Home Builders Assess Risky Mortgage Exposure

New York, NY, March 15, 2007--Home builders are assessing their exposure to home buyers with weak credit histories amid a subprime mortgage lender meltdown, while one analyst estimated the figure at 8 to 15 percent of their business on average.

Rising fears of mortgage foreclosures have sent shares of home builders down about 25 percent from a recent high last month, JP Morgan analyst Michael Rehaut said at an investor conference call on Wednesday.

"We think the discount ... is overdone," Rehaut said, adding that the U.S. housing industry and particularly the large home builders are seeing some signs of stabilization of supply and demand.

Others did not share his optimism.

"Just because things are getting less worse, that means earnings are going up? No," said Alex Vallecillo, co-manager of of the Allegiant Mid Cap Value Fund, which sold its holdings in home builders about two years ago.

"They're perhaps going to be flat for a long time at a low level," Vallecillo said.

Credit Suisse analyst Ivy Zelman said the situation is likely to worsen as foreclosures increase the supply of houses on the market and depress prices.

"With delinquency and foreclosure rates continuing to rise, we believe this will result in more supply hitting the market throughout the year," she wrote in a recent research note. This could lead to another round of charges for a further reduction in the value of the land that home builders control.

Analysts say it's difficult to determine the exposure home builders have to the subprime market.

"Everyone defines subprime slightly differently," Rehaut said.

Some use the amount of the loan compared with the price, while others use credit scores and the lack of documentation of employment and income. What is more, most home builders originate only a percentage of the mortgages that their customers assume, while outside brokers account for the rest.

As a rough rule, home builders with the highest concentration of first-time buyers and lowest credit scores will probably have the most exposure to subprime borrowers, Rehaut said.

KB Home, whose customer base is comprised of about 40 percent first-time buyers, has estimated its subprime exposure at 13 percent.

Hovnanian Enterprises Inc.assessed its exposure at 18 percent in 2006, and that has gone down to 14 percent in its fiscal first quarter. First-time buyers comprise 35 percent of Hovnanian's customers, Rehaut said. 

Beazer Homes USA Inc. has the most exposure to first-time buyers, followed by M.D.C. Holdings Inc. and KB Home. Lennar Corp and KB have the most exposure to buyers with lower credit scores.

Companies with the least exposure to both of these factors are luxury builder Toll Brothers and Pulte. Only 17 percent of Pulte's customers are first-time buyers, and 40 percent of its business is derived from retired and older buyers.

Some home builders recently began limiting their exposure to subprime customers.

KB and D.R. Horton Inc. the largest U.S. home builder, won't begin construction of a home for a subprime buyer until the mortgage is approved.

"I think that's going to be a critical area of discipline for the industry this year," Rehaut said.