Majestic Research

Reuters

Housing Shares Sink on Subprime, Earnings Jitters

Published: July 10, 2007

Housing stocks took another whack on Tuesday as investors were spooked by disappointing earnings news and the possibility of downgrades to bonds backed with subprime loans.

The largest U.S. home builder, D.R. Horton Inc. (DHI.N: Quote, Profile, Research), on Tuesday cited the deteriorating housing market when it posted its first quarterly loss since it listed on the New York Stock Exchange in 1995, sending its shares to a three-year low.

Also on Tuesday, Home Depot Inc. (HD.N: Quote, Profile, Research), the largest U.S. home improvement chain, reduced its 2007 earnings outlook and attributed the lowered view to housing market softness.

Housing jitters intensified when Standard & Poor’s said it may downgrade $12 billion worth of bonds backed by subprime loans, signaling the rating agency’s conviction that the future holds more subprime defaults.

Defaulters will return housing stock to the market, driving home prices down and pinching builders’ profits still further, said analyst John Tomlinson of Majestic Research in New York.

“How much more inventory is going to be put back into the market, when there’s already too much inventory already?” Tomlinson said.

Continued weakness in the subprime market is especially bad news for builders like D.R. Horton, which features among its offerings lower-priced homes better suited for first-time buyers who may be more willing to take on subprime loans because of patchy credit, Tomlinson said.

The wave of defaults has caused lenders to tighten credit standards, which in turn reduces the potential pool of first-time buyers, Tomlinson said.

The reduction in those numbers, combined with a surplus of more affordable inventory, could have a negative effect even on more-upscale builders by leaving real bargains available at the market’s lower end and lowering prices generally, said Tim Ghriskey, chief investment officer with Solaris Asset Management in New York.

“Builders producing housing with all the bells and whistles are not directly impacted by the collapse of the subprime market, but that real estate’s going back on the market, and it’s taking a potential buyer away,” Ghriskey said.

After the closing bell on Tuesday, another homebuilder, Ryland Group Inc. (RYL.N: Quote, Profile, Research), also warned that its quarterly results would be far lower than expected.

Builder Beware

Across the industry, home builders will lose money in 2007, said Eric Landry, analyst at Morningstar in Chicago.

“The big builders are going to show operating profits of about zero or less,” he said. “Net earnings are going to be negative for the year for the group as a whole.”

The Dow Jones home construction index (.DJUSHB: Quote, Profile, Research), which tracks home builders, closed 3.1 percent lower on Tuesday, with the heaviest losers including KB Home (KBH.N: Quote, Profile, Research), down 4.4 percent; WCI Communities Inc. (WCI.N: Quote, Profile, Research), down 5.1 percent; and Meritage Homes Corp. (MTH.N: Quote, Profile, Research), down 5.6 percent.

The latest subprime and housing news only deepens analyst and investor gloom over the housing market’s future.

“You don’t have motivated buyers out there, because pricing was at bubble levels and it’s coming down. So they think, ‘I can wait a little bit longer, and get lower prices” Ghriskey said.

Housing is soft despite favorable interest and employment rates, Tomlinson pointed out.

“If any of those pillars were to fall, the housing market could experience further decline especially because inventories on the new and existing side remain way too high,” he said.

Housing will remain weak at least through the first half of 2008, Tomlinson said, while Ghriskey said the spring 2008 selling season was the earliest he would expect to see any reduction in inventory.

But not everyone is betting on a 2008 rebound.

“No one has any idea when it will turn around,” Morningstar’s Landry said.