May 25, 2018
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Homebuilders approach bear market on rising U.S. mortgage rates

By Prashant Gopal, Bloomberg

U.S. homebuilders fell for a fourth day, approaching a bear market, as concern mounted that rising mortgage rates could restrain a revival in the housing market.

The 11-member Standard & Poor’s Supercomposite Homebuilding Index has dropped 19 percent from a May 14 peak, a decline close to the 20 percent threshold considered to be a bear market.

The prospect that the Federal Reserve may slow bond purchases has stoked investor concern that mortgage rates will rise and limit new-home sales, which have jumped as inventories for existing properties tightened. Housing shares may have climbed too far after a rally that sent the S&P builder gauge up 84 percent last year, more than six times the gain in the S&P 500 Index, said Vicki Bryan, an analyst at Gimme Credit LLC.

“Investors got way ahead of themselves in estimating performance results for the sector, perhaps by years in the case of some builders,” she said in a telephone interview today from New York. “They’ve already sapped most of the logical upside. That only leaves room for disappointment.”

D.R. Horton and PulteGroup, the two largest U.S. homebuilders, have led the decline since May 14, with each losing 24 percent. Ryland Group has fallen 23 percent, while KB Home has slumped 21 percent.

The average rate for a 30-year fixed mortgage jumped to 3.93 percent last week from 3.35 percent in early May, according to Freddie Mac. Borrowing costs probably will rise further after Fed Chairman Ben Bernanke said last week that policy makers may slow bond purchases this year amid signs of an improving economy. Wells Fargo & Co., the largest U.S. home lender, is offering a 30-year mortgage at 4.75 percent today, according to its website.

An extended rise in rates may hurt homebuilders’ mortgage- origination businesses, which account for an average of about 28 percent of their operating profit, Megan McGrath, an analyst at MKM Partners LLC, said in a note to clients Monday.

The spread between the rate the financial-services businesses underwrite mortgages for and what investors pay for the loans will shrink, she said. Lennar Corp., the third-largest homebuilder, may be most at risk of lower revenue and margins from this business, according to McGrath.

“Investors should be braced for increased volatility in homebuilding shares over the remainder of the summer as continued fears around higher rates battle with what we expect will be generally positive housing data,” McGrath wrote.

New-home sales rose 2.3 percent in April from the previous month, according to the Commerce Department. A report tomorrow will probably show that purchases in May climbed to a 460,000 annualized pace, the highest since July 2008, according to the median estimate in a Bloomberg survey of economists.

The short-term turbulence in homebuilder share prices will create a “long-term opportunity,” said Robert Wetenhall, an analyst with RBC Capital Markets in New York.

“In the near term, homebuilder stocks will struggle in a rising interest rate environment due to concerns — either real or imagined,” Wetenhall said in a note to clients today. “In the long term, however, we think that better pricing practices and strong volume growth will reward patient investors with a multiyear holding period.”

The decline represents a “knee-jerk reaction” to rising rates, which may bring share prices down to more realistic levels, said Robert Curran, a managing director at Fitch Ratings in New York.

“This is the market adjusting itself,” Curran said in a telephone interview. “There was an over-reaction on the upside and there was something of an over-reaction to the news on the interest rate. At some point, further out this year, there will something more of a normal balance.”

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