Moody's Investors Service is out with a report that says several large U.S. home builders are in danger of violating their loan covenants in coming months as sales remain slow and inventories continue to swell.

The report, issued late last week, is a follow-up to an alert put out by Moody's in December, and it foretells a further deterioration in the housing market. "Now, as the spring selling season shows signs of being a bust and a stunning surge in mortgage credit problems is roiling the nation's mortgage market, 2007 looks to be a complete wash out, while 2008 is probably the earliest that some stabilization will begin to occur," the report states.

Moody's analyst Joseph Snider said in the report that "the impact of the current protracted downturn has eclipsed past slowdowns in key respects. More than half the home building industry remains in negative cash flow territory as we now head into what is widely viewed as the sixth quarter of the current downturn."

According to Snider, things are going to get worse. That is because the subprime, Alt-A. interesit only and ARM loans originated in 2005 and 2006 - with a combined value of some $1.5 trillion, are going to reset at substantially higher interest rates during 2007 and 2008. He estimates this could translate through tightened credit and foreclosures into 500,000 fewer home sales and the addition of an astounding 800,000 unsold homes to the market. In comparison, some 7.6 million new and existing homes were sold in 2006.

Moody's reports Centex, WCI, Hovnanian Enterprises, Standard Pacific, Pulte, Technical Olympic, M/I Homes, Toll Brothers, Stanley-Martin Communities, William Lyon Homes and Meritage Homes all had negative cash flows on a last-twelve-month basis at the end of fiscal 2006. Snider noted that Centex is expected to turn cash-flow positive when it reports its earnings today (May 1).

The report warns that negative cash flow could put builders covenants and credit revolvers in danger of being "triggered," which would lead to credit downgrades and perhaps worse. "While some of the home builders have succeeded in obtaining relaxation of the covenant and other will undoubtedly do the same, the fact is that these original covenants were established at levels that home builders should have been able to achieve with little effort in most situations. That they cannot signals a serious problem that could have ratings consequences."

Moody's currently has a "negative" outlook on WCI, Hovnanian, Pulte, M/I, Beazer and KB. Technical Olympic is under review for a possible downgrade.