Effects of Fed Rate Increases Begin To Show, Some Say

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The New York Sun

The housing industry in America, which has accounted for about half the economy’s expansion since 2001, is becoming perilous for bond investors.


Anyone who bought the debt of D.R. Horton or Toll Brothers in June, when new home sales set a record, has lost more than 6% in a tailspin that may be far from over.


The combination of rising interest rates and record-high home prices means that it’s the most difficult time to buy a home since 1991, according to the National Association of Realtors.


The Washington-based trade group said last week that home sales and prices probably peaked during the third quarter.


“Everyone believes the home-building business is about to roll over and start a downhill slide,” Steven Bohlin, who oversees $4 billion of bonds at Thornburg Investment Management in Santa Fe, N.M., said November 15. Mr. Bohlin said he recently sold the debt of Fort Worth, Texas-based D.R. Horton, the largest American homebuilder.


How the $64 billion market for real estate bonds went from boom to bust in a few months shows that the Federal Reserve’s 3 percentage points of interest rate increases since June 2004 may finally be having an impact on borrowing costs.


The average 30-year mortgage rate reached 6.37% last week, up from the low this year of 5.53% in July and the highest since April 2004. The Fed increases mean that payments by consumers who took out adjustable-rate mortgages in the last few years will rise by $80 billion next year and $1 trillion in 2007, according to estimates by Deutsche Bank AG.


Merrill Lynch & Co.’s index of homebuilder bonds is down 2.2% since September 1 as the 10-year Treasury note’s yield, which helps determine home mortgage rates, climbed about half a percentage point to 4.46% as of Monday.


For the year, the homebuilder index is up 0.1 of a percentage point, after returning an average of 9.8% annually since 1997. Returns ranged from 4.6% in 1999 and as much as 19% in 2003 as home sales and housing prices ballooned.


“Investors are expecting higher interest rates, weaker housing starts, weaker new home sales, and an adverse impact on homebuilder earnings,” said Joseph Snider, senior credit officer at Moody’s Investors Service in New York during an interview November 15.The homebuilding companies “won’t report losses or necessarily report lower earnings, but it certainly suggests that the rate of earnings growth will moderate in 2006.”


The National Association of Homebuilders/Wells Fargo’s index of builder confidence dropped the most in four years to an 18-month nadir. Moody’s expects a slowdown in the housing market in 2006, and may revise its estimates for economic growth and home sales, Mr. Snider said.


Slower earnings growth may reduce the cash cushion companies have to make debt payments. The extra yield, or spread, investors demand to buy bonds of builders rated below investment grade instead of Treasuries widened 41 basis points since September 1, according to Merrill. By comparison, the spread for junk bonds overall grew 4 basis points. A basis point is 0.01 percentage point.


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