Majestic Research

CNNMoney.com/Dow Jones

Optimists Expect Builder Impairment Charges To Shrink

By Dawn Wotapka
Published: April 23, 2008

The worst of the home-builder write-downs might be over.

Major builders have racked up more than $21.5 billion in charges in the last two years, fueled chiefly by falling land and house values. With a flood of home-builder earnings due in the next two weeks, some experts think the size of these write-downs, known as asset-impairment charges, will be smaller. That, they say, signals a baby step toward the housing market’s recovery.

“I expect most of the impairments are behind us,” said Vicki Bryan, senior analyst with Gimme Credit, an independent research service on corporate bonds.

So far, so good. Recent charges have paled to last year’s jaw-dropping numbers: Market titan Lennar Corp.(LEN) took a $107 million charge in the first quarter, much smaller than the $1.9 billion it took in the fourth quarter. KB Home (KBH) took a $224 million charge, compared with the $403 million it was hit by in the fourth quarter.

“It’s still early in the game, but the trend is favorable,” said Kenneth Leon, an analyst with Standard & Poor’s Equity Research. “We would conclude if asset impairments are an early indicator, that the market is stabilizing. We would view that they are.”

To be sure, this isn’t to say the nation’s home builders aren’t hurting. Most continue to nurse losses and bloated inventories they’re struggling to offload, even at deeply discounted prices, to leery American home buyers.

Late Wednesday, both Pulte Homes (PHM) and Ryland Group Inc. (RYL) are expected to continue yet another grim earnings season. Bryan doesn’t anticipate significant charges, but Lehman Brothers’ Megan Talbott McGrath forecasts $350 million in inventory-related charges for Pulte and $80 million for Ryland.

But impairments, industry watchers have learned, are practically impossible to accurately predict—creating many earnings-day surprises. Meanwhile, charges could loom for individual companies that have so far avoided them, warned UBS’ David Goldberg.

They occur as builders evaluate communities, using appraisals and other competing local neighborhoods, to adjust land values and housing prices, and as they explore abandoning options, or down payments for land they no longer want to buy. “It’s essentially a bottoms-up process where they look at each community, saying, ‘What is the market?’” Leon said. “Are we correctly valuing our land and land options? Did we pay too much? Do we have to write it down or fully write it off?”

And it isn’t an exact science: “There are a lot of assumptions that management makes internally,” said Majestic Research’s John Tomlinson.

For builder-owned parcels, charges reflect the realizable value of land and any associated capitalized costs, according to UBS. When builders can’t negotiate with the land owners, they take a hit for the option deposit. Both charges flow through the income statement and reduce book value, the value at which an asset is carried on a balance sheet.

Since early 2006, the top 15 public home builders have written off more than $ 21.5 billion in land inventory, land options, goodwill and joint-venture investments, according to Leon.

If land and housing prices stop falling, so too should impairment charges. If they don’t, “there’s a good probability write-downs will continue,” Tomlinson said.

“The land prices are really about as low as you’re going to go. They can’t fall anymore unless you’re talking about being worthless,” said John Fioramonti, senior managing director of Meyers Builder Advisors, a real estate consulting firm.

But others predict more pain to come: Builders must also compete as foreclosures sweep the nation, depressing prices, while existing home sales remain weak. That has left single-family supply 34% above the normal rate, according to Merrill Lynch, which expects home prices to fall about 15% in 2008.

“Today’s highly elevated inventories and rising delinquency and foreclosure trends will cause further significant pressure on pricing and result in continued large impairment charges over the next few quarters,” said JPMorgan’s Michael Rehaut.