Wednesday, September 26, 2007

Who's Next?

CFC has been fun and now Lennar is getting spanked. Interestingly I can't seem to tease out the the land writedown details. I can't be sure but it almost looks like when they optioned raw land they were putting the property onto the books at the purchase price. That wouldn't be right as they aren't carrying the associated balancing debt until they actually close. That would be a horrendously misleading effect on their asset totals. And surely they didn't have $850 million in options that expired or some combination of owned land being revalued and expiring options.

Let's just hypothetically assume they were putting land on the books at purchase price when they only had options. If they were doing it, who else? That's the question. Who's Next? Oh and for a laugh; one analyst revised his outlook for Lennar from $45 down to $31. So $23 is ia screaming buy? One can only guess how much he has in the portfolio.

Okay, recent high flyer, hasn't taken their turn at the guillotine, possible phantom landholdings, burning cash. NVR? Look at this chart. Pulte, Centex and Ryland are all similar and they're down a whole lot more. For real fun with charts put up Bank of America, Countrywide and a random Homebuilder. For years Countrywide traded with the banks and then this spring it started trading like a HB. Math is fun.

14 comments:

bluto said...

It's possible they were fair valuing the options which if acquired early enough (and were deep in the money) would look pretty similar to purchase price (with no debt component).

Say you had a home builder with a pile of options acquired 2000-2006, that acquires the land at ground breaking (or shortly before). If they are marking their option book annually, the value of that portfolio would be pretty near land values for the options acquired 2000-2004, while the 2005 and 2006 options wouldn't be worth anything.

Murst?

Sweet Cashback said...

$190 billion for Iraq/Afghanistan. Imaging what kind of bailout we could set up with that type of money!

760000 homes at a full 250k......

What would Wall Street do on such news?!

tough guy said...

I'm a little lost on this one, but wasn't the $800M+ an impairment charge that included write-offs and write-downs?

I can imagine them writing down land that they have on the books (whether they owned it from day 1 or from some mechanism of FIN 46 requiring them to book sometime after optioning but prior to purchase - deposit thresholds or JV restructuring). How about write-downs of homes that are in standing inventory? Is that something you can write down?

As far as write-offs, I can see them walking from deposits, option payments, and any entitlement costs they have sunken into dead deals. Maybe also lost money on land that they've sold?

What I don't get is that this is just another charge in a series. How overvalued were their deals that they're taking such a huge charge now? Shouldn't the first few charges have corrected most of the bad business decisions so that they wouldn't need such a big charge? Again, I'm a little lost on this one.

tough guy said...

Oh, and any thoughts on Beazer being delisted from the S&P midcap 400 (let alone the accounting scandal)? How about Standard Pacific stopping dividend payments and offering $100M in convertible notes? Results from K. Hovnanians Amazing Race to the Bottom ("Deal of the Century"), or lack thereof?

Someone labeled Beazer, Standard Pacific, and K. Hovnanian as the Three Horsemen of the Housing Apocolypse. I tend to agree. I call Beazer as the first big public builder to go under.

Peripheral Visionary said...

I think the "one-time charge" also included inventory, which means that they slashed a lot of prices on a lot of existing homes. But beyond that, as bluto pointed out, they were likely marking-to-market the options, which were previously deep in the money thanks to the run-up in land prices. If you buy an option on $100k of land only to see land prices (much more volatile than housing prices) zoom up to $500k on the same parcel, you now have $400k sitting on the books, even though you only put as little as $10k down. When prices drop back down to "only" $300k, whoops!, $200k loss.

But remember, they're "taking a bath" this quarter, which means that they're going to take every write-down that they can justify. Lost value on land, lost value on options, reduced value of homes in inventory, go through the supplies closets and count up the missing pencils and write those down too. The more value they write off, the more potential upside for when (if) they head back up.

tough guy said...

I'd love to use this as an opportunity to learn about what you guys are talking about if you're willing to explain it. I'm not clear how the accounting of option payments that you guys are describing work. Is there some accounting rule that triggers booking when price appreciates? What am I missing here?

I always thought optioned lots were booked when they were "taken down" whether as a bulk lot purchase or on an individual lot takedown. I thought production builders generally try to keep raw land off the books via various joint ventures. I also was under the impression that Lennar extensively uses partnerships to keep land off the books.

Again, I'm sincerely asking for an education here if you guys are willing to share your knowledge. Thanks!

Rob Dawg said...

Let me give this a try. It will be wrong and I'll need correction.

Say A Bulding Company (ABC) needs raw land to continue heir business plan. Land is expensive and they won't need it for 3 years. So instead of buying land outright and carrying the mortgage while trying to get approvals and scheduling they make a deal with the farmer who owns the land. They agree to a $10 million price three years in the future. The farmer says fine expect I'll need a deposit 10% or $1 million. ABC pays for the option with commercial paper debt. The farmer gets his $1 million and ABC pays some piddling $20,000 per month on the money they borrowed with a balloon payment. Say durring the first year land prices got up 10%. The property under contract is now worth $11 million. The option however is worth $$1.8 million, the orignial $1 million minus time value and the $1 million gain which belongs to the option holder. And so far after 1 year the option has only cost $230,000 or so.

Confused yet? ABC has an asset worth $1.8 million and only paid $240,000 for it.

Now when the price of the underlying property drops below the agreed upon purchase price the reverse happens. They write off the now worthless option and still carry the debt but now with no asset backing.

PV is spot on with the "take all the bad news in one lump" strategy. Everyone does it. I just don't think this is the end of their problems.

Check out Dominion and I have got to see how St Joe carries their land on their books.

tough guy said...
This comment has been removed by the author.
tough guy said...

Think I finally got it. You're talking about the value of the option as the item being accounted for, and for which value is being determined by a fluctuating land price? If so, that's a whole lot of land they were optioning if the write downs if most of the charge came from options and not lot or home inventory. Thanks again.

Peripheral Visionary said...

Well, I'm not an accountant, though I have taken several classes in it, so I'll throw in my unofficial opinion. The general rule of accounting is that most things can be accounted for several different ways--it's just a matter of justifying your approach. So don't be surprised if different companies book things different ways.

The land isn't on the books, because it's not purchased yet, but the option is, and the option has real value. The option's value is the difference between its strike price and the market price--if you have an option to buy a parcel at $10MM, but the real market value is $15MM, your option is worth $5MM. But if the value of the property drops back down to your option strike price ($10MM) or lower, your option is now worthless.

Real estate companies consider options on land, as well as the land itself, to be investments, so that means they (should) mark-to-market. So every once in a while, they go and revalue the land and revalue the option. That's where the games come in. If the land has gone way down in value but they don't want to take a loss, they procrastinate revaluing it. If, on the other hand, investors are expecting bad numbers, they may as well send an appraiser out and realize the loss immediately.

Of course, for land and homes, it's more straightforward--they don't have any option strike price to worry about, they just value them straight up. But once again, there are plenty of games you can play--when you revalue, which appraisers you use, etc. And you mentioned joint ventures, one very common tactic is to try and move assets (or debt) the company doesn't want off the balance sheet, or to reverse the process and move it back on. The SEC is very sensitive to those types of moves, however, especially moving debt off the balance sheet, so it's not as common as it was back in the Enron days.

Peripheral Visionary said...

A couple of follow-on comments--I think they did take some big hits in inventory, which when you're talking about $500k McMansions, can add up fast.

But they also walked away from a lot of deposits. As I understand it (Rob can correct me if necessary), the money that they put down for the option is not the price of the option, but rather a potential advance toward the purchase of the property. If they buy, then that money is part of the price. But if they don't, they lose the money.

For the last year or so, the homebuilders have been reluctant to cancel their options, even though they knew that many of them were worthless, because they didn't want to take the loss. Now that they're not reluctant to take losses, they're walking away from their depost money, and that's adding up fast.

tough guy said...

Well, hopefully, this will pan out through owning-up and reporting, and there won't be any surprises in terms of fraudulent accounting. A Lenron revelation would be a catastrophe. But who knows with all the fishy business going on with KB and Beazer.

Rob Dawg said...

There is absolutely no chance whatsoever in any way shape or form that the current reporting is NOT fraudlent. Now hold on. First understand this is like a cop making an equipment stop. A "good" cop can find a half dozen violations of a car fresh off the new vehicle lot.

Second, as bad as thngs are getting it is a sure bet that the rules will be changed retroactively. At the very least the enforcement and interpretations of the rules wil change. Don't believe me? Ask any S&L from 20 years ago.

Third, I don't think it matters. We have as much as 4 million extra homes in a climate of increasing anti-immigration fostered by past lax illegal immigration enforcement.

Fourth, This is uncharted territory. I think at this point the write downs that the HBs need to take are so extreme that their own accountants would call them into question as being too agressive and evey bit as wrong as not realizing enough mark down.

Funny Circus Bears said...

Robert, 90% of NVR's business is to first time buyers in states like Maryland, Virginia, West Virginia, Pennsylvania, New York, North Carolina, South Carolina, Ohio, New Jersey, Delaware, Michigan, Kentucky, and Tennessee - Places that weren't massively hosed.

That said, even though NVR was just a bit late to the "Shortstock" festival, they have been getting righteously shorted for some time now.

I still see alot of short ribs on the bone there.