Home Builder Stock Outlook

If there was ever one unwritten rule in the world of CEOs, it would be this: never, never, never tell them what you really think.

I mean think about it, how many CEOs of companies in troubled industries have gone on TV and told viewers about how strong and vibrant their companies were only days before they went belly up?

The answer is all of them, because in the world of business, wearing the mask in the face of real adversity is the rule rather than the exception. That’s why CEOs make the big bucks–it’s their job to inspire confidence.

So when a CEO slips and lets forth a moment of real candor, it’s enough to turn a lot of heads and raise a lot of eyebrows.

That’s exactly what happened last week when Donald Tomnitz, the boss of the largest U.S. homebuilder, let loose before a group of investors.

"I don’t want to be too sophisticated here, but ’07 is going to suck, all 12 months of the calendar year," he said.

Suck? Wow. When I heard those words I practically fell off my chair.

That’s because someone that surely knows the facts about the housing market finally had the nerve to tell the absolute truth. It was like the kid telling the emperor that he has no clothes.

He also went on to say that excess inventory, built up during the boom cycle that saw housing construction reach all-time highs, is the biggest problem facing the sector.

And judging from the state of the mortgage markets, that problematic glut is now going to be much harder to work off.

That’s because according to a recent analysis by Bear Stearns, tougher lending standards stemming from the shakeout in the beleaguered sub-prime mortgage industry could prevent up to 1.1 million U.S. homebuyers from getting mortgages this year.

"That’s a non-trivial number," said Dale Westhoff, Bear Stearns‘s head of mortgage research.

It’s growing trend that a report by Credit Suisse analyst Ivy Zelman says will heavily affect the new home business.

In her report, Zelman contends that the continued contraction in mortgage credit will create an "approximate decline of 236,000 new home sales from December’s annual pace to 887,000 units." In other words, a major decline.

Her report adds, "With delinquency and foreclosure rates continuing to rise, we believe this will result in more supply hitting the market throughout the year. In addition, we estimate that current inventory figures released by the NAR could ultimately be 20% higher when homes currently in the foreclosure pipeline hit the resale market."

Against this backdrop, and amid all of the sub-prime noise, homebuilding stocks have quietly declined to near their 52-week lows.

So are the new home builders the next shoe to drop? Probably.

After all, given the current conditions the downdraft seems inevitable.

Just take a look at this five-year chart from Hovnanian Enterprises (HOV:NYSE). It encompases the full run of the bubble and is nearly the mirror image of all the others in the business. Man, is it ugly.

Technicians, of course, will recognize not one but two "head and shoulders" tops.

The first began at the end of 2004 and ran until spring of 2006, when housing stocks broke down the first time.

The other one, of course, is much larger. Not surprisingly, it began when the traditonal lending standards were first tossed aside with conviction in 2003. Conversely, it is now beginning its descent just as lending standards are tightening up again, completing a neat little circle of sorts.

Add it all up, and building stocks go much lower. In fact, if you were being honest you just might say that they will "suck."

But you didn’t hear that from me.

And for those of you that are all hung up on book value, consider this: New Century Financial’s book value last quarter was $37.21 per share.

Before being delisted this week its share price fell to $1.66.

Mortgage Matters

Dear Steve,

I have an adjustable rate mortgage that is going to reset for the first time this year. The problem is that I’m not really sure how it all works, the reset that is. Can you help me understand what to look for?

Thanks for your help.

P.W.

Dear P.W.,

Unfortunately, you’re not alone. According to recent estimates, some $1 trillion in mortgages are set to go higher this year, creating "payment shock" for nearly all of those borrowers.

To understand exactly where you payment may be headed, you need to go through your closing documents and find your adjustable-rate note. Of all the documents you signed, this one is the most important because it is the agreement between you and your lender to pay back the loan over time.

In fact, if you had to pick any one document to actually read at settlement, this would be the one.

You won’t find your new payment spelled out in its pages, but you will find the information that you need to figure it all out.

So let’s start with the basics. Your loan, like all ARMs, is tied to an index. It may be the 11 District Cost of Funds Index (COFI), the London Inter Bank Offering Rate (LIBOR) or the Constant Maturity Treasury (CMT), just to name a few. Approximately 80% of all ARMs are tied to these indices.

Once you figure out what index your loan is tied to, you then need to find the margin value. The margin is specified in your note and remains fixed over the life of your loan

This number will usually be between 2% and 3%. The lower the better.

In order to find out your new rate, then, you need to add the margin figure to the current value of your index.

For instance, let’s assume that your loan is tied to the LIBOR and that you have a 2.5% margin.

If your loan reset today, your lender would add your 2.5% margin to the current LIBOR value of 5.25% and your new loan would carry a rate of 7.75%.

Remember also that most ARMS offer built-in caps to protect against enormous increases in payments. These caps are both lifetime and periodic, and none of your resets can exceed them. These caps will also be found in your note.

Hope that helps,

Steve Christ, Editor

By the way . . . According to a report published today by Reuters, top investment guru Jim Rogers sees nothing but further pain for the housing market.

A commodities ace, Rogers earned his fortune along with George Soros when they co-founded the Quantum Fund in 1970. Along the way, they generated the type of returns that legends are made of. Before he retired in 1980, the fund delivered gains of 3,365%, while the major averages advanced only about 20%.

In the story, Rogers says, "Real-estate prices will go down 40-50 percent in bubble areas. There will be massive defaults. This time it’ll be worse because we haven’t had this kind of speculative buying in U.S. history

"When markets turn from bubble to reality," Rogers continued, " a lot of people get burned."

Wishing you happiness, health and wealth,

Steve Christ, Editor