that will probably be considered a recession,” the agency said in its biannual report on the budget and economic outlook.

Toll Brothers

While sales of new homes, counted when contracts are signed, may have rebounded to a 365,000 annual rate in July from 350,000 the prior month, according to the median forecast of 73 economists surveyed by Bloomberg, the figure compares with a peak of 1.39 million sales in July 2005.

“Fundamentals continue to improve in the sector, but that’s already reflected in the prices of the securities,” Thomas O’Reilly, who co-manages the $3 billion Neuberger Berman High Income Bond Fund in Chicago, said. “The gains there are going to be more market-related than outperforming the market.”

Toll Brothers reported fiscal third-quarter net income of $61.6 million yesterday on increased revenue, beating analysts’ estimates for the Horsham, Pennsylvania-based company, the largest U.S. luxury-home builder.

“The growth is beginning,” Douglas Yearley, chief executive officer of Toll Brothers, said in a Bloomberg Television interview. “There is a long way to go.”

To contact the reporter on this story: Sarika Gangar in New York at sgangar@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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