Sales of Notes Tied to Homebuilders Surge Amid Hope for Recovery

U.S. investors are increasing bets on structured notes tied to the recovering housing sector, even as a period of record-low interest rates comes to a close.

Banks sold $301.9 million of securities this year tied to companies whose business is primarily building or selling homes, up from $8.34 million during the same period in 2012, according to data compiled by Bloomberg. The biggest share, $186.3 million of notes in six offerings, is linked to the Philadelphia Stock Exchange Housing Sector Index.

Federal Reserve Chairman Ben S. Bernanke said on June 19 that the central bank may start reducing its $85 billion in monthly bond purchases later this year if economic growth meets policy makers’ forecasts. Since then, the average cost of new 30-year, fixed-rate home loans has climbed to 4.61 percent from 4.05 percent, according to data. The measure reached 4.64 percent on July 5, the highest level since May 2011.

“Historically, in periods where interest rates increased and mortgage rates increased, homebuilder stocks underperformed,” said Jason Benowitz, a money manager at New York-based Roosevelt Investment Group Inc., which sold its stake in Lennar Corp. and D.R. Horton Inc. about a month ago. “We see no reason why that won’t be the case now.”

Yields on benchmark 10-year Treasury notes soared to 2.74 percent on July 5, the highest since August 2011, before declining to 2.66 percent July 10.

Rising Prices

Before long-term interest rates jumped, house prices were rising. They gained 12 percent in 20 U.S. cities in April, the biggest year-over-year gain since March 2006, according to S&P/Case-Shiller data released this week. Construction spending climbed 0.5 percent to an $874.9 billion annualized rate in May, the highest level since October 2008, led by expenditures on residential projects.

Investors bought $115.6 million of notes tied to homebuilders Lennar, Toll Brothers Inc., PulteGroup Inc., MDC Holdings Inc., KB Home and D.R. Horton, in 55 offerings this year. During the same period in 2012, banks sold $3.68 million of securities tied to the companies in two offerings.

On June 27, Bank of America Corp. issued $46.3 million of two-year notes tied to the Philadelphia Stock Exchange Housing Sector Index, the fifth-largest offering last month. The securities can yield at least 35.09 percent if the benchmark doesn’t decline with protection against 5 percent of losses, according to a July 1 prospectus filed with the U.S. Securities and Exchange Commission.

Call Option

The notes are automatically called after one year, for a 10 percent return, if the index is at or above its initial value. Bank of America, which valued the securities at 95.3 cents on the dollar, distributed them for a 2 percent fee.

The housing gauge has risen 4.1 percent this year to 178.5 yesterday.

Susan McCabe, a spokesman for Bank of America, didn’t return a request for comment on the note.

Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

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