This is the problem with being stupid like me. I look at this mess and can't figgur out nothin'. Down 20% in 5 months right? A zillion somethins ahead of the movin' average thingy. All that and the HGX (Philadelphia Housing Index) is still at the values we saw on 2001. Ignore everything else and just tell me why, in 2007, the HBs are worth what they were at the start of the greatest real estate run up in history. Addendum: I just noticed The Big Picture has a similar discussion this morning as well.
20 comments:
First and murst!
From a T.A. standpoint, I would say that it may be part of a 'head and shoulders' formation. I would need to pick up the right of 2007 (2006) portion. In fact, the section from April to Jul looks like a head and shoulders formation.
That being said, the moving average inversion seems to indicate a 'refersal' but it has not been confirmed by volume...
Now for my non TA hat. I would have to look at things like upcoming mortgage resets ( I have a graph of pending resets that would make your hair turn grey if you own real estate, salivate if you don't ).
Personally, I don't use T.A... it is just not technical. I feel like it is akin to reading tea-leaves on the bottom of a cup.. certain patterns mean certain things. I personally know someone who went bust 3 times using T.A.
The graph was done by Deutsche Bank.
I don't do Tech Analysis, but I also question why the HB stock prices are where they are. Most have fallen further in the last month, but I can't call a bottom. Too many land impairment shenanigans for my comfort. I reminds me of tech companies booking revenues strangely to suit their earnings needs.
I've seen the Deutsche Bank mortgage reset chart and it's going to get ugly in late Q3 all the way to Q1 in 2008.
I'm not sure why you're bothering with the homebuilders. Oh, sure, the homebuilders are in serious trouble; but they have room to make adjustments. They can cut their losses on land (where they mostly have cheap options rather than direct ownership), they still have some room for profit in many regions even at lower prices, and given the amount of contracting they do, they can "cut staff" with relatively little pain simply by not entering into new one contracts.
No, it's the investment banks and the hedge funds where the real fireworks are going to happen. They're the ones who are holding the securities that are backed by the real estate itself. Every drop in home prices cuts the value of all the MBSs and CDOs out there. The banks and the hedge funds have yet to reflect those losses and realize them on their income statements, clinging to wishful-thinking-pricing (a.k.a. mark-to-model pricing). Only when lenders force them to revalue based on market transactions will they be forced to realize losses, and the losses will be sudden and deep. And then it will be the BKX chart that we will be looking at . . .
I think the evidence is buried in the financials. We need to look at the quarterly to find out more.
The quarterlies are beyond even my worst predictions. For but one instance; LEN reported -$1.55 vs. +$0.05 predicted.
I've been a little hesitant to totally trash the HBs because they have so many "hedges" in their business. They have stables of tradable assets, they don't overextend to option land like thet did in the early 90s. Spec construction is managed in real time. A little cash and solid credit lines. Their ability to "smooth" out problems plus their traditionally low market valuation should have kept them from imploding as quickly as they appear to be imploding now.
I see a new problem. "All real estate is local." This works against the national HBs in a declining market. No one will want to own the whole and the parts are worth far less disagregated.
It's a little simpler than that. The "book value" of the builders (and I use that term loosely) is acting as a floor on the valuations. For an example - take Pulte Homes (symbol PHM). They have very little cash on the balance sheet but over $10 billion in "inventory."
That inventory is included as part of their assets when you calculate the book avlue. Pulte is trading around $22 with a similar book value. I expect the stock to continue its decline as eventually once the downcycle period is extended the Homebuilders should trade at a discount to book - somewhere between 30-50%.
Obviously - if they were to take the initiative and mark their inventory holdings to market this process would move a lot faster. Some of the companies are doing this more aggressively than others.
Which returns to the question, how do you justify the value when there is a state of decline.
Most real estate-based companies have to diversify their business in order to cover such turns in markets.
@Ben Green
If it has $10bil in inventory, with the RE price declines, this should impair the inventory value.. leading to a write-down on the inventory and a write-down on the book value. The question is how much? I guess one might want to look at where the 'inventory' is distributed within the US.
I don't think the questin is not "how much." Many people following the bubble are expecting price declines in most of the bubble areas of minimum 50% - peak to trough. This could eliminate most of the book value of the builders over two-three years if the bust lasts that long.
The important questions are 1) WHEN and 2) WHY.
The "When" question is important because we are making an assumption that the Builders have to continuously mark their "inventory" to market. I don't know whether this is true under GAAP or not.
The "Why" question is important because it asks whether the Builders are marking down their portfolio based on some type of regulatory or stockholder pressure or whether they are just going to follow the accounting rules under GAAP to their best advantage if in terms of delaying the inevitable.
Just my thoughts. BTW - I don't understand Southern Bread's point about diversification.
Interesting observations. The HBs did diversify. Unfortunately they diversified upchannel with financing divisions. They doubled down when they should have been passing the shoe.
The mark to cost or market is an interesting issue. I've long complained that the lower of cost or market should be purchase plus improvements in a rising market. The HBs have been marking to last comparable sale instead. Gross oversimplification but you get my point.
I've said it before. THe HBs learned not to repeat their mistakes of the last downturn. Insterad they made a whole bunch of new mistakes.
IMO between asset revaluation and profitability the HBs basically have a negative value.
If you re-read the Bigpicture article that you posed the link to, they discuss book value in depth. The builders that do not go Bankrupt are likely to bottom around 50% of Book Value according to the chart and the results of the last cycle in the early 1990s.
Because book value itself could be much lower 12-15 months from now - 50% of that would be even lower. I do not have enough experience to predict / anticipate which HBs will go bankrupt, although it probably will have something to do with the way they finance their businesses and the amount of long-term debt they have / maturities of that debt.
Ben thanks.
First Mr. Ritholtz at BP leaves more financial accumen on his napkin after dinner than I could ever have. Yes, the BP article is required reading on the subject. There are some older Calculated Risk threads worth looking up as well. As far as investment possibilities I'm looking at the redheaded stepchildren of the housing sector. For instance; International Paper owns several HomeBuilders including my local Pardee. They are also in the Philly index (^HGX). They might get thrown under the same bus.
In the mean time I'm rather pissed that I am so stupid as to imagine the old saying doesn't apply to me. "The market can stay irrational longer than you can stay solvent."
Actually, how much is important. It is important enough that you jump to it in the last statement, first paragraph (50% based upon historical). The problem with historical; is that 'historically', the run up was not as great. Figure in 50% on book adding carry costs on the construction loans (see below).
'When' is a hard one to answer. Even large builders have to finance their projects. Because their cost per house is significantly less than any 'flipper' or F**ked Buyer (FB) out there, they can dump property below asking price of everyone else. Since the flippers and FBs are holding on and refinancing for dear life, I think the part that will tell are the foreclosures. The bank does not want to hold onto the properties and will dump them and 1099 the foreclosee (to offset profits for other years). The builders may eventually have to compete on price with foreclosures for buyers.
I do have a question as to your 'why'. There is a GAAP requirement that the inventory be currently valued (can't pick an choose the high price over previous years). This is kind of similar to the Black-Sholes accounting for Options if I am not mistaken. Trying to get as much per property as they liquidate inventory (pricing just under equivalent for re sellers on properties) will allow them to price their inventory higher than its real worth upon eventual liquidation. This will make the book look higher than it really is for a period of time.
I don't think this will go as a full out crash-reassignment of prices. It will deflate as each party lowers their asking, each trying to get at the dwindling number of buyers.
As hinted to in this statement;
For instance; International Paper owns several HomeBuilders including my local Pardee. They are also in the Philly index (^HGX). They might get thrown under the same bus.
The incidental ripples of this are very hard to gauge. You also have to look to retirement accounts/pensions that hold a large portion of CDOs. Companies have to make sure that their pensions are properly funded, so a bad return on pension funds will cause the company to have to increase funding on their pension beyond what they might have been. With respect to governmental pensions, same also applies, leading to reduced services and/or higher taxes when things are getting worse.
An interesting and deadly fact with San Diego, to get pension growth up because they underfunded the pension, San Diego invested in Credit Default Swaps..
Article by Toscano, of Piggington.
"I do have a question as to your 'why'. There is a GAAP requirement that the inventory be currently valued (can't pick an choose the high price over previous years)."
You may be right for "inventory."
"This is kind of similar to the Black-Sholes accounting for Options if I am not mistaken. Trying to get as much per property as they liquidate inventory (pricing just under equivalent for re sellers on properties) will allow them to price their inventory higher than its real worth upon eventual liquidation. This will make the book look higher than it really is for a period of time."
I don't understand the relation to Black Scholes that you mention. Black Scholes is a model for valuing options that includes different variables such as risk free interest rate, instrinsic value, time to expiration, implied volatility, etc.
The markdown of the homebuilder's inventory models seems like more of a game. That is - 1) how can they maximize the amount of time to write down their existing inventory and 2) how can they coordinate those inventory markdowns so they happen sequentially before any possible market upturn so as to maximize the earnings surprise factor.
Does Rob have any readers involved in accounting for public companies? Don't know if that would give a definitive answer but may at least give you some framework to estimate from.
There is an interesting corrollary here to the Mortgage Banks. I have been following WAMU for some time now. They have over $100 billion (greater than 50%) of their retained loan portfolio for INVESTMENT purposes invested in either Home Equity Loans or Option ARMs. Of that $100 Billion approximately 1/5 or $20 billion is invested in subprime loans retained on the balance sheet for investment purposes.
My understanding is that under GAAP they are not required to revise or mark to market their loan portfolio because it is held for long-term investment. Only loans held for sale or actually sold would be marked to market.
If this is the case it seems like only regulators could force them to write down those loan values.
So at what point in the accounting cycle do you start depreciating unsold inventory? I know if basic account, but I wonder how it works in fishy accounting?
I may work for a public accounting firm, but I myself am not an accountant (I'm in the government consulting practice.) I have, however, taken a significant number of classes in accounting, though my memory is a bit sketchy at times.
Inventory, if I recall correctly, is held at lower of cost or market value. If the homebuilders are holding finished and under construction homes as inventory, they should be carrying them at cost (land plus construction costs), only marking down if the market value drops below that. As mentioned above, though, their cost (even including land) is still significantly below comparables in most (but not all) markets.
The big write-downs that the homebuilders have been taking is on land, which (I believe) is held as an investment. Investments do need to be marked to market--but that's where the gray area is. "Market" can mean current asking prices (e.g. wishful thinking prices), or it can mean recent comparables, or it can be a more sophisticated measure based on what they think it will go for, if it's an illiquid market.
But bear in mind that the homebuilders actually have conflicting incentives on revaluation of inventory and land. Marking them down looks bad, because it hurts the bottom line and the book value. Marking them down, however, can set the company up for bigger upside "surprises". At this point, the homebuilders are down enough that I suspect they're tempted to manipulate the numbers down, rather than up.
With respect to the banks holding mortgages, I believe that they're held at historic value.
MBSs are bit more complicated. Had to check FASB on that one:
"Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost."
"Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings."
"Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity."
"This Statement does not apply to unsecuritized loans. However, after mortgage loans are converted to mortgage-backed securities, they are subject to its provisions."
There you have it. The banks can make the argument that they're holding the MBSs/CDOs/etc. to maturity; I don't think the hedge funds can make that argument. Oh, they might try to make that argument, but the problem is that they probably have debt covenants which require them to hold their collateral (the asset-backed securities) at fair value.
With respect to timing, I believe adjustments are made for each financial statement, specifically quarterly, although I am under the impression companies sometimes do a more superficial review of valuations quarterly, then do a more in-depth review on a less frequent basis (i.e. when it's in the best interest of management to revalue the inventory.)
Very informative. Thank you. I also didn't think to look at FASB webpage. I will see if I can find more specifics about the structure for WAMU and Countrywide. WAMU is holding some MBS on balance sheet but the majority of the retained portfolio is not securitized.
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