Building Woes for Beazer

The ouster of its accounting officer "suggests there could be corporate involvement" in a lending scandal, according to one analyst

by David Bogoslaw

As if mounting defaults on subprime mortgages, tighter credit standards, and bloated inventories of unsold homes weren't problems enough, Beazer Homes USA (BZH) has another mess on its hands. After the market close on June 27, the sixth largest residential homebuilder in the U.S. said it had fired its chief accounting officer, Michael Rand, for attempting to destroy documents, a violation of the company's document retention policy under its code of ethics.

Rand's ouster "dramatically increases the appearance of the company's culpability" in a swath of recent lawsuits alleging improper lending practices, Citigroup Global markets said in a research note on June 28.

Beazer's aggressive lending practices and some of its financial transactions have been under the microscope since March, when the Federal Bureau of Investigation's North Carolina field offices, the Internal Revenue Service and the Justice Dept. launched a wide-ranging criminal probe. The criminal investigation division of the Housing and Urban Development Department also joined the fray due to the large portion of Beazer's loans made to low-income borrowers (see BusinessWeek.com, March 28, 2007, "Beazer, Builders Under a Microscope").

Until recently, equities analyst Gregory Gieber at A.G. Edwards & Sons said he believed what was occurring in the Carolinas was a "rogue operation," outside the view of the corporate office. One thing that apparently tipped off investigators was an exceptionally high foreclosure rate -- in the mid 20% range -- for a particular residential subdivision.

"[Rand's] firing changes the profile and suggests there could be corporate involvement in it," Gieber said.

Behind the most obvious question of what was in the documents being shredded looms a more important question: "Was he shredding under orders? If not, who else had knowledge of the information in those documents and what does it imply for the then-CFO?" Gieber said, who has had a sell rating on the stock since March.

James O'Leary resigned as chief financial officer on March 22 to become chief executive of Kaydon Corp., a specialty engineering and manufacturing company.

Beazer did not respond to a request for comment prior to publication of this story.

The chief accounting officer isn't generally the person who sets financial policy, nor does he under normal circumstances have primary responsibility to approve major financial transactions, Gieber said. That begs the question of what was going on at corporate headquarters that someone felt needed to be buried, he added.

In its note, Citigroup said it was downgrading the stock to speculative hold from speculative buy and cutting its 12-month target price to $32 from $49 a share. Regardless of how the lawsuits are resolved, "we do not expect the intense cloud of uncertainty around the company to abate any time in the foreseeable future," virtually killing any chance of its outperforming over the next few quarters, the note said.

Besides the lawsuits, Citigroup said its downgrade was also based on the Atlanta company's unwillingness to abandon a bigger portion of the land options it held at the peak of the housing cycle, in contrast to its peers. Beazer probably put down large deposits to hold those options and will be forced to write them off in their entirety at some later date, since the cost basis of optioned lots can't be impaired.

Beazer swung to a net loss of $1.12 a share, in the second quarter of fiscal 2007, ended March 31, from a profit $2.35 a share a year earlier and soon after withdrew its full-year profit estimate of $1.25 to $1.50 a share, excluding land charges, due to the slump in the housing market.

Beazer shares fell 7.3% to $26.46 in afternoon trading June 28 after touching a 52-week low of $26.12 earlier in the session.

Further confirmation of housing market woes came early June 28 when KB Home (KBH) reported a loss from continuing operations of $2.26 a share, for the second quarter, versus a profit of $2.20 a share a year earlier. A pre-tax land impairment charge of $308.2 million compounded the damage from a 36% drop in revenue. Wall Street analysts had been looking for a profit of seven cents a share.

KB Home shares dipped 0.35% to $40.29 in afternoon trading June 28.

Gieber doesn't own Beazer stock and A.G. Edwards doesn't do investment banking with the company. Citigroup has an investment banking relationship with Beazer and the bank, or its affiliates, has a significant financial interest in relation to the company.

Bogoslaw is a reporter for BusinessWeek's Investing channel.