Analysts See Opportunity For Homebuilders To Tap High Yield Debt Market (XHB, DHI, KBH, MDC, RYL)

Analysts at Wachovia, which recently turned more bullish on the homebuilding sector (NYSE: XHB), said a window to the high yield market is opening for more homebuilders driven by CDS spreads.

The firm notes that recently Toll Brothers (NYSE: TOL) issued $400 million of 8.91% senior notes and Lennar (NYSE: LEN) issued $400 million on 12.25% senior notes. They said other builders could follow with their own issuance, including DH Horton (NYSE: DHI), KB Homes (NYSE: KBH), MDC Holdings Inc. (NYSE: MDC) and Ryland Group Inc. (NYSE: RYL).

The firm said a window has opened up for the builders due to the positive spread between their Credit Default Swaps & bond yields. The firm said the cost to buy 5-year senior CDS for builders has declined by 31% over the last 2 months and in some cases the cost of CDS is well below bond yields, which provides an opportunity for a carry trade. As an example, the firm said, "investors could buy a bond yielding 10% and insure it at only 5%. If held to maturity, the trade would be effectively risk-less (excluding counterparty risk). The caveat is that the CDS market far outsizes the actual principal amount of bonds outstanding, so finding debt to match the CDS can be difficult. The recent debt offerings of TOL and LEN provided investors more access to these limited pools of debt."

The firm doesn't expect Pulte Homes (NYSE: PHM) or Centex (NYSE: CTX) to issue debt due to the pending merger, although they have a positive spreads. Also the firm does not believe that Standard Pacific Corp. (SPF), Beazer Homes (NYSE: BZH) or Hovnanian Enterprises (NYSE: HOV) could issue high yield bonds at a realistic price given the cost of their CDS.

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