Published:
December 26, 2007
The Morgan Stanley Capital
Protected Bear Notes (AMEX: HPB, $12.93) are a bet that the
U.S. housing sector will continue to deteriorate. Inversely tied to
the Philadelphia Housing Index (HGX), HPB goes up when the index goes down
and vice versa. The HGX itself is based on 20 large U.S. housing
companies -- residential builders, mortgage lenders, and firms that
supply construction materials -- in other words, a cross-section of
the building industry.
The notes are capital protected -- that is, they are guaranteed to
return $10 per note when they mature on August 30, 2010. There is no
provision for early redemption, but they can be traded at any time.
The notes do not pay regular interest, but rather give a one-time
dividend at maturity.
Since the notes were issued in May 2005, the HGX has fallen from
264.33 down to 144.19, providing a nice return for current holders
of HPB. However, the
question now is: "Has the subprime basement been reached?" We believe
the answer is: "Not yet."
Here are some reasons. The National Association of Homebuilders
Housing Market Index assesses builders' beliefs about home sales. In
November, it declined to 19 -- the lowest level since 1985.
Further, new home sales are expected to decline next year. In 2006,
1.05 million new homes were sold. That figure is expected to decline
-24% to just 796,000 homes in 2007, and another -13% to 693,000
homes in 2008.
Moreover, mortgage originator Fiserv Lending forecasts that median
home prices nationwide will fall -5.7% in 2008. That decline would
make it the worst year for real estate in at least 40 years. The
industry is expected to be hampered by tighter lending standards,
rising defaults on mortgages and falling existing home prices.
Comments from the industry reflect the doom and gloom. Robert Toll,
Chairman and CEO of luxury homebuilder Toll Brothers (NYSE: TOL),
says U.S. conditions vary from "miserable to outright purgatory."
Daniel Mudd, President and CEO of Fannie Mae (NYSE: FNM), predicts that there
won't be "a bottom until the end of 2008, and then we have some
period of time to work our way back up again."
Even late 2008 might be optimistic. Continued high oil prices and a
possible recession would further dampen already battered consumer
confidence and put off a recovery even further.
Homebuilding stocks typically anticipate a recovery in the industry
between six and nine months before the recovery happens. Owners of
HPB should therefore monitor first-quarter 2008 earnings reports of
homebuilders to see if the outlook has become more upbeat.
Action To Take ---> Existing
holders of the notes should hold their position. For new money,
clearly the risks are higher. Still, the housing index may fall even
further, making HPB suitable for somewhat more aggressive investors
at this point.Good investing!
Carla Pasternak
Editor
High-Yield
Investing
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