Who Will Be the Next Homebuilder to File Chapter 11??

Includes: MTH, TARR, WCIM
by: Scott Weitz

I have to be honest. I have been a housing bear for quite some time. Not once amidst this “credit crisis” have I heard a strong argument that things are improving, nor can I find reliable statistics that would indicate a recovery. Home prices have continued to fall and we have seen a significant rise in foreclosures the past 12 months. Mortgage delinquencies more than doubled in the past year and more than 155,000 homeowners lost their homes in bank repossessions during the first quarter of 2008. Moreover, the total inventory across the U.S. has risen to an average of 10 months worth of unsold homes with 2.9 million vacant homes currently for sale according to the Census Bureau.

With that gloomy foundation set, I thought I would grace readers with a list of homebuilders that are inching ever so close to bankruptcy. After considering most of the publicly traded residential builders in the US, I narrowed it down to a handful of companies that seem most likely to file Chapter 11 sooner rather than later.

Tarragon (TARR)

Tarragon operates both a Development Division and an Investment division. Obviously, the development division will be under heavy fire with the glut of homes on the market. According to the company’s website, Tarragon has over 14,600 homes under active development. It would be an irresponsible and premature statement to declare that these developments will be a failure; however, the general economic conditions do no bode well for them.

The Investment Division, which consists mostly of apartment complexes, should help their bottom line as the rental market has been strong given the inverse relationship to new home sales. This Division could help Tarragon remain afloat while the dust settles around the new construction industry, but it seems like a long shot. Here’s a glimpse of what company executives have to say, as well a look at the underlying fundamentals:

Executive quote from the 2007 10-k:

Sudden and rapid deterioration in the real estate credit markets prevented us from completing financing transactions that had been under negotiation, materially affecting our liquidity , including our ability to repair existing indebtedness as it became due, meet other current obligations, and our ability to comply with financial covenants contained in our existing debt agreements.

Financials (numbers in thousands):

  • Total Assets: 1,134,084 – down from 2,022,761 in 2006
  • Total Liabilities: 1,246,071
  • Operating Loss (2007): (379,287) – down from 3,341 in 2006
  • Stockholders Equity: (112,817) – down from 279,514 in 2006

Bottom Line

Tarragon faces decreasing margins, increasing inflation and a real estate market that is not poised to help them with either of these issues. To their credit, they have begun focusing on the Investment division to boost earnings, but I think this mountain is be too tall for them to climb as they are currently operating at a loss and liabilities already exceed assets.

WCI Communities, Inc (WCI)

A Florida Condo developer…need I say more? WCI operates out of Florida and has developed communities of luxury homes and high rise developments in Florida, the Northeast, and a small region in the Virginia area. They also maintain Mortgage and Title businesses.

  • Financials – 2007
  • Total Assets: 2,891,231 - down from 3,831,859 in 2006
  • Total Liabilities: 2,471,197
  • Operating Loss (2007): (582, 070)

A quote from the most recent 10-Q:

Holder of our 125 million, 4% contingent convertible Senior subordinated notes due 2023 (convertible notes) have an option of requiring us to repurchase convertible notes at a price of 100 percent of the principal amount on August 5, 2008….We do not anticipate having sufficient liquidity to satisfy bank covenant liquidity tests….we may try to re-negotiate…either situation would have an adverse effect on the solvency of our company.

Bottom Line

Can you say, “throw me a life jacket, please? Assets diminishing rapidly, coupled with a current operating loss and a huge debt load, is never a good sign. Granted, the current financier may want to renegotiate a deal to avoid bankruptcy protection, but that may just be delaying the inevitable. Unless WCI has a major turnaround soon or a stroke of good fortune, they’re going to meeting with a bankruptcy trustee in the near future.

Meritage Homes Corp (NYSE:MTH)

Meritage Homes Corporation is a builder of single-family homes in 12 metropolitan areas including Arizona, Texas, California, Nevada, Colorado, and Florida. They are headquartered in Scottsdale, AZ.

Financials (2007)

  • Total Assets: 1,748,381
  • Total Liabilities: 1,018,217
  • Operating Loss (’07) (420,069) Down from a 331,812 gain in ‘06

Bottom Line

While Meritage may not be on the brink of Chapter 11 like the others, they are in the fast lane headed in that direction. They have no diversification of business activities outside of residential development, and the regions they operate in are among the hardest hit by the Real Estate fall out. Inventory of unsold homes in Arizona is off the charts and Meritage does not have the capital to stay in the game as only the strong will survive in these competitive regions over the coming years.

Disclosure: none

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