The release of Levitt Corp.'s third quarter earnings on Nov. 9 proved to be the nail in the coffin for production home building's longest-lived legacy. Beleaguered subsidiary Levitt and Sons filed for Chapter 11 bankruptcy after steep impairment charges on home building inventory drove the parent company to a $169.2 million loss during the quarter.
The bankruptcy marks the painful passing of one of the industry's most well known brands and leaves stakeholders in hiatus as assets are evaluated. More significantly, it establishes a new threshold of pain for the industry. Prior to Levitt and Sons, bankruptcies had been caged in the private sector. But the news of its bankruptcy filing opens the door to the public builder sector.
Cash crunches of the ilk that ushered regional private builders like Illinois-based Neumann Homes and California-based Dunmore Homes into insolvency threaten to do the same for a handful of publics. It's touch-and-go these days at both WCI Communities and TOUSA, and the situation could get uglier at companies including Standard Pacific Homes, Beazer Homes USA, and Hovnanian Enterprises if management can't generate cash and pay down debt.
Bondholders are growing increasingly jittery, and their nervousness over the industry's outlook is manifesting itself in declining bond prices. More telling is that spreads on credit default swaps for public home builder debt are increasing, meaning that the market is pricing in an elevated risk of company defaults on their bonds. The cost of purchasing this type of credit insurance for home builder bonds has grown in recent months, particularly for Standard Pacific, Hovnanian, and Beazer. KB Home is the notable exception; it's the only large public builder to experience a decrease in the cost of insuring its bonds.
Bond prices and credit default swap spreads are arguably shortsighted and volatile, but finance experts still look at them as a leading indicator when it comes to possible bankruptcies. And from today's standpoint, more public builder failures are imminent.
How executive teams choose to manage the bankruptcy process will determine how much home building's competitive landscape will change. Management can try to resuscitate the ailing companies or just let them expire.
In the case of Levitt and Sons, the parent company is likely to deconsolidate the subsidiary, ridding itself of what some would deem an albatross on its balance sheet. Without the home building subsidiary and its more than $400 million in debt and depreciating land assets, Levitt could emerge from the mess a more financially stable entity, albeit a much smaller one solely focused on land development.
"The best thing that could happen would be for Levitt to get rid of that giant anchor wrapped around its neck [in Levitt and Sons]," says Eric Landry, a home building analyst with Morningstar.
In the meantime, Levitt executives will be counting on Lawrence E. Young, a managing director at global restructuring, consulting, and financial advisory firm Alix Partners, to sort out the details of the bankruptcy as the company's chief restructuring officer. Young states he will "explore the potential sale of all or some of Levitt and Sons' assets" to repay creditors.
The company ceased making interest payments on $2.6 million in debt owed to its five lenders as of Oct. 10, triggering defaults on $181.5 million in loans and a $125 million revolving credit facility.
Levitt and Sons' liquidity crisis has its roots in CEO Alan Levan's ambitious plans to grow the company to 10,000 homes by 2010. The company expanded into several new regions at the height of the housing frenzy, often paying premium prices for competitive land position.
Today, a significant number of communities are underwater, forcing management to authorize the use of hefty incentives, dramatic price reductions, and aggressive marketing tactics to drive sales and reduce inventory. The strategy has met with limited success as margins have compressed and cancellations ballooned to 76.2 percent in the third quarter.
Founded in 1927, Levitt and Sons became the industry's biggest brand with its post-WWII construction of the mass-produced Levittown communities in the Northeast.
Hot Button Q&A
Although he has only been president and COO at Newport Beach, Calif.-based William Lyon Homes since March, Doug Bauer has spent almost 20 years with the company. During his tenure as division president for Northern California, Bauer was at the helm of a team-based, sales organization focused on customer experience. In November, he spoke with senior editor Lisa Marquis Jackson about his sales strategy.
BB: William Lyon is active in some of the toughest markets in the country. How do you compete?
DB: If you don't sell a buyer on the experience, you won't be successful. There are seven phases of customer urgency in buying a house, and those are all emotional attachments.
BB: Can customer experience really help your business in today's environment?
DB: Yes. It's as critical as it has ever been in our industry, because in order to separate ourselves from the competition today, we need to make sure that we get the home buyers to have an emotional attachment to the house.
BB: How do you expand the focus on customer experience beyond the sales team?
DB: We are all in the sales business right now. When a super does a pre-flooring walk or meets the buyer in the sales office, [he] is a salesperson. I told them, "You are the expert. The homeowner thinks you know everything about building a home." That's a lot of responsibility. The warranty people, they are salespeople for one to 10 years after a customer buys a house. Referral rates pay huge dividends.
The real mantra is to change the organization to be a sales oriented, customer focused, customer experienced business. I can't compete with Horton or Lennar on [pricing] techniques, but you can go through my communities, and I think I am selling as well as they are. We want to keep everyone in this mode, because when we come back to better times, we'll be that much more successful.