Sterne Agee analysts Jay McCanless and Annie Worthman pick out homebuidling winners if subprime mortgage lending expands.
We believe D.R. Horton, Inc. (NYSE:DHI), Lennar Corporation (NYSE:LEN), Beazer Homes USA, Inc. (NYSE:BZH), KB Home (NYSE:KBH), and M.D.C. Holdings, Inc. (NYSE:MDC) have the highest exposure to entry level home buyers in our coverage. If, as has been suggested in a media report this morning, subprime (also known now as non-prime) mortgage lending returns in a meaningful fashion, we expect entry-level buyers and entry-level builders could benefit from an expansion of credit.
Expansion in subprime mortgage lending, catalyst for the builders
According to an article in this morning’s “Financial Times“, Moody’s Corporation (NYSE:MCO) published a report discussing the potential for mortgage servicing companies to offer subprime mortgages and/ or expand their current prime lending activities into subprime. We do not have an opinion as to whether or not this will happen, but if it does, we expect KB Home (NYSE:KBH) which already has a relationship with Nationstar Mortgage Holdings Inc (NYSE:NSM) may be best-positioned among our coverage. However, we anticipate our other builders with entry-level exposure at 40% or more of their sales mix (DHI, LEN, BZH, and MDC) should also see some benefit from a greater availability of subprime credit.
Wells Fargo’s reentry into subprime lending
Along the same lines, a Reuters story published on 2/14 asserted Wells Fargo & Co (NYSE:WFC) was tiptoeing back into the subprime mortgage space via loans insured by the Federal Housing Administration (FHA). We view this story and the fact that a Wells Fargo executive is quoted as incrementally positive for housing demand because it is one of the first signs that mortgage availability for first-time buyers, who we believe have been locked out of the housing market for the last few years, may be increasing. From a timing standpoint, we believe Wells Fargo’s (and hopefully other originators) efforts may be a demand catalyst in 2H14 and later.
Entry-level buyers have declined to 26%
The National Association of Realtors’ existing home sales report for January indicated entrylevel buyers represented 26% of that month’s 281,000 sales or approximately 73,000 homes. We anticipate a return of subprime lending could close the gap between the 26% and the historical 40% to 45% range and potentially lift the gross amount of home sales higher in a given month.
Prime mortgage FICO scores have been trending lower
In addition to the recent press about subprime mortgages, the average FICO (Fair Isaac Credit Score [Fair Isaac, NC, $53.11]) score for completed prime mortgages has been trending lower for several months, according to the monthly data from Ellie Mae Inc (NYSE:ELLI). As of January, the average FICO score on a completed prime mortgage was 755 versus a peak of 764 in November 2012. For comparison, the national average FICO score as of C3Q13 was just below 700, according to the New York Federal Reserve. We anticipate a return of subprime credit could help bridge the gap between the average US FICO and the average FICO for prime mortgage originations.