To go along with their traditional hammers and saws, home builders these days are adding some new tools to their trade--mortgage-backed bonds.
As conventional sources of capital and mortgage loans grew too expensive or dried up during the recession, builders began casting about for new, cheaper sources of money. One solution to this problem, which has just started to get off the ground but which is gaining popularity, is for the builders to issue their own bonds using mortgages as collateral.
An official at the National Association of Home Builders characterized these builder bonds as a "little blip on the horizon now," making up $1 billion to $1.5 billion of the $900-billion-a-year industry, but said they represent "a fundamental alteration in the way the industry does business."
The market for mortgage-backed securities is "unlimited," according to several experts, and "to the extent that medium- and large-scale builders are gaining expertise, they're getting into it," said Barton Doyle, NAHB's director of investor relations.
Builder bonds lower the builder's cost of raising money. A home builder borrows short-term money from a bank or S&L and uses it to finance a mortgage. With the mortgage as collateral, he issues a bond and sells it. With the proceeds from the bond sale, he pays back the money to the bank or S&L. Because the rates the builder must pay on the bonds are less than he would have to pay to a bank, his financing costs are reduced. Builders may pass on some of the savings to home buyers in the form of lower mortgage rates.
Home builders who also are mortgage originators gain tax benefits as well. Normally, profits from sales are taxed as ordinary income as houses are sold. But when a home builder receives mortgage money from the bank, issues a bond and sells it, the process creates an installment sale and the builder is taxed only on the money paid yearly on the mortgage by the home buyer.
Large home builders such as Ryan Homes Inc. and Ryland Homes Inc., which have operated financial subsidiaries to their home building companies and offered conventional financing arrangements through S&Ls and mortgage bankers, have begun issuing bonds within the past year.
RYMAC, Ryan Homes' financial subsidiary, sold $250 million in bonds in the past 12 months, according to Larry Brean, vice president of planning at Ryan Homes. The Pittsburgh-based company is the eighth largest home builder in the country, with sales topping $370 million in 1982.
Ryland, the Columbia, Md.-based firm that ranks 17th among home builders, has sold $90 million in bonds since its first issue last November. Ryland Mortgage Co., Ryland's subsidiary, found funds raised this way only "marginally cheaper," but use of the bonds provides other benefits, according to Sidney Davenport, vice president of Ryland Mortgage.
"It is a vehicle to give better service to customers, a more expeditious process," Davenport said.
He called the margin for profit in home building slim and said any product that "increases the bottom line . . . is very exciting."
Large home builders are not the only ones entering this market. American Southwest Financial Corp., based in Tucson, was formed in the spring of 1982 by 12 medium- and large-sized home builders from the Southwest to issue and sell bonds. The company, with a combined income of $1.4 billion, has sold more than $120 million in triple-A-rated mortgage-backed bonds guaranteed by the Government National Mortgage Association. American Southwest has grown to include almost 30 home builders, with sales ranging from $25 million to $150 million.
American Southwest was established "to allow medium- to small-sized builders into the same markets as Ryan, US Homes, Ryland" and other large builders, said James Marshall, managing partner of the Phoenix office for Kenneth Leventhal and Co., a large accounting firm. "It's a competitive instrument."
Marshall, who advised the builders about setting up American Southwest and who continues to act as a consultant, said other incentives for entering the bond market far outweigh those of tax deferrals. "It means we're no longer confined to the local finance market. Our ability to fund is based on the national economy," he said.
Ryland is setting up a program through which smaller builders in the Washington metropolitan area can issue bonds while Ryland warehouses the bonds and handles the risk management.
One builder who is looking at Ryland and various other plans is Stephen Eckert, vice president of Porten Sullivan Co. in Bethesda. Porten Sullivan, with sales of $36 million, finances many first-time home buyers, and builder bonds may open up a market for mortgages that are too large to be sold in the normal secondary market, Eckert said.
By law, Ginnie Mae must limit the mortgages it buys to $80,000 for Veteran's Administration loans and $105,000 for Federal Housing Administration loans. The privately owned Federal Home Loan Mortgage Corp. and Federal National Mortgage Association, also must limit the size of mortgages to $108,300.
Home builders are turning to private mortgage insurers such as General Electric Credit Corp. and Residential Funding Corp., a subsidiary of Norwest Mortgage Inc. of Minneapolis, to package these pass-through certificates that Fannie Mae and Freddie Mac cannot buy.
"From our analysis, it looks like it would provide us with access to the capital market and provide an alternative to traditional financing for mortgages," Eckert said. "It looks like it might give us a slight pricing advantage, so our total cost will be less and our customers will pay less."
Another route into the builder bond market is through investment bankers. Merrill Lynch Pierce Fenner & Smith Inc., which began issuing mortgage-backed bonds in the spring, has designed an underwriting program for builders of all sizes, according to associate Robert Franklin. Its builder finance unit is the first such division devoted solely to builders that he knows of, Franklin said.
"The mortgage market is just exploding," he said. "I underwrite bonds of $75 million to $100 million monthly now. A year from now, we expect to do $300 million to $400 million a month."