Homebuilders: Hell Fights Back

Yesterday we discussed the Pulte House From Hell. The August 13 BusinessWeek cover story Bonfire Of The Builders suggests that hell is fighting back:

Elizabeth and Armando Motto are living a real estate nightmare with a new breed of monster: the big homebuilder as lender. In November, 2005, the couple, who have four children, agreed to pay $540,000 for a newly built three-bedroom house in suburban Clarksburg, Md., near Washington, D.C. Rather than send them to a bank, the builder, Beazer Homes USA Inc. (BZH), offered to provide a mortgage itself in an arrangement of the sort that helped fuel the long housing boom across the country.

But when it appeared that the Mottos might not qualify financially for the loan, things took a troubling turn. Beazer, according to the couple, inflated the pair's earnings in loan-application documents by incorrectly stating they were collecting rental income from the house they were leaving.

"I don't want to misrepresent myself," Elizabeth said in e-mail correspondence with Beazer's outside mortgage service, dated July 14, 2006. But in the end, the couple signed the documents, and soon after they closed on the Clarksburg house.

They now regret it. The Mottos moved to Clarksburg, but they haven't succeeded in unloading their previous home in Rockville, Md. They have nearly $1 million in mortgage debt on the two dwellings. With $145,000 in family income, Elizabeth says, they are "on the brink of foreclosure" on both houses. "We are so broke."

The Atlanta company has much more than the Mottos to worry about. On Aug. 1 its stock fell nearly 18% on rumors that it was preparing to file for Chapter 11 bankruptcy court protection—which Beazer swiftly denied, calling the Wall Street gossip "scurrilous and unfounded." Just five days earlier, Beazer revealed that the Securities & Exchange Commission had elevated an informal inquiry into its mortgage business to a formal investigation. The company warned that criminal penalties could follow. Earlier this year, Beazer received a subpoena from the Justice Dept. seeking documents related to its home loans, and the company is also under civil investigation by the North Carolina Attorney General's office.

Even as the housing supply began to exceed demand last year, builders kept sales brisk by pushing adjustable-rate, interest-only, and other risky loans. In some cases they attracted clientele who couldn't afford conventional mortgages. In others, builders allegedly violated federal lending standards to get customers to sign on the dotted line. KB Home (KBH) paid a record $3.2 million settlement in July, 2005, to resolve allegations by the Housing & Urban Development Dept. that the builder's mortgage unit overstated borrowers' income, among other practices, to obtain loan approvals. KB, which denied wrongdoing, sold its loan business before settling.

It's hard to feel truly sorry for anyone in living hell if that hell was a result of being a willing party to commit fraud. But sooner or later hell nearly always strikes back at everyone involved in fraudulent transactions.

Emails of the Mottos have now provided a smoking gun for the justice department, the North Carolina Attorney General's office, and the SEC to investigate. Expect shareholder lawsuits over this matter as well.

Desperation at Beazer or just complete foolishness?

In what is likely a foolish waste of money if not an act of pure desperation given all the investigatory and liquidity problems Beazer is facing, Beazer nonetheless declared a $.10 dividend on Friday.

August 03, 2007 12:00 PM Eastern Daylight Time Beazer Homes USA, Inc. (NYSE: BZH) (www.beazer.com) today announced that its Board of Directors has declared a quarterly cash dividend of ten cents ($0.10) per share of common stock. The cash dividend will be payable on September 21, 2007 to shareholders of record at the close of business on September 10, 2007.

With a tip of the hat to Minyanville for the idea, let's take a look at a 1 minute chart of BZH before and after the news.

BZH One Minute Chart

If that dividend announcement was an act of desperation, the market sure caught on quick and commenced voting with its feet.

Investing in Homebuilders is Foolish

Over the long haul shareholders never even profit but insiders sure do. Take a look at Beazer Insider Transactions. Massive numbers of shares were acquired by insiders for $0.00 and dumped on the market for whatever the insiders could get. Especially note the transactions of Ian J. McCarthy, CEO.

Builders build until they go bust. It's the same every cycle. They keep plowing all earnings into more and more land at artificially inflated prices until the Ponzi scheme finally blows up.

BZH Monthly Chart

Anyone who bought BZH from 2001 through 2007 is now underwater. Poof. And where were the dividends four years ago? Three years ago? This is why investing in homebuilders is a foolish proposition: they do not pay dividends when they can and should but attempt to do so smack in the middle of massive investigations and liquidity issues.

Insiders have made countless millions in the last six years. But those investing in the biggest housing boom in history lost money. Sure some playing the greater Fool's game made out, but for every one those, other investors holding for the "long haul" got clobbered with as much as 86% losses.

HOV Monthly Chart

Hovnarian (HOV) is now back to 2002 prices.

LEN Monthly Chart

Lennar (LEN) is hanging out just above 2002 prices.

WCI Weekly Chart

WCI just started trading publicly in Autumn of 2003. The weekly chart shows the entire history. But check out the arrogance of WCI turning down an offer at $22 as late as May 2007.

Earlier this year, WCI rejected an offer by Icahn to purchase the company for $22 a share, saying it was financially inadequate. His tender offer expired in May, without him buying any shares. At the time Icahn made his offer, WCI’s stock traded in the range of $20. WCI moved its annual meeting from June 15 to Aug. 30 to give it more time to entertain offers.

As WCI’s stock has taken a nose dive, some have questioned whether the company made a mistake when it rejected Icahn’s original offer.

Question? There is no question. Icahn clearly lost his mind to offer $22 for WCI but was bailed out because a bigger fool refused to take the offer. Add that to the list of lawsuits to be filed.

Meanwhile Back in Hell

While the debate continues about whether or not WCI should have taken the offer (or if the offer was even real as some conspiracy theory question), the mad scramble to turn out product as fast as possible has raised a significant amount of quality issues.

BusinessWeek is asking You Call This A Home?

The next boom for builders may be complaints from angry homeowners.

Residents of a new housing development in South Carolina fear that fumes from contaminated soil have caused dizziness and blackouts.

In Colorado, homeowners say they were led to believe they'd enjoy a recreational lake that never materialized, causing property values to slip. As the housing slump worsens, U.S. homebuilders increasingly find themselves fending off complaints of shoddy construction, unsavory sales tactics, and use of unsafe land.

Criterium Engineers, a Portland (Me.) building-inspection service active in 35 states, found that from 2003 to 2006 the number of new homes with "significant problems" rose more than 13%.

"Right now you're seeing the construction claims start to come in," he says, "but it'll take five to seven years" to get a full measure of the angry fallout. Anti-builder Web sites are proliferating, and two consumer groups, HomeOwners for Better Building and Homeowners Against Deficient Dwellings, are compiling online lists of beefs against developers.

The National Association of Home Builders says 55% of customer grievances concern caulking, paint, and other nitpicky issues.

Lennar Corp. (LEN), another large builder, has drawn scrutiny in South Carolina. Residents of its new Pebble Creek development in North Charleston, such as Bill and Holly Hurley, say they have suffered from light-headedness, lethargy, and depression. Home inspections they commissioned showed unsafe levels of methane gas, which the Hurleys and others fear may be linked to possible soil contamination by a previous land owner.

Let's rephrase that statement by the NAHB as follows: The National Association of Home Builders admits nearly 50% of homeowner grievances are both valid and significant.

Unfortunately the NAHB provided no percentages for these questions: Of the 45% of grievances that are "not nitpicky", how many homeowners are happy with the resolution? How many are not happy about forced arbitration when the homebuilders get to pick the arbitrators?

Real Estate Gripe Sites

• Homeowners Against Deficient Dwellings [HADD]
• Homeowners for Better Building [HOBB]
• Crap Construction
• Exposing New Homebuilders
• K. Hovnanian Homes Suck
• Not-Khov.com
• Levitt and Sons, Problems
• The Pulte Homes Experience
• Neighborhoods for Quality Homes
• My Pulte Experience
• StopBEAZERHomes
• Fight Pulte
• Fight Divosta
• Fight Del Webb

The above list compiled by and thanks to BusinessWeek.
Two images from the article (titles mine)

Pure Hell #1

Pure Hell #2

There is much more in the issue. I'm picking up a copy.

That said, in the back of my mind is the idea that magazine covers like these often mark major turning points. Then again, unless homebuilder sales pick up dramatically several of them (or more) are going under.

Perhaps the cover marks not a turning point but a major recognition point about how bad the problem is. As late as a couple weeks ago Paulson was talking about how "contained" the problem is. Well it's obviously not contained.

Another problem the builders face is that people are going to read the issue, see the problems, and be scared to death to buy from any builder in question. And then there is the problem of massive condo building in Florida with tens of thousands of units being built even as there are tens of thousands of units that nobody wants already sitting in inventory. Finally there is the problem of a severely slowing economy with unemployment rates poised to go up dramatically.

Bankruptcy is one way out for these homebuilders to stop the lawsuits cold turkey and walk away scot free of what some might say would be their moral obligations. No doubt some of these builders will soon find that option attractive. The only real question about bankrupt homebuilders is "Who's first?" As for "Who's to blame?" the list is long but start with the Fed and proceed to Congress and this administration.

Comments

[Reggie Midd...:]

For those who really do not have the time to read building company annual reports, here is a bullet list of tidbits that all will find interesting, particularly in light of today's mortgage environment:

1. Joint venture debt and depreciating inventory held off balance sheet, so you and I can't see it.
2. A significant amount of the non-conforming market has all but seized up, which will significantly reduce the demand for housing, in an environment where the supply demand ratio was totally out of whack to begin with. I know you think you already know this, but wait...
3. Large public home builders are some of the largest non-conforming mortgage originators, funded by warehouse credit lines that have been the source of unprecedented margin calls throughout the non-bank mortgage industry (which the homebuilders are a member). Banks have internal financing such as deposit accounts to fund mortgages, but non-bank entities must rely on credit lines to fund loans. Significant non-conforming mortgage operations that have already been put out to pasture amount to about 60 mortgage companies - totally out of business, and the secondary market has effectively frozen. Reference LEND, American Home Mortgage, New Castle, most recenlty LUM to see how quickly this can bankrupt a company. These are entities that do not have to deal with the cash burn and depreciating assets of the homebuilders as well. In just a few months, Amercian went from the 10th largest lender, to bankruptcy. In just one week, LUM went from rosy managment pronouncements to postponing earnings and halting trading, stating that thier business model has simply been locked up (this is what American did the week it declard bankruptcy). All of these non-bank lenders had margin calls on their credit lines combined with an inability to sell their product. The builders use the EXACT same business model to fund much of thier sales, and in some cases the vast majority of thier sales. Some builders (such as Centex) named the mortgage subsidiary as one of the significant contributors to their bottom line, performing much better than home building. Think about it.
4. From the 2006 HOV annual report: 9.5% of our homebuyers paid in cash and 62.9% of our non-cash homebuyers obtained mortgages from one of our mortgage banking subsidiaries. Mortgages originated by our mortgage banking subsidiaries are sold in the secondary market within a short period of time. (Tell that to LUM, LEND, AHM, New Century, etc.) Even those buyers who do not need mortgages will be hurt if they cannot sell their existing properties (to those who need mortgages) to move up to their newer purchse (this is how most pay cash for the 9.5% referenced earlier). Thus the backlog that is stated in the builder's financial statements will not, and cannot, be fully realized, and thus is overstated.
5. From the LEN 2006 annual report: "We provide a full spectrum of conventional, FHA-insured and VA-guaranteed, first and second lien
residential mortgage loan products to our homebuyers and others through our financial services subsidiaries,
Universal American Mortgage Company, LLC and Eagle Home Mortgage, LLC, located generally in the same
states as our homebuilding segments and Homebuilding Other, as well as other states. In 2006, our financial
services subsidiaries provided loans to 66% of our homebuyers who obtained mortgage financing in areas where
we offered services. Because of the availability of mortgage loans from our financial services subsidiaries, as
well as independent mortgage lenders, we believe access to financing has not been, and is not, a significant
obstacle for most purchasers of our homes." For the record, second lien loans are not being bought in any volume for the week ending the day of this writing. It is the second lien loan that is used to get cash strapped buyers into homes. This is a problem for LEN, if it accounts for up to 66% of thier sales. They say they issue FHA and VA loans, but fail to break out a granular analysis. "
During 2006, we originated approximately 41,800 mortgage loans totaling $10.5 billion. Substantially all of
those loans were sold within a short period in the secondary mortgage market on a servicing released,
non-recourse basis; however, we remain liable for certain limited representations and warranties related to loan
sales." Can a company that is losing money at the rate of Lennar afford to buy back or get stuck with unwanted assets that have extremely wide spreads such as the $10.5 billion (41,800 actuall mortgages) that they quoted here?"
Increasing interest rates could cause defaults for homebuyers who financed homes using non-traditional
financing products, which could increase the number of homes available for resale.
During the recent time of high demand in the homebuilding industry, many homebuyers financed their
purchases using non-traditional adjustable rate or interest only mortgages or other mortgages, including sub-prime
mortgages, that involve significantly lower initial monthly payments. As a result, new homes have been more
affordable in recent years. However, as monthly payments for these homes increase either as a result of increasing
adjustable interest rates or as a result of principal payments coming due, some of these homebuyers could default on
their payments and have their homes foreclosed, which would increase the inventory of homes available for resale.
In addition, if lenders perceive deterioration in credit quality among homebuyers, lenders may eliminate some of the
available non-traditional and sub-prime financing products or increase the qualifications needed for mortgages or
adjust their terms to address any increased credit risk. In general, if mortgage rates increase or lenders make it more
difficult for prospective buyers to finance home purchases, it could become more difficult or costly for customers to
purchase our homes, which would have an adverse affect on our sales volume.
We sell substantially all of the loans we originate within a short period in the secondary mortgage market on
a servicing released, non-recourse basis; however, we remain liable for certain limited representations and warranties related to loan sales and certain limited repurchase obligations in the event of early borrower default."
6. Additionally from LEN 2006 report: "
Our Financial Services segment could have difficulty financing its activities.
Our Financial Services segment has warehouse lines of credit totaling $1.4 billion. It uses those lines to
finance its lending activities until it accumulates sufficient mortgage loans to be able to sell them into the capital
markets. These warehouse lines of credit mature in September 2007 ($700 million) and in April 2008 ($670
million). If we are unable to renew or extend these debt arrangements when they mature, our Financial Services
segment’s mortgage lending activities may be adversely affected."
7. Pulte relies on internal mortgage financing for nearly 100% of their home sales. This is a serious problem in the current environment. From the Pulte Annual Report: "In originating mortgage loans, we initially use our own funds and borrowings made available to us through various credit arrangements. Subsequently, we sell such mortgage loans and mortgage-backed securities to outside investors. Our capture rate for the years ended December 31, 2006, 2005, and 2004 was approximately 91%, 89%, and 88%, respectively. Our capture rate represents loan originations from our homebuilding business as a percent of total loan opportunities, excluding cash settlements, from our homebuilding business. During the years ended December 31, 2006, 2005, and 2004, we originated mortgage loans for approximately 77%, 75%, and 72%, respectively, of the homes we sold. Such originations represented nearly 100%, 98%, and 92%, respectively, of our total originations. During 2006, 21% of total origination dollars were from brokered loans, which are less profitable to us, compared with 26% and 36% in 2005 and 2004, respectively. The decrease in brokered loans can be attributed to a shift in product mix towards funded production.
8. HOV, as I am sure other builders, have not only SEVERAL mortgage subsidiaries, but off balance sheet mortgage joint ventures that have the potential to add untold amounts of additional liability and exposure to what has put so many non-bank lenders out of business.
9. The homebuilders, due to thier highly negative cash flow, have either violated or come close to violating thier loan covenants. Some have renogotiated them, but have done so with terms that they are not likely to be able to comply with. DHI has already defaulted on thier loans, just to have them bought out by a hedge fund that is charging them 15% interest, up from 9% that the bank charged them for non-invesment grade paper. This is a true junk rate that DHI just can't afford. Look at thier numbers... They are losing money hand over fist, and the market is getting worse, not better.
10. Some of builders use special purpose (financing shell) companies that banks fund and the builder repays the bank via swaps to fund thier mortgage arms (ex. Centex). Most banks require investment grade swap partners, which most builders will find hard to be identified as.
11. Rating agencies have downgraded most builders to junk status
12. Credit swap spreads are as high as 450 basis points (cost to insure builder debt)
13. Banks have been lenient thus far, but all you need is one to decide that the risk is too great and it will create a run on the builders. The first creditor to move will most likely be the one to get back the most of its lunch money. No one wants to be left holding the bag.
14. Finally, the real estate market, as we all know by now, is entering into a bust, which is most likely to protract into 2 to 3 year range. Do the homebuilders have the cash to last that long, writing down billions of dollars of asset value per year and half of them operating at negative operating earnings (Sans write downs). Will the banks, who have literally ran from non-conforming (loans that cannot be sold to government sponsored entities such as FNMA, Freddie MAC), ALT A, and subprime loans be willing to fund these money losing business that rely on these very loans to unload depreciating inventory for another 2 to three years? It appears that many of the banks have real estate related issues of thier own, and cannot prudently afford to baby sit the homebuilder.

2007 Aug 07 04:57 AM

[Rocktex:]

Thank you for your great article that refreshes my mind to the reality very much.

2007 Sep 03 01:02 PM

[Cindy S:]

Consumer advocates and a few others have for years been predicting the massive fallout coming from shoddy construction and predatory lending. It's a shame that blogs, gripe sites, message boards, etc, had it right, long before mainstream media screwed up the courage to speak the truth, and certainly long before our govt would speak the truth, (still waiting for that). Unfortunately, consumers, especially those off line, don't often have much exposure to sites like Seeking Alpha, HADD, HOBB, and so on. They tend to find those sites after it's too late, and they're looking for information that might help them undertand and control a problem that's wrecking their family finances. There are people in the housing industry who committed loan fraud and they should go to jail. Long before that miracle occurs, if it ever does, hundreds of thousands of homeowners will lose their homes and suffer lasting credit damage. I suspect tax payers will end up picking up the tab one way or another, and the real perpetrators, the builders, loan originators, certain others in the industry, will get off "scott free." Even if their reputation is wrecked and they go bankrupt, they'll just rise like the Phoenix bird out of their own ashes, but under a new name, and go on with the same thing. E.g. bankrupt Kara Homes in NJ has been in the news as reorganizing and being called Maplewood Homes. They're hardly the first to think of using a new name to hide from a checkered past.

2007 Aug 07 03:04 PM

[aquany3k:]

What can I say, there is a saying we have all used at 1 time or another that goes" someone needs to die before they do anything" well someone has died by ELECTRICUTION and not for committing a crime, but for simply doing a job in a new Lennar built Death Trap in Cleremont Fl. Sept. 20th, 2007 will be the 2nd. Birthday of his youngest daughter and the anniversary of his death. They called it a Bizarre Accidnet, may have been, but how many more accident's are out there just waiting to happen.
Our saga can be viewed at www.local6.com/video/7..., this is the investigative report done by Mike Holfield 5 mo. after my-son-in-law's death. To date Lennar, Pike Electric, ao any of their subs have accepted responcibility, they are still to busy pointing fingers, and of course playing all the Legal games they can get away with, leaving his disabled wife and 2 small children to deal with all the fall out, including loosing their home. The problem's in new homes touch so many people in so many different ways. As I type this my Daughter is back in the Hospital again, and facing a possible Heart by pass surgery in the future so now I have the responcibility of caring for my Grandchildren and her, one which I am exceedingly happy to do, not really able to enjoy ,watching the effect's this entire situation has on them. My oldest Grandaughter, who was 4 when her Daddy was killed, cries everytime we go anywhere like a playground and sees other children with their Daddy's playing, so now her fun turns to sadness and we have to leave, we cannot pass a Fouhtain of any kind without her seeking a quarter, she needs a quarter as it is a really big wish, that is always the same " I wish my Daddy will come back" and I have to do the Horrid task of explaining to her that some wishes no matter how good cannot come true, this to a Little Girl who like most believes in Fairy Tales. True there are children who loose their Daddy's every day either by act's of God or Nature, and these are very difficult to deal with as is any death of a loved one, but that you in your heart and mind can eventually deal with, we are dealing with a death caused by out right negligence, on the part of many. Bottom line is that these UNHUMANE, Greedy, non caring, and outright beligerant attitudes. I want to wish you all only the best outcome for your effort's and with every issue you have no matter who your builder was. If any of you are having any sort of electrical concerns, PLEASE PLEASE have an independent electrical inspector check it out even if you have to take or cut a wall out. Thank You for your time and concideration.
Donna

2007 Aug 17 08:37 AM

[Rocktex:]

So sad to read your article.
But life goes on with hope and wishes.
Best wishes to you and your granddaughter.

2007 Sep 03 01:00 PM