U.S. Housing Rebound Evident in Bond Yield Gap: Credit Markets

U.S. Housing Rebound Evident in Bond Yield Gap
The housing market is stabilizing, bolstering the balance sheets of those builders that survived the worst financial crisis since the Great Depression, even as the world’s biggest economy shows signs of weakness. Photographer: George Frey/Bloomberg

Investors are accepting the lowest yields since the real estate boom peaked in 2005 on the debt of U.S. homebuilders relative to the rest of the junk-bond market as evidence mounts that housing is on the rebound.

Homebuilder yields have fallen 1.1 percentage points below the average for U.S. speculative-grade notes, the biggest gap since September 2005, after the housing bust pushed them above the average. Debt of Hovnanian Enterprises Inc. to Los Angeles-based KB Home has returned 11 percent this year, the highest for the period since 2009 and more than double the 5 percent gain for junk overall, Bank of America Merrill Lynch index data show.

The housing market is stabilizing, bolstering the balance sheets of those builders that survived the worst financial crisis since the Great Depression, even as the world’s biggest economy shows signs of weakness. Home prices advanced 1.1 percent in April from a year earlier, according to data provider CoreLogic Inc., while purchases of new homes rose to an almost two-year high as record-low mortgage rates lure buyers.

“After a couple of challenging years, people feel that the worst is over,” said Sabur Moini, who manages about $2.5 billion of high-yield assets at Los Angeles-based Payden & Rygel. Moini, who owns bonds of KB Home and Lennar Corp., said in a telephone interview that housing prices have probably “bottomed out.”

‘More Confidence’

Credit-default swaps on the 10 biggest homebuilders climbed 15 percent since the end of April to 348.6 basis points, according to data compiled by Bloomberg. That’s half the 32 percent increase in the cost of protection on the benchmark Markit CDX North America Investment Grade Index, which rose as U.S. employers added the smallest number of jobs in a year in May.

“People have gained some more confidence in the fundamentals,” said Jennifer Machan, a senior high-yield analyst in Des Moines, Iowa, at Principal Global Investors, which manages $258 billion. “Home prices are starting to show some stabilization.”

Homebuilder bonds yielded 1.135 percentage points less than speculative-grade debt on June 8, the least since Sept. 29, 2005, Bank of America Merrill Lynch Index data show. Over the past seven years, yields in the U.S. junk market were 0.8 percentage points less than the homebuilder index on average.

Default Swaps

Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, declining by 1.6 basis points to a mid-price of 123.3 basis points as of 11:51 a.m. in New York, according to prices compiled by Bloomberg.

The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default 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.

The U.S. two-year interest-rate swap spread, a measure of bond market stress, rose 0.41 basis point to 30.85 basis points as of 11:52 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

Bonds of General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, with 42 trades of $1 million or more as of 11:51 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Home Prices

Home price declines are easing. Values in 20 U.S. cities fell 2.6 percent in the 12 months through March, the slowest pace in more than a year, according to the S&P/Case-Shiller index. Prices will likely rise 1.4 percent next year, 3.7 percent in 2014 and 4.4 percent in 2015, JPMorgan analysts led by John Sim wrote in a June 12 report.

“There’s less of a fear of another major drop,” Martha Ucko, an analyst at CreditSights Inc., said in a telephone interview. “The builders prepped their balance sheets and their businesses to survive at these levels.”

Purchases of new homes in the U.S. rose 3.3 percent in April from the previous month to an annual pace of 343,000, the Commerce Department said May 23. Homeowners are benefiting from falling borrowing costs. The average 30-year U.S. mortgage rate dropped to 3.67 percent in the week ended June 7, down from 5.05 percent in February 2011, and the lowest since McLean, Virginia-based Freddie Mac began records in 1971.

An index of housing affordability is at the highest level in data going back to 1986, according to the National Association of Realtors. The gauge, which is updated every quarter, climbed to 205.9 at the end of March.

Recovery Stage

“People are a bit more confident about purchasing homes,” said Bob Curran, a New York-based analyst at Fitch Ratings. “You need a catalyst and there’s been pent-up demand as people had deferred on buying homes.”

Hovnanian earned $1.8 million in the three months ended April 30, after losing money for the previous eight quarters, Bloomberg data show. The Red Bank, New Jersey-based company’s $797 million of 10.625 percent notes due October 2016 climbed to 90.5 cents for a yield of 13.6 percent on June 12 from 80 cents and 16.9 percent at the end of last year, Trace data show.

“We’re encouraged that the homebuilding industry may be entering the early stages of recovery,” Larry Sorsby, Hovnanian’s chief financial officer, said yesterday at a conference organized by Deutsche Bank AG.

Toll Brothers

At Toll Brothers Inc., orders climbed to 1,290 homes in the first quarter from 879 a year earlier. Hovnanian’s net contracts for its fiscal second quarter jumped to 1,775 homes from 1,166 a year earlier.

Yields on some homebuilders’ junk-rated debt are at or approaching levels of investment-grade companies.

The debt of Toll Brothers, based in Horsham, Pennsylvania, yields 4.05 percent on average, better than the 4.12 percent for BBB rated companies, Bank of America Merrill Lynch index data show. The yield on Fort Worth, Texas-based DR Horton Inc.’s bonds averages 4.16 percent, while that of Ryland Group Inc., based in Westlake Village, California, is 4.74 percent.

Lack of issuance by the companies is partly responsible for the low yields, according to Principal’s Machan.

“Anything available to buy has been getting grabbed in a hurry,” said Machan, who doesn’t own any homebuilder bonds. “People don’t want to be short the sector anymore.”

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