American credit market outlook

US home builders are likely to face more credit ratings downgrades this year as a weak spring sales season raises expectations that housing market weakness will persist into 2008. The risk of home builders defaulting on their debt, however, remains low as the companies still have strong overall liquidity.
"In recent weeks, the fundamental and ratings outlooks for the homebuilding sector have taken a sharp turn from market expectations during much of the fall and winter," Barclays Capital analyst Seth Glasser said on Friday in a report.
"Ratings risk has now risen materially, and we expect pressure to intensify throughout 2007, with multi-notch cuts not out of the question," Glasser said. "Even so, we believe that default risk for all but a handful of troubled names is fairly low over the next twelve months."
Among the recent ratings changes, Moody's Investors Service this month cut its ratings on K. Hovnanian Enterprises, Inc, and Fitch Ratings changed its outlook on the builder to negative. Both Fitch and Standard & Poor's also both changed their outlook on Beazer Homes USA Inc to negative in recent weeks.
"Year-to-date, there have been 16 negative rating actions and we expect more to come," Bear Stearns analyst Sue Berliner said in a report. "That said, with 'BB' trading more similarly to 'CCC/B' levels, we believe that downgrades have been priced in."
"Although we continue to believe that some of the 'BB' builder levels are irrational and at a future juncture will represent good relative value, it is difficult to pinpoint a catalyst for spread tightening," Berliner said. An index of credit default swaps for "BB" rated builders is around 164 basis points, compared to 158 basis points one month ago and 142 basis points two months ago, Berliner said. Spreads of investment grade homebuilders have widened to an average of 137 basis points, from 67 basis points one month ago, and 51 basis points two months ago.
Crossover companies, such as Beazer, Hovnanian, KB Home and Standard Pacific Corp, have been most affected by the steep drop in earnings and their credit metrics are likely to deteriorate at a more rapid rate as earnings worsen more dramatically, Barclays' Glasser said. Multi-notch downgrades are "a distinct possibility," in the next 3-6 months, especially for crossover names, Glasser said.