‘Non-Investment Grade’ Builders ‘Vulnerable’: S&P
Some housing bubble reports from Wall Street. “Investment-grade homebuilders are well positioned to face the current slowdown in the U.S. housing cycle thanks to more conservative business practices, according to Standard & Poor’s. But the outlook is less rosy for speculative-rated homebuilders.”
“‘Several non-investment-grade homebuilders will find the going difficult because of aggressive inventory investment and share repurchases that will limit future flexibility and leave them vulnerable to credit pressures,’ S&P said.”
“A drop in orders for new homes, especially in markets known for speculative buying, and an increase in cancellations of existing orders have hammered homebuilders in recent months as rising interest rates curb demand for homes.”
“St. Joe Co., one of Florida’s largest real estate companies, said Tuesday its second-quarter profit fell, weighed by lower sales in the weakening Florida property market. The company also cut its full-year financial forecast for the second time this year.”
“‘At established Joe resort towns, sales remained slow during the second quarter, which had a significant impact on revenue and earnings,’ said CEO Peter S. Rummell. ‘Considering the high levels of resale inventory available in many parts of Florida, including Joe’s core markets in Northwest Florida, we believe activity in our resort and seasonal markets will remain slow for at least 18 to 24 months before there is a return to supply-demand equilibrium.’”
From MarketWatch. “Freddie Mac said Tuesday that it will limit the annual growth of its retained mortgage portfolio to no more than two percent above the level at June 30, 2006. The unpaid principal balance of the company’s retained portfolio was $722 billion as of June 30.”
“‘This voluntary, temporary growth limit is in response to a request of the Office of Federal Housing Enterprise Oversight (Ofheo), the company’s safety-and-soundness regulator,’ the company said in a press release.”
“The move by Freddie Mac follows a similar action by Fannie Mae, which limited its portfolio to $727 billion. Both companies are emerging from accounting scandals. Analyst Jaret Seiberg said the move by Freddie would contribute to congressional efforts to finish a bill putting in place new rules on Fannie and Freddie.”
Are these builders, too, going down with the “SHIP”. These have been too funny.
‘Several non-investment-grade homebuilders will find the going difficult because of aggressive inventory investment and share repurchases that will limit future flexibility and leave them vulnerable to credit pressures’
If the firms piling up the land and subdivisions get into credit trouble, the first thing they will do is lighten up on their holdings, putting further downward pressure on prices, IMO.
Ben,
this is an excellent article that does a wonderful job of explaining the current bubble.
http://safehaven.com/article-5643.htm
Maybe the condo ship might have a better chance in LA, SD, SF, HI, or FL. Of course, there is a severe shortage of condos in places like SD, and Miami.
I’m no banker, but if Freddie and Fannie are limiting mortgage portfolio growth, will banks still be willing to lend as quickly and aggressively as they have in the past few years?
Simple answer? No.
I believe the technical term is actually: NFW.
LOL, Robert!
Mortgage portfolio growth isn’t the same thing as MBS creation. Besides most lending in the bubbliest areas is not backed by the enterprises.
For the past few years, I’ve watched an explosion of residential building to the east of Colorado Springs, along with an associated explosion commercial space buildup in the same area. Won’t commercial real estate take a hit if residential does?
Depends on how much commercial was built and how many residents are living there. Some commercial space will always be needed near new residential areas, whether it booms or not depends on whether industry (beyond basic services) want to locate there.
I think that there is a direct correlation with retail health and reports that students are leaving schools, as has been reported in several communities. When people leave the area, it is simple… there will be less business for commercial establishments. Look for increased vacant space popping up all around.
OT - Follow up link to video of David Lereah on Today show encouraging buyers to offer 10, 20, 30% less than asking prices.
Lereah comes on at about minute 2:00.
http://video.msn.com/v/us/msnbc.htm?g=643e60b5-6092-45ba-af29-3a2c601bd4f4&f=00&fg=email
OK, so, what I’m going to do is print out his picture, with a quote, and when presenting my lowball offers, I’m going to attach his picture and quote, and just let the seller and seller’s realtor know that this is what the head of the NAR said to do and since he’s an expert, he must know what he’s talking about. (With a dumb, innocent look on my face)
Here is a partial transcript:
David Lereah: The west coast and the east coast, that’s slowing, that’s cooling significantly. The middle of the country is doing very well right now, so this is a tale of two markets.
Matt Lauer: What do sellers need to consider?
Brandie Malay: First thing they need to do is price the home appropriately. Use recent comps. Don’t use comps from a year ago. [Sellers] need to get realistic about what the market is doing.
Matt Lauer: What percentage of an asking price is a fair - not insulting - offer when you are starting to negotiate?
David Lereah: That’s really tough and it depends on the marketplace, it depends on the inventory of homes, but certainly right now you should not be afraid to negotiate. For the last five years it’s been a sellers’ market, buyers have not negotiated. It’s hard to get over that hurdle, now they can. They can go right to that seller and tell their realtor they want to negotiate. Uh, they can bring prices…I’ve seen prices come down ten, twenty, thirty percent.
Matt Lauer: Let me ask you to look into your crystal ball for a second. What do you see happening over the next twelve months in the real estate market?
David Lereah: The real estate markets are cooling. Again, this is…half the country is cooling right now. It will be a soft landing. There could be some local markets that experience some pain - don’t know which ones they are right now - it could be a market in California that has severe affordability problems and a lot of this depends on the Federal Reserve. If they continue to raise rates, some of these real estate markets could get hurt. If they don’t raise rates, I think we’re in for a soft landing.
Thanks, John, I was listening to the audio portion, couldn’t get the video, but I thought I heard someone make a comment that buyers always set the prices, or determine the market or some such thing. And actually, that’s true. It will always depend upon what the buyers are willing to do relative to demand. Lereah’s interest is in the NAR and its members, so he’s always going to say anything that will help the members of the association make money. If nobody’s buying, no commissions. So, it is in his interest to get sellers to drop and encourage buyers to lowball. High prices, low prices, doesn’t matter, as long as selling is taking place, commissions will come in.
Agreed.
At this point, realtors just want sales. We’ve been giving them too much credit lately saying they are trying to prop up the bubble. That’s too complicated for them. Realtors don’t operate on the macro-economic level (especially DL). They operate on 2 levels
1. I’m selling houses this month
2. I’m not selling houses this month
That’s their market indicator. I don’t think they have a forward looking level.
Lereah: “There could be some local markets that experience some pain - don’t know which ones they are right now - it could be a market in California that has severe affordability problems…”
Oh yeah, don’t know which ones! Gosh, it would be hard off the top of my head to think of a market, somewhere, maybe in California, just maybe, that might experience some pain. Might possibly… no, too hard, can’t think of one, can’t think of any…
If they continue to raise rates, some of these real estate markets could get hurt. If they don’t raise rates, I think we’re in for a soft landing.
We are already way ahead of if this or that… rates will go up… Just look at the stock market. its already pricing in a next rate hit …. in mean hike…
Great freaking video…. no such thing as soft landing … never ever seen one …. I never even heard of a soft landing in all the readings.
Funny,
I didn’t come across any of this advice in his latest book.
DL also says buyers should “wait, wait, wait”!
Ok, when do we get a bounce to start shorting or buying puts on these pigs? Anyone have some favorite candidates?
I am tracking WCI, LNR, KB, TOL
When do we get a bounce!? When do we get a day when they go down on bad news instead of up, you mean. There hasn’t been a period where the HB’s are up seven days out of eight since before the HB stock bubble broke last July!
I wonder which builders the S&P considers non-investment grade? St Joes balance sheet seems stable compared to Toll Brothers.
“I wonder which builders the S&P considers non-investment grade?”
Ben, you beat me to it. Total debt, cash on hand, operating cash flow, and book value ought to be in S&P’s formula somewhere. Aren’t the “investment grade” HB’s incurring debt to buy back stock (lower cash on hand) and slashing prices (lower operating cash flow) while writing down impaired assets (lower book value)?
Toll Bros qualifies for plunge protection, St Joes is too small (now where did I put my tinfoil hat?)
Good answer. You always have to consider if they have protection by the politicos gangsters and the financial mafia at the FED. It’s like the GM, Ford or Fannie Mae stocks. These stocks should be worthless. There is no equity or assets left in these companies. The accounting is rotten and phony. But still, somebody keeps buying. Yes the US government and the FED, are in the business of protection racket. There is the stock market and then, there is the stock racket with the Plunge Protection Team. Free markets are a joke. Will they be doing this too, when the real estate bubble explodes ? Yes.
I am curious about Toll’s inventory figures:
10/03 $3.1b
10/04 $3.9b
10/05 $5.1b
1) What made that number grow by $1b/year, and now that it is so high, will it stay permanently high?
2) If that number shrinks, does it subtract from earnings?
Home builders’ inventory includes land at the lower of cost or market. I believe it also includes the value of options on the purchase of new land (there was a post a few weeks back about a home builder walking away from an option to purchase land from a public school district). If the land is determined to be an impaired asset then it must be written down with a direct hit to earnings. However GAAP give companies wide latitude in determining when and how much to write down since it is based on managements’ best estimates.
“… wide latitude in determining when …”
Let me venture to guess that this latitude is exercised to quickly report increases in land asset valuations and to very, very slowly report impairments…
Land is valued at lower of cost or market. Increases in land valuation don’t get reported at all. That’s why analysts sometimes get excited about natural resource companies or company-owned chain stores with lots of “hidden value” on the balance sheet. The balance sheet doesn’t reflect the increased value of land that may have been acquired decades ago.
Things that increase inventory value:
purchases of land or housing materials (these are valued at what you paid for them unless your auditors believe they are now worth less than what you paid for them)
the carrying cost of your employees who either build homes or work on zoning issues. So when you pay an attorney to get the property zoned from A-1 (farmland) to R-2 (city lots) what you paid him goes into inventory. NOTE: the change in the value of the land due to the zoning change is NOT reflected only the cost of the employees to make the change.
For most companies that’s essentially it.
Things that reduce inventory:
Write downs-these occur when you can no longer justify to the auditors that your inventory is still worth what it cost (an easy example is when the telecom bubble crashed lots of companies had DRAM that had a market value 1/10 of what they paid for their RAM. It must be non-temporary which gives managment quite a bit of wiggle room.
selling a product-when a home is constructed the price of the lot, time spent rezoning, cost of the materials and labor for the home are removed from inventory and added to cost of goods sold.
If inventory write downs occur they do go through earnings (but usually the market had been discounting them for at least a year). If inventory declines due to homes being sold then the reductions probably add to earnings, but it would depend on what the gross mark up was and the other costs.
And from Toll’s Earnings statement:
Net Income Applicable To Common Shares
2005 $806,110
2004 $409,111
2003 $259,820
1) Does that rate of earnings growth look sustainable?
2) What if it starts to shrink?
3) Where does the annual increase in inventory valuation since 2003
enter the earnings statement?
Because only “revenue” looks big enough to contain those $1b
increases in inventory, but increased inventory valuations do not
seem to properly belong in the “revenue” line, any more than a
homedebtor’s paper home equity gains belong in his total annual
income.
http://finance.yahoo.com/q/is?s=TOL&annual
CTX is my personal favorite HB short. It has high debt, a large exposure to land option write-downs, and a high inventory that is growing rapidly. These factors will work against the company in the bond market at a time of declining revenue and margins.
But CTX finances its operations, land purchases, and stock repurchase through the bond markets. And with limited cash on hand, they will be forced to riley on the bond market even more heavily. Then they’ll pay more for that money as their rating drops … further hurting earnings … further degrading bond ratings … (and so on).
Toll Brothers is mentioned by name in that article, they are now only “stable” instead of “positive”.
I looked at http://www.standardandpoors.com to see if these ratings were easily available. They aren’t; you have to register and I didn’t want to take the time.
I figure that not having that information won’t hurt me. Let’s say I short the one with the worst balance sheet and the least likely chance of making it through the hard times. The perverse logic of Wall Street will make that the one talked up as a “takeover candidate” with the resultant 20% premium over its “fair value”.
“The perverse logic of Wall Street…..”
This is the reason I would recommend shorting the Homebuilders’ S&P Index ETF, symbol XHB. If you’re right about the industry you deserve to make money. Why take a chance of betting on the wrong company?
Excellent suggestion old sport. My short of choice, HOV, has given me nothing but heartache and wallet-ache in the past two weeks, especially the past two or three days, compared to XHB and $HGX. All of a sudden it’s the fair-haired boy of the home builders, stock-price-wise.
The volume in XHB since that first bottom two weeks ago is amazing. Daily action in the HB’s since the bottom has been that they ratchet up on any market-wide buy programs but nobody seems to sell when the that buying pressure abates. I wonder if this volume represents a lot of people buying at what they think is “the bottom”, thinking the biggest real estate bubble in the history of mankind has completely normalized itself in exactly one year. (07/20/05 was the high for $HGX, 07/21/06 is the low so far.)
Investment grade means a bond credit rating of BBB- or better (same as Baa3 or better) BB+ (or Ba1) is the first junk rating from Moody’s and S&P. They rate based on more than just public financial statement info. Postitive, Negative, and Stable are equity ratings (or directional color added to bond ratings). Bond and equity investments can move in opposite directions (a good example is an LBO which greatly benefits equity and is generally very bad for existing bondholders).
If you are making levered bets with anything other than play money and you don’t know what investment grade implies, you are likely the fish at this table.
Please,
none of these builders is “investment grade”. Unless you mean they get an “F”. They are all crap. None have a great outlook. I doubt few will be able to survive without severe damage, and I doubt we’ll be able to tell which ones will survive based on their “investment grade”.
remarkable how FAST the tide is changing in the RE..
psychology took it UP.
It will take it DOWN now.
clouseau
My fellow San Jose bubble sitters, we have a new low in selling. Now they plan to have a fake model available for this “Luxury” Condo tower in downtown San Jose because the project won’t be complete for two years. Notice how thay are using this to “gauge” the market while they collect deposits. Comments section is open, have fun !
http://tinyurl.com/orn3w
I think that would be a great place to live for the right price if you worked in downtown San Jose…. except that landing airplanes come in so low over downtown you can’t talk outdoors. The Children’s museum two blocks away has a window under the flightpath which displays silluettes of the major airplanes so that kids can ID them as they go by. Which is pretty each considering how low the planes are.
LOL! The urban livestyle of downtown San Jose died when they closed San Jose Live in ‘98! that was that big nightclub sportsclub comedy club under one roof…. not much left now…
thanks to a change in California Department of Real Estate laws effective this year, they can put a down payment on a unit two years before construction is done
If you like the drama of wondering whether your Earnest Money will be there after a year, you’ll love this twice as much!
(Federal Reserve. If they continue to raise rates, some of these real estate markets could get hurt. If they don’t raise rates, I think we’re in for a soft landing.)
More jawboning the FED. Short term rates are already neutral. If the FED doesn’t raise them further and inflation continues to kick up, long term rates may rise quickly by 2-3 percent. If there is a recession rates may fall, but banks won’t lend anyway.
Sorry NAR, it doesn’t matter what the FED does. A “soft landing,” in reality, is that prices fall to the level where people can afford to buy again, and they subsequently start buying. But that won’t feel like a “soft landing” to those who bought after 2003 or HELOCed themselves into a box.
“The market is softening a little bit,” she said. “Nobody’s overly concerned right now. I think it’s just the summer vacation doldrums.”
http://tinyurl.com/m5orv
$500K+ houses in an area where they sold for less than 200K 6 years ago and the median income won’t support the prices. Textbook recipe for disaster…..
I am selling my sep 22.5 WCI and CORS sep 30 puts and buying Jan 15 WCI and Mar CORS 25 puts. Two weeks ago my housing bubble put option portfolio went up 100K, last week it lost $30 k. I am not worrying about the very short term, but usually buy 3-12 month at the money put options. I have been taking profits when options reach 150-250% profit and rolling into further out at the money options. BBX has been a great bank put as has CORS.
I am looking for more banks and lenders for shorts. If you believe in a coming recessions, long term, out of the money banks with high RE holdings look good. You can often buy 6-12 month near money puts for $1-3 per contract.
I cannot believe the price action on JOE today. I am always worried when a stock rallies on bad news. Also, another problem with JOE and CORS puts is the huge bid-ask spread. They both should follow WCI eventually, but it sure is taking a while.
Read about San Diego Home Sales Figures: Not All That They Seem.
“Just open up the Sunday real estate section of your local paper and the magnitude of these incentives becomes quite apparent. Just a few incentives I noted in my recent paper: $15,000 closing cost credit and $25,000 towards an interest rate buy down or upgrades; $50K to help pay your mortgage; seller pays interest portion of your new loan payment for first 6 months, all nonrecurring closing costs, plus 12 months of HOA fees. I could go on, but, you must understand that the builders are not being altruistic. No, they just want to move standing inventory, and move it now before any further declines!”
Anybody notice Orange County Register stop putting up there
Orange County home prices and sales for this week?
I have last weeks and many months of other to watch the trend which from last week your seeing alot of negitives marks and now nothing for this week. Does that mean RE ask to have that removed so we cant see the negitives? Any help to find again or get them to put it back?
I noticed. I even asked John L - NO RESPONSE!!
From another story on Marketwatch link posted by Ben http://tinyurl.com/j9ug3
The core personal consumption expenditure price index, excluding food and energy, increased 0.2% for the third straight month in June, and has risen 2.4% in the past 12 months, matching the largest year-over-year gain since April 1995.
Consumer prices including food and energy also rose 0.2% in June, and are up 3.5% in the past year.
The 2.4% year-over-year gain in core inflation exceeded the 2.3% pace most economists had been expecting.
It’s the biggest yearly rise in core inflation in 11 years, matched only by an equal 2.4% gain in September 2002, when the inflation rate was briefly boosted by a statistical anomaly related to insurance payments stemming from the terror attacks on Sept. 11, 2001.
Core inflation will likely accelerate to 2.5% in July, said Stephen Stanley, chief economist for RBS Greenwich Capital.
“This is why we think that the Fed has to tighten again next week,” Stanley said, characterizing such a decision as “pure and simple.
“Core inflation is too high and still accelerating. It is very risky for the Fed to stop hiking when inflation is still accelerating,” he said.
The article notes that the markets are expecting the Fed to pause, but with core inflation (and CPI) both trending up, it seems like it will be tough for the Fed to pause and maintain credibility that it is committed to price stability. Sure, they may try to talk the bond market into believing by saying that the previous hikes have not had a chance to fully take effect (likely true), that consumer spending is retreating (true), and that the economy is slowing (also true), but I just don’t know if that’s enough for the bond market considering that BB is still pretty new on the job and has not yet earned the credibility that only comes with performance over time. If the Fed pauses and the bond market gets spooked, it seems like interest rates could rise dramatically, causing that much more pain to FBs with loans re-setting. IMO, it seems like the Fed needs to raise rates at the next meeting in order to gain more credibility about fighting inflation, keeping the bond market happy, and supporting the dollar.
to discover non-investment grade look at bonds below BBB
Not that it will make a difference to the housing market, but I think he will raise rates. He has to keep foreign buyers happy or the government won’t get funded.
I started buying puts when TOL was 58 and BZH 70 and have made a ton and IMHO, the best remaining 2 short candidates are CFC and KBH. KBH has literally spent all of its available cash on buybacks and is majorly cash flow negative and that is going 2 quarters back so expect some more carnage there. For a home builder to be cash flow negative, with a huge land bank of land priced at ridiculously high levels, means the bottom line will get hit as land reprices. Could take next quarter for the destruction to commence but it is coming.
CFC is still 15% within its highs so it has a lot of room to drop. Consider that it has barely moved down from its all time highs and looking forward, does anyone doubt that the future will be significantly worse than the recent past? I think Jan 08 puts on CFC will pay off real well. Why is it so strong? Well, it is so complex and huge that the numbers have not truly shown the entire story yet, which is credit quality decreased, foreclosures are rocketing and cash flow from mortgages are tanking as a result as foreclosure occurs. Also, their reserves are pathetically low which puts them at serious risk if loans default on massive scale and liquidity dries up.
Does KBH have quality problems? RYL and LEN are facing serious problems with quality issues on homes they have sold. Seems to me that such problems make them better than average short candidates.
Yes:
http://www.kbhomestink.org/default.asp
the other site, kbhomessucks.com appears to be down.
Isn’t CFC a potential buyout target (by Citi)?
So the “investment-grade” builders are the good ones? What about the “place to live in” builders? Do they even exist? They will…
Community Zip Median % chg Sales % chg
All homes $646,000 7.1% 3,608 -26.3%
Total resale houses $700,000 6.1% 2,218 -28.7%
Total condominiums $456,500 3.9% 968 -32.0%
Total new homes $796,750 5.8% 422 16.3%
What is wrong with this… it’s from Dataquick for the OC. When I use my math, I don’t come up with a 7.1 increase… do you?
I just had a lunch with a friend who owns 3 homes. She and her husband have wised up and are willing to price one of the homes agressively. I wasn’t exactly subtle about warning about not “chasing the market down.” I pointed out that if there isn’t interest within two weeks, keep dropping the price. My best advice was price below Zillow.
Luckily, they’ve owned that home since 1999, so they should still come out in the black.
This couple is a more financially savy “artsy” couple. The question is, how long will it take others to wake up to this fact.
Oh, she asked how big of a price drop. I replied “you don’t want to know.” I also pointed out that:
1) I’m not a financial advisor, so as someone who missed the run up, maybe I’m not the best person to listen to.
2) Rumors are by September mortage qualifications will tighten a lot. (I recommended getting the home on the market by today!)
3) By early next year, mortgage resets will kill the market.
Neil
Does anyone wonder why the Fed keeps on commenting on the Housing market-Isn’t the Fed’s job to control inflation? Not sure when it became their job to moderate asset prices or the minutiae of the consumer market
Some of the Fed Governors must have opened their yaps at 2 PM today just like the bad old days. They’re scared to death of being named the “proximate cause” of the death of the housing market. The HB’s shot up a percent in like five minutes and barely gave any of it back by the close.