Let's say Coca-Cola had to disclose in its financials so much information about its interactions and transactions with ingredient sources, manufacturing partners, and other suppliers that its so-called secret formula was no longer a secret.
Or what if Google, in its Securities and Exchange Commission (SEC) documents, had to map out its financial partnerships with software designers and hardware component providers in such detail that the search engine was no more mysterious and duplicable than a plastic Visible V-8 engine model used for hobby?
Now, that would be transparency!
Undoubtedly, their investors, creditors, and government agency regulators would feel that they were getting a clearer picture about the nature of relationships with outside entities and suppliers, which would allow them to make smarter investment decisions; more informed assessments about the relative risks around borrowings and potential windfalls; and more straightforward pronouncements about the validity of the corporate accounting.
The problem is, though, without its secret formula, Coca-Cola would not be the Coke we know today, and Google likely would have been a dot-com casualty circa 2000.
So it is perfectly understandable why home builders bristle about SEC attentions, ratings company assessments, and securities analysts' constant clawings for greater detail into what is essentially their secret sauce–proprietary land position strategy.
No trend in home design or land use has managed to supplant “location, location, location” as the first three reasons home buyers buy. So land, which accounts for 25 percent to 40 percent of construction costs, is precisely that–the secret sauce.
Land deals come in infinite varieties, mostly because there are always people and always terms of negotiation involved. And many deals' terms work in seeming defiance of accounting practices and typical risk and benefits analyses that attempt to make them look and work all the same.
This brings us to the latest firestorm over accounting for optioned and joint ventured land. At September's JPMorgan National Homebuilders Financial Executive Symposium, Joseph Snider, vice president and senior credit officer at Moody's, presented his latest polemic on the complexities of dirt.
Snider's mission for Moody's is to fairly represent risk to the debt home builders carry among lenders. He says that while he understands that land positions, strategy, and financial terms are part of the secret sauce of their business, banks and lenders obsessed with liability to equity ratios want more visibility into each kind of land structure or else.
The “or else” means a credit ratings punishment of sorts. “Absent clear financial statement disclosures, well above and beyond the current norm, [and] significant use of off-balance sheet land acquisition structures will put downward pressure on ratings relative to companies with less complex and more transparent structures,” explains Snider in his August analysis, “U.S. Homebuilding Land Options and Joint Ventures: Hidden in Plain Sight?”
Home builder financial officers don't begrudge Snider about his having to do his job. They do contend, however, that many of the accounting principles and rules that apply to the financial structure of their land positions, particularly FIN 46, unfairly characterize the risks involved in those deals.
So builders are left with a dilemma: To remain stubbornly unwilling to disclose details in their land dealings or basically, to reveal to everybody the closely held secrets of their businesses. Tough choices.
Moody's Swing Adjusted home builder debt-to-capitalization can effect what lenders charge for credit based on their perceived risk.
