Housing: A Fresh Jolt of Bad News

KB Home reports a huge loss and Countrywide fights off bankruptcy rumors. Looks like the U.S. housing sector is in for another tough year

by Ben Steverman

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In case you were still harboring a tiny bit of optimism about the U.S. housing sector, just take a look at a couple of headlines from Jan. 8. KB Home (KBH) President and Chief Executive Officer Jeffrey Mezger said in a conference call with investors that he sees "no sign" that the sinking housing market is stabilizing in 2008, after announcing a staggering $9.99 loss per share in the last quarter of 2007.

On the same day, shares of Countrywide Financial (CFC) plunged as the mortgage lending giant denied rumors it is facing bankruptcy.

"Slow-Motion Train Wreck"

"The housing correction continues to be similar to a slow-motion train wreck," wrote Deutsche Bank (DB) economist Peter Hooper in a recent analysis of the outlook for the housing market.

KB Home's loss last quarter was much worse than expected, even though $6.85 of the loss per share is a tax-related accounting adjustment. Analysts had been expecting a loss of $1.34, according to Reuters Estimates (RTRSY).

That is a bad sign for other homebuilders this earnings season. "This points to continued pain and continued significant impairment charges for the industry," wrote Michael Rehaut, an analyst at JPMorgan Chase (JPM).

Countrywide, which supplies more than 2 million loans per year to the housing market and services more than 9 million mortgages, was plagued by reports it was about to go bankrupt. A spokesman said there was "no substance" to the rumors, but the stock of the U.S.'s largest mortgage lender still dropped more than 25% on Jan. 8.

Rumors or no, Countrywide's situation remains challenging. Standard & Poor's equity analyst Stuart Plesser says the recent slowdown in mortgage purchases by government-sponsored enterprises could put stress on the company's loan funding.

A Well-Known Litany of Problems

Mezger listed the factors that had sapped KB Home's results, and it's a familiar list: An oversupply of homes on the market, which amount to a 10-month supply. A rise in foreclosures, which adds more and more houses to the market. Increased competition. The fact that home prices had risen to a level that made them unaffordable to many buyers. Falling consumer confidence. And, turmoil in mortgage and credit markets, which have made it tougher to get a mortgage.

KB Home specializes in moderately priced homes, often for first-time home buyers. An increase in KB Home's cancellation rate from 50% to 58% may be a sign these buyers are having a tougher time getting loans, noted UBS (UBS) analyst David Goldberg.

Deutsche Bank's Hooper says the future direction of home prices may be determined by whether subprime homeowners—those with riskier credit histories and mortgage payments that are resetting to higher levels —can avoid foreclosure. Under a worst-case scenario, 40% of subprime mortgages could foreclose, and house prices could drop 15% to 20% over the next two years. If foreclosures are confined to 20% of subprime borrowers, prices could fall 5% to 10%.

In any case, "home prices could decline for the next couple years or more," putting a drag on consumer spending that "could be with us for some time to come," he wrote.

At KB Home, the statistics are grim. In the fourth quarter, the company delivered 8,132 new homes, down from 10,386 a year ago, while the average selling price dropped 12%, to $247,800. Revenue dropped from $3.01 billion a year ago to $2.07 billion in the quarter.

KB's Long-Term Prospects

KB Home has reacted to the housing slowdown by cutting costs and selling land. It has exited several markets and slowed down new building. Also, it says it's trying to build cheaper, more affordable homes.

The one bright spot: Most analysts give KB Home high marks for financial management. Most think the company—and other major homebuilders—are in a good position to survive even a long, tough housing slowdown and to prosper when the market eventually recovers.

Executives bragged about the $1.33 billion in cash available at the end of the fiscal year. KB's debt level has fallen as the company continues to generate cash even as it records accounting losses.

In fact, KB Home's $6.85 per-share tax adjustment may be an advantage over the long term. Whenever the company returns to profitability, that $514.2 million charge would return to the company's balance sheet in the form of a reduced tax bill.

KB Home's stock fell more than 9% on Jan. 8, trading below $17 per share. KB Home's executives told analysts they believe the company is worth far more. The company has a market capitalization of just $1.51 billion, even though it holds $1.33 billion in cash and is expected to generate more cash throughout 2008.

Recovery Is Still Distant

But the continued spiral of the housing market has investors understandably spooked.

Bank of America (BAC) analyst Daniel Oppenheim says he thinks KB Home will cut prices aggressively for the spring season to try to build up a backlog and reduce unsold inventory.

But such steps could only minimize losses, not spark a recovery. The fates of homebuilders like KB Home, along with mortgage lenders like Countrywide, remain in the hands of market forces beyond their control.

Steverman is a reporter for BusinessWeek's Investing channel.