Homebuilders Boom as Lending Masks Uneven U.S. Recovery
Construction is taking a back seat to lending for some U.S. homebuilders, turning the uneven housing recovery into an earnings boom.
At PulteGroup Inc. (PHM), the second-largest builder by market value, mortgage revenue jumped 70 percent in the third quarter, almost six times the revenue gain from home sales. At Lennar Corp. (LEN), the No. 1 builder, mortgage-unit revenue surged 60 percent, double the increase in sales revenue. Aided by lucrative lending units, both companies posted the biggest overall profits since 2006.
“Homebuilders are getting extra help right now from mortgages,” said Jack Micenko, a homebuilding analyst at Susquehanna International Group in New York. “They’re over- earning in those areas because lending margins are so wide, but they can’t depend on that going forward.”
A Federal Reserve program aimed at lowering borrowing costs by purchasing home-loan bonds has widened margins across the lending industry, with JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon in October describing his bank’s mortgage production margins as “very high.” The average gain-on-sale, which measures the difference between the rate homeowners pay and the rate paid by investors, has doubled this year on increased demand for the securities, Micenko said.
“The Fed might have preferred that its interventions created less of a windfall for homebuilders and more for their buyers in the form of lower rates, but that’s something it can’t control,” said Stephen Stanley, chief economist of Pierpont Securities in Stamford, Connecticut.
Investors are already beginning to lose confidence after a rally boosted the 11-member S&P Supercomposite Homebuilding index 83 percent this year through October as housing rebounded from a six-year low. The gauge dropped 0.5 percent today in New York and has tumbled 5.9 percent since the end of October after a Commerce Department report showed fewer new homes were sold in October than forecast and purchases were revised downward for the prior month.
The top 11 U.S. builders have a price-to-earnings ratio of 38.8. The measure shows how much investors are willing to pay per dollar of earnings. For the Standard & Poor’s 500 Index, the ratio was 14.5.
Goldman Sachs Group Inc. said last month that homebuilder stocks already price in the recovery and investors should consider alternatives such as indexes linked to subprime bonds.
Despite the industry’s lackluster sales in recent months, overall profits probably will at least double in the current quarter at Lennar and PulteGroup, according to the median estimate of homebuilding analysts including Micenko and Stanley. At No. 3 DR Horton Inc., profits probably will gain about 75 percent, and No. 5 NVR Inc. (NVR) will probably see a gain of about 70 percent, the analysts projected.
None of the top 10 public homebuilders break out lending margins in their earnings statements, and only a handful provides mortgage volumes. The ones detailing lending and revenue illustrate how wide the difference can be.
At Bloomfield Hills, Michigan-based PulteGroup, the dollar- value of originations grew 25 percent to $685 million in the third quarter, while mortgage-unit revenue jumped 70 percent. At NVR, based in Reston, Virginia, loan closings rose 22 percent to $594.9 million, while mortgage-banking revenue grew twice as fast.
“The homebuilders are little players in the lending world, but they’re benefitting from the wide margins of the big players,” said Michael Widner, an analyst at Stifel Nicolaus & Co. in Baltimore. “If you’re Lennar, why charge much less than the banks that are your customers’ alternatives?”
Fort Worth, Texas-based DR Horton reported last month that fiscal fourth-quarter operating income at its financial services unit more than doubled. Miami-based Lennar cited lending margins as a driver of profit in its third-quarter earnings statement, without breaking out origination volume.
Increased profitability in Lennar’s mortgage unit “was primarily due to increased volume and margins in the segment’s mortgage operations,” its Sept. 24 earnings statement said. Denver-based MDC Holdings Inc. (MDC), the No. 7 homebuilder by market value, cited mortgage margins as boosting third-quarter profit in a regulatory filing last month.
Lennar spokesman Marshall Ames declined to comment. PulteGroup’s spokesman James Zeumer also declined to comment for the story, as did NVR’s Dan Malzahn. Fred Cooper of Toll Brothers Inc. (TOL), the No. 4 builder by market value, said its mortgage revenue is “immaterial” to the company’s profits.
Homebuilders’ mortgage units, usually identified in regulatory filings as financial services, often include title businesses that insure the ownership of a home, though in many states the rates are fixed by regulators and profit margins don’t change.
At a Nov. 15 building conference sponsored by UBS AG, Toll Brothers Treasurer Martin Connor described during a presentation the “hand-holding” benefits of having a mortgage unit. When customers use the mortgage unit of their builder, it’s easier to coordinate completion dates with loan closings, he said. The Horsham, Pennsylvania-based builder doesn’t break out mortgage- unit margins in its earnings statements.
“This mortgage company is important to us because it gets our buyers to show up with the right amount of money, on the right day, at the right place to settle their homes,” Connor said.
Future profits at big lenders such as No. 1 Wells Fargo & Co. (WFC) and small lenders including community banks and homebuilders depend on how the Dodd-Frank law of 2010 is implemented, said Megan McGrath, executive director at MKM Partners. The law created a category of loans known as qualified residential mortgages, or QRMs, to be held by low-risk borrowers who will get the most affordable rates.
The definition of the new category of loans has yet to be determined. As well, the Obama administration and Congress have declared their intentions of privatizing the mortgage industry by abolishing Fannie Mae and Freddie Mac or shrinking their roles as home-loan securitizers. And, the Fed’s so-called quantitative easing may end, she said.
“At this point in the cycle, when homebuilders are just starting to get profitable again, it’s not bad to be making money off mortgages -- it’s just a little bit of a risk because there are a lot of factors beyond the control of builders that could influence that,” McGrath said.
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