The Homebuilding Equity Research team at Credit Suisse is out today (March 12) with a pair of sobering reports regarding home builders and the credit market. Among conclusions drawn by the team: a rebound in sales in 2007 is less likely; pricing of new and existing homes will continue to fall; and the fallout from lax standards for mortgage qualification will be more widespread than has been generally reported.
"With over four weeks of the commonly cited spring selling season in the books, we are more confident that expectations for a 2007 rebound in demand are premature," the report states. "We expect pricing to remain under pressure for the foreseeable future," the report continues. "Adding to these concerns is the meltdown in the subprime space that is likely to impede financing at the entry-level, the effect of which is spreading to other price points on the housing pyramid."
Credit Suisse, which downgraded building stocks to "underweight" in December, now expects earnings per share among the publicly held building companies to fall 78%, excluding impairments, compared with a 13% decline in 2006. It expects orders to fall 30% from their peak, which, when combined with existing backlog, will result in a 24% decline in closings. It also expects closing prices to fall 6% and operating margins to fall to 5.4% year over year.
Regarding the credit market, Credit Suisse issued a separate report that estimates that as many as 565,000 homes that are now in the process of foreclosure could be put on the market within the next two to six months. When added to the estimated 135,000 that are already listed or about to be listed, the total inventory of foreclosed homes could increase existing home inventory, as reported by the National Association of Realtors, by as much as 20%.
Moreover, Credit Suisse estimates that 40% of all mortgages originated in 2006 were either subprime or Alt-A mortgages (20% each), the two categories where default rates are climbing. Though the Alt-A category is considered less risky because holders of these mortgages generally have higher credit scores than those in the subprime market, a "staggering" 81% of these loans featured low or no documentation, so called "liar loans." Also, their loan-to-value ratio for 2006 was 88%. Another 55% of home buyers who took out these loans in 2006 also took simultaneous second mortgages (piggybacks). And 28% of Alt-A loans in 2006 were of the one-year hybrid ARM variety.
"We do not want to underestimate the impact that rising foreclosures and delinquencies will have on the supply and pricing dynamics of the housing market, the Mortgate Report states. "Given the recent credit deterioration in the subprime and Alt-A markets, and the likely fallout throughout the entire housing chain, we are of the opinion that there is a real threat of 'pent-up supply' that will hit the market in the next six-to-twelve months as a result of the lax underwriting standards of recent years."
Regarding pricing, the Mortage Report states, "Several of our builder contacts have reported increasing instances of appraisals coming in below the price that the home was sold for a few months earlier, which is causing builders to lower the price to the appraised value. In some cases, appraisals that were done thirty days before closing are coming back to the table just days before closing due to falling home prices."
The same is happening in the market for existing homes, according to Credit Suisse. "Many builders have reported buyers in backlog that have had to cancel because when their existing home was appraised, the appraisal value came in below their sales price and outstanding loan value. While most of the focus on lending tightening has been on the actual mortgage products and lending criteria, we believe that this headwind may prove to have a significant impact on the overall housing market by forcing the next drop in home prices, as reluctant home sellers finally face the reality that their home is not worth what it was two years ago."