Bank's FLS revision opens buying window for housebuilders

28th Nov 2013 16:39

Shares in UK housebuilders subsided markedly today after the government said it would scale back its scheme to boost mortgage lending as the property market continues to improve, which offers investors underweight the sector an opportunity to buy. As house price inflation looks set to accelerate further, the Bank of England announced it will switch the focus of the Funding for Lending Scheme (FLS) solely onto small business lending, having previously looked to boost both consumer and companies. "Although the growth in household loan volumes remains modest, activity is picking up and house price inflation appears to be gaining momentum," BoE Governor Mark Carney said in a letter to Chancellor George Osborne, who backed the move.This does not affect the separate Help to Buy scheme, which is designed to address the specific issue of access to mortgages for borrowers without large deposits, unlike the FLS, which was designed to boost lending more generally. First-time buyers are anyway becoming better served by the market. Analyst Anthony Codling at Jefferies noted that Chelsea Building Society has launched 36 mortgage products with 95% loan-to-value (LTV) that were outside the scope of Help to Buy. "In addition, empirically, first time buyer mortgage approvals are not correlated to mortgage rates," he pointed out.Stock market reactionNevertheless, shares in FTSE 100 giants Persimmon and Berkeley crumbled 7% and 3.0%, while in the 250 Bovis Homes was down 7.8%, Taylor Wimpey 6.8%, Bellway 5.6%, Barratt Developments 5.5% and Redrow down by 2.9%. Analyst Mark Hughes at Panmure Gordon said the market's reaction was not surprising. "I think it's probably logical that a sector like housebuilding, where you do have a higher than average amount of beta, or volatility, will overreact like this. He pointed to a similar US overreaction to the possibility of quantitative easing tapering, which has lessened on the realisation dawned that tapering is due to the strengthening economy. "I think in six months' time we'll look back at this as a buying opportunity rather than a terrible thing for the housing market." Codling agreed that the stock market's response was an "overreaction" and reiterated his high-conviction buy on the sector.For one, usage of FLS has been reducing. After launching in July 2012, the scheme hit £9.47bn of both household and business lending in the fourth quarter of 2012, before falling to £2.6bn for the first three months of 2013, and then halving again to £1.1bn in the second quarter. As these figures includes both household and business lending - the Bank of England has not provided a split - it is difficutl to know the exact effect on residential mortgages. Scribbling some calculations, Codling said that if the average mortgage advance is currently roughly £130,000: "If all the FLS usage was mortgages, that would equate to around 45% of mortgages in Q4 2012, 12.5% in Q1 2013, and 5% in Q2 2013."He said the mortgage supply was unlikely disappear, in his view. "FLS reduced mortgage rates on average by circa 0.6% for a 75% LTV floating rate mortgage, by circa 1.0% for 75% LTV fixed rate mortgages and 90% LTV fixed rate."Individual stock picksLooking independently of today's movements, among the larger volume housebuilders, Hughes favourite play from a value perspective is Barratt Developments, with Bovis Homes his pick among the sub-£1.5bn players. In a recent note, with the shares at almost exactly same price, Hughes set out his valuation argument that Bovis was the cheapest stock in the UK Housebuilding sector on the basis of price to net asset value (PNAV). The stock trades on 1.18 times its 2014 expected NAV, falling to 1.08 times in 2015. This equates to a PNAV relative of 0.84 versus the sector. Panmure's target price of 875p, versus the current 760p, is based on 1.40 times the average NAV for the next three years, plus the next three years dividend, discounted back to present value using a 7% discount rate.For Barratt on the other hand, the target price is 382p based on an average 45% premium to NAV over the next three years, discounted back to PAV using the same discount rate. Adding cumulative dividends for the forecast period, this equates to 382p. A note from the Jefferies team suggests investors increase their weight in the UK housebuilders, "topping up existing holdings while the current pricing anomaly remains". Codling's top picks on valuation grounds are also Barratt and Bovis, with respective price targets of 435p and 1022p.OH