Home builders at widest CDS spreads in 5 years

NEW YORK (Reuters) - The cost to insure the debt of U.S. home builders is trading at its highest level in at least five years, but while credit default swap spreads may widen further, the risk of most builders' defaulting on their debt remains low.

Home builders were dealt a fresh blow on Tuesday after Countrywide Financial Corp. CFC.N, the largest U.S. mortgage lender, posted a 33 percent decline in quarterly profit and cut its 2007 earnings forecast as more homeowners fell behind on payments.

The news followed statements last week from the chief executive of KB Home (KBH.N), the No. 5 U.S. home builder, that he does not expect the overall U.S. housing market to bottom out until the end of next year, and that prices will not increase until well into 2009.

"Home builders have significantly underperformed the broader market," said Bank of America analyst Christopher Brown.

"In the investment grade world we are very comfortable with the liquidity and financial flexibility of the builders and therefore believe it is extremely unlikely that there's much default risk," Brown said.

"However, we are not at all ready to call the bottom of the market."

The cost to insure the debt of D.R. Horton, Inc. (DHI.N) and Pulte Homes (PHM.N) both rose by around 15 basis points on Tuesday to around 280 basis points, or $280,000 per year for five years to insure $10 million in debt, and 285 basis points respectively.

D.R. Horton and Pulte's spreads are trading wider than their peers as the builders are rated the lowest investment grade by Moody's Investors Service and both have negative credit outlooks that could topple them into junk rated territory in the next 12 to 18 months.

Lennar Corp. (LEN.N) and Centex Corp.'s (CTX.N) credit default swaps, which are trading among the narrowest of the investment grade builders, each widened by around 10 basis points on Tuesday to 167 basis points and 186 basis points respectively.

"There is significant liquidity and financial flexibility and every investment grade builder, with the exception of Toll, is generating positive cash flow from operations over the last 12 months," Brown said.

Brown has a sell recommendation on the debt of Toll Brothers Inc. (TOL.N), which he views as trading relatively tight at around 180 basis points, considering it also has a negative outlook by Moody's.

As spreads deteriorate, most builders' credit default swaps are trading at levels that imply much lower ratings, and many investment grade builders are trading at levels that imply junk ratings, according to the credit strategy group at Moody's Investors Service.

Centex, for example, is trading as though it is rated "Ba3," four levels below its actual rating of "Baa2," Moody's said in a report on Tuesday. In high yield, K. Hovnanian Enterprises, Inc. (HOV.N) is trading at levels that imply a rating of "Caa1," seven levels below investment grade, and three levels below its actual rating of "B1," according to Moody's.

Bear Stearns recently upgraded its recommendation on Hovnanian to "outperform," saying the current trading levels of more than 600 basis points imply more distress in the name than is the case.

"I think that 600-plus in CDS is implying a liquidity event ... which we absolutely don't see at this point," Bear Stearns analyst Sue Berliner said on Monday in a conference call.