The Lowdown on Homebuilder CDS

The actions of the Federal Reserve under Alan Greenspan are considered to be a leading cause of that which has come crashing down all around us these past two years. Alan continues to do what he thinks he does best and that is to analyze data to see as far into the future as he can; even if that is only the past.

A.G. was heard saying recently that “the crisis cannot end fully until home prices in the U.S. are at least stabilizing.” That seems to make good macro-economic sense regardless of who is saying it. The question then becomes: are home prices stabilizing?

The quick answer is no. The National Association of Realtors reported this week that the median sale price of and existing single family home at $172,900, was 16.1% lower in May of 2009 than in that same month in 2008.

S&P/Case-Schiller maintains a few other slightly more complicated measures of home prices, but you would expect nothing less from a Yale professor and half of the team that brought you securitized debt that magically turns from AAA to BBB when the going gets rough. In any case, the indexes looked after by S&P/C-S for the 10 and 20 largest metropolitan areas in the country showed a close to a 19% decline from 1Q08 to 1Q09.

In true government fashion, the Federal Housing Finance Agency, which limits its monitoring to only those homes sold that were financed with mortgages backed by FNM and FRE showed a 6.8% decline year over year. In all fairness, until someone in D.C. decided to “roll the dice” by lowering FNM’s and FRE’s lending standards, a FHA mortgage was not that easy to get so it would make sense that well-healed buyers bought in tony areas and have been somewhat insulated from the carnage going on in FL, AZ and of course, CA.

Mr. Greenspan also sees most of the problem being created after 2005 and says; “the bulk of conforming mortgages made since 2005 are close to being underwater.” For those hoping for a slowing in the rate of decline, we can all only hope your wishes come true as Alan estimates: “We can take another 5% decline in house prices without much macroeconomic impact”. But, he says: “if prices fall by more than 12%, more than four million additional homeowners will be underwater.”

Seeing as by some measures we’ve just dropped 19% YoY, somebody better find the brake pedal quick and stomp on it hard.

A few days ago I wrote about Lennar (LEN) and how they were buying back property, on the cheap, that they had previously sold at a dear price. LEN is not alone in its efforts to emulate Rahm Emanuel and “not waste a good crisis” as a number of homebuilders are actually buying more land to build more houses. The trick here is that that properties are primarily owned by the banks and are selling at prices that amount to the cost of turning raw land into buildable lots e.g. the cost of knocking down the trees and putting sewers and roads in. In these deals, the land itself is essentially free.

All of this bodes well for the builders once we come out of this recession but the timing of that exit appears in question as the 5% buffer Mr. Greenspan talks about seems awfully close at this point. More so given that by certain measures the rate of decline is still in the high-teens.

The CEC Strategy has been short a number of names in the home construction and remodeling space since mid-to-late May, depending on the name. This was the result of widening CDS spreads and lower equity prices. This week’s economic announcements have caused a bit of a reversal in those relationships with the XHB hitting an intra-day low of $11.05 on Tuesday the 23rd but closing last night on its highs at $11.91, a 7.78% increase. MTH in particular has had a great run off of its closing low of $$16.44 on June 16th to its close last night at $19.18, a 16.7% pop and enough, when combined with a narrowing CDS spread, to close out the short position.

Needless to say shorting low dollar value stocks can be exhilarating as it doesn’t take a big nominal price movement to bust through your risk parameters on a percentage basis. It remains to be seen if the other home-builder names will carry through or if, given the quarter and half-year end window dressing, this is just a flash in the pan.

One thing that can be surmised however, is that if the 2/3rds of Americans who own their homes and for whom it is their largest investment continue to suffer price declines and are therefore locked into living where they are living, it won’t matter how cheaply the builders can acquire land because there won’t be anybody moving anywhere.

Enjoy the weekend.

Comments

[ESK:]

I would also recommend following the IAS360 House Price Index (www.iasreo.com/ias360....). It’s the only timely and granular index to go down to the county level making it the leading industry index.

Jun 30 05:54 PM