U.K. Homebuilders Seen Hunkered Down for Whatever Brexit Brings

  • Average default risk fell to two steps above high-yield zone
  • Only huge stock drops, debt spikes would make them junk-like

U.K. homebuilders have a lot of breathing room to survive plunging share prices and the potential for a Brexit-induced housing slump, data compiled by Bloomberg show.

Gauges of credit health held at investment-grade levels for 11 of 13 listed U.K. homebuilders, even as their stocks slumped an average 27 percent in the wake of the U.K.’s vote to leave the European Union. McCarthy & Stone Plc dropped into junk territory under Bloomberg’s risk model, which is based on debt loads, interest expenses, cash flow, volatility and share prices. Trafalgar New Homes Plc was already in the high-yield zone.

With two-thirds of U.K. households owning their homes, the health of the housing market is closely associated with the country’s economic prospects, making the industry “a key bellwether,” said Niraj Shah, a London-based economist for Bloomberg Intelligence, in an interview.

The drop in gilt yields since the vote “is an indication that mortgage rates are not going to go up,” Shad said, and there are signs that “available credit is not going to dry up, which is the biggest risk to the economy and the housing industry.”

Builders including Taylor Wimpey Plc and Persimmon Plc have amassed cash reserves in recent years as the U.K.’s spiraling home prices stoked sales and profits. That may help them weather any housing-market slowdown as economic uncertainty following the Brexit vote adds to drags caused by higher taxes on private landlords.

“Homebuilders have made progress since the financial crisis, and their balance sheets are better prepared for a downturn,” said Henrietta Pacquement, a London-based portfolio manager at ECM Asset Management, which is part of Wells Fargo Asset Management. “You’d expect a lull in terms of activity in house building” because of the referendum, she said.

Nobody at Trafalgar New Homes was available for comment on credit risk when called. A McCarthy & Stone official declined to comment on credit risk and referred to a June 29 announcement.

“Notwithstanding any short-term market impact of last week’s referendum result, the business remains in good shape to deliver on its medium-term strategy,” Chief Executive Officer Clive Fenton said in the statement. The company focuses on retirement homes.

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Shares of Persimmon, Taylor Wimpey and Barrat Developments Plc have all fallen more than 30 percent since the referendum. They are the biggest decliners in the FTSE 100 Index, along with Royal Bank of Scotland Plc.

The U.K. homebuilding industry’s credit health took a hit in the referendum’s immediate aftermath, with the typical company falling the equivalent of one gradation to two steps above junk as their average probability of defaulting in one year increased from 0.11 percent to 0.22 percent, the Bloomberg model shows.

To deteriorate significantly more, things would have to get a lot worse. Even another 10 percent drop in share prices and a 10 percent increase in volatility would leave the homebuilders, on average, in the same category. Their implied credit-default swap spreads, a measure of the cost of insuring against default, would go up just 10 basis points to 134 basis points.

It would take all that plus a 10 percent increase in debt and like-sized drop in operating cash flow to push them down another level. Falling into junk territory would take a catastrophe -- borrowing enough to increase debt by third with operating cash flow and share prices nosediving by a like amount as well as increased volatility.

House Prices

U.K. house prices could fall by “a mid-to-high single-digit percentage over the next 12 months,” S&P Global Ratings analysts Marie-Aude Vialle and Franck Delage said in a note on Monday. They affirmed a Taylor Wimpey’s BBB- rating, the lowest investment grade.

“Brexit may very well bring an end to the trend of real estate asset appreciation in the U.K., and London in particular, over the past several years,” Vialle along with analysts Eric Tanguy and Mounia Chaoui Roquai said in a separate report.