Fitch: Rocky economics for US homebuilders if rates spike

The US homebuilding sector could endure rocky economics if the Federal Reserve raises interest rates too high, too quickly, according to Fitch Ratings. Fitch is maintaining its long-standing forecast for the Fed to start raising its key interest rate in mid-2015, and for rate rises to follow a gradual path, reaching 2% by end-2016. We forecast the US economy to grow 3.1% in 2015 and 3.0% in 2016.

Rising interest rates may be a net negative for housing turnover and homebuilders. Interest rates often rise in an expanding economy. But meaningfully higher rates do affect affordability and a rapid increase in rates tends to dampen the psychology of home purchase. Lower home sales mean less revenues for the builders. Also, builders regularly issue debt to support land growth and development spending. Higher rates mean greater interest expense and, possibly, some pressure on earnings.

In the short term, however, a relatively sharp rise in rates may motivate indecisive buyers to get off the fence and commit, spurring short-term sales. Moderate rate rises accompanying US economic recovery could support the sector, although home price inflation may cool.

The homebuilder sector's higher-than-average risk profile reflects the cyclicality and seasonality of demand for housing, economic sensitivity, demographics and affordability. The few issuers with investment grade ratings typically have a long track record of low leverage or high liquidity. Conversely, issuers with lower ratings tend to have less financial flexibility, smaller size, limited geographic spread and less access to well-situated land.

Other economic factors that influence the decision to buy a home include demographics, pent-up demand, rising income and improving consumer confidence. Thus, the effect of higher financing costs will be somewhat muted when rates rise due to a robust economy with healthy job growth (and perhaps better paying jobs) and personal income expansion, and when there is a lower-cost alternative in ARMs. If these are the motivating factors, housing metrics might still advance, perhaps even at a healthy pace, especially given recent loosening in credit qualification standards and lower fuel prices.