KB Home (KBH:US) is missing out on the biggest rally in homebuilder bonds in more than two years as rising prices and the loss of MetLife Inc. as its financing partner stymie potential sales at its housing developments.
Credit-default swap traders are now betting that it’s more likely than not the Los Angeles-based homebuilder will fail over the next five years. The company’s implied default odds jumped to 52 percent, up from 41 percent a month ago, after KB Home struggled to close deals in its first quarter, when 36 percent of transactions fell through, compared with the industry average of 23 percent, according to debt researcher Gimme Credit LLC.
KB Home’s developments languished as Lennar Corp. and Hovnanian Enterprises Inc. saw sales rise, helping homebuilder bonds gain 9.5 percent in the quarter, the most since 2009. Jeffrey Mezger, the company’s chief executive officer, is avoiding the use of price cuts to increase volume even after MetLife’s January exit from the home-loan business.
“They raise prices and try to hold prices higher, but the market doesn’t support it,” Vicki Bryan, an analyst at New York-based Gimme Credit, said in a telephone interview. “The loans are falling through. Other builders aren’t having that issue.” She rates KB Home bonds “underperform.”
Susan Martin, a spokeswoman for KB Home, declined to comment. The company is replacing MetLife with Nationstar Mortgage Holdings Inc., which will make it easier for buyers to arrange loans, Mezger said on a conference call to discuss first-quarter earnings (KBH:US) with analysts and investors on March 23. KB Home also decided against cutting prices to slash inventory, he said.
Default swaps on KB Home soared to 11 percent upfront on April 11, almost triple their 4 percent cost a month ago, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. That means it would cost $1.1 million initially, then $500,000 a year, to insure $10 million of KB Home’s debt (KBH:US) for five years.
Swaps traders are even more pessimistic about Hovnanian’s prospects. The contracts on that homebuilder cost 47 percent upfront, which implies a 72 percent chance of default over the next five years, according to CMA.
The swaps imply that KB Home should be rated B3, a level lower than its current grade (KBH:US) from Moody’s Investors Service. Lennar is rated B+ by S&P, equivalent to the Moody’s level. Hovnanian is Caa2 at Moody’s and CCC- at S&P.
KB Home’s stock has dropped 34 percent in the past month to $8.12 as of 11:11 a.m. in New York. The company announced yesterday that it would cut its quarterly dividend to 2.5 cents a share, from 6.25 cents.
Kaufman & Broad
Founded as the Kaufman & Broad Building Co. in 1957, the company became the first homebuilder to be listed on the New York Stock Exchange in 1963, according to Hoover’s Inc., the provider of historical business information. It was started by accountant-turned-philanthropist Eli Broad and the late Donald Kaufman, who founded the KB Toys retail chain.
Kaufman & Broad expanded in the 1990s and early 2000s, adopting the name KB Home in 2001, and then found itself vulnerable to the economic downturn in the latter part of the last decade, according to Hoover’s.
KB Home has $1.58 billion of bonds outstanding, the first of which mature in February 2014, according to data (KBH:US) compiled by Bloomberg.
Average spreads on KB Homes bonds climbed 123 basis points since March 15 to 705 basis points yesterday. That’s more than the 19-point increase to 588 for the Bank of America Merrill Lynch homebuilder bond index.
Unable to Adjust
The homebuilder’s net orders fell to 1,197 in the quarter ended Feb. 29, down 8 percent from a year earlier, according to an April 9 regulatory filing. KB Home’s loss of $45.8 million in the period brought its total losses since 2007 to $2.3 billion, wiping out its profits for the prior three years when housing boomed.
“They haven’t shown an ability to adjust their business model,” Martha Ucko, an analyst at CreditSights Inc., said in a telephone interview. “They’re not bringing in free cash flow.”
S&P cut the company’s credit rating one level to B, five steps below investment grade, on March 27. The downgrade came less than two months after KB Home issued $350 million of 8 percent notes due in 2020.
Those securities, issued at 98.5 cents on the dollar on February 1, fell to a record low 95.9 cents on April 11, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They now yield 8.71 percent, or 6.69 percentage points more than comparable maturity Treasuries, Bloomberg data show.
“We’ve seen some pretty decent improvement from many of their peers,” George Skoufis, an analyst at S&P, said in a telephone interview. “People were expecting better performance in the first quarter.”
The 2.6-cent drop since the KB Home bond issue is the fifth-worst among 68 U.S. high-yield sales from February, Bloomberg data show. The worst performer was Houston-based oil and natural-gas producer Linn Energy LLC’s $1.8 billion of 6.25 percent debt due in November 2019, which has dropped 3.9 cents since it was issued on Feb. 28.
Home sales at the company dwindled to 5,812 last year from a record 32,124 in fiscal 2006, according to regulatory filings. About 45 percent of the 2011 sales were in California, Arizona and Nevada. The company bought too much land in areas of the country that were hit hard by foreclosures, such as California’s Inland Empire, said Ucko, who rates the company’s bonds “underperform.”
‘Just a Disaster’
“They’re still buying land in the places where people were buying in 2005,” Ucko said. “It was working for a while, but now it’s just a disaster.”
While credit remains tight, demand for housing in the U.S. has been bolstered in recent months by an improving economy, record affordability and unusually warm weather in much of the country. The number of contracts to buy previously owned houses jumped 14 percent in February from a year earlier, the National Association of Realtors said March 26.
Lennar’s orders increased 33 percent in the first quarter from a year earlier, Jonathan Jaffe, the Miami-based builder’s chief operating officer, said on a conference call with analysts on March 27. Hovnanian’s net contracts rose 27 percent in the quarter ended January and 38 percent in February, according to a company presentation.
“The market has tended to trade this whole group up and down as if there was very little differentiation,” Gimme Credit’s Bryan said. “This year, I think we’re going to see more differentiation.”
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