Beazer Fallout Hits Homebuilders

Shares in the sector slumped Wednesday on word of a criminal probe of the Atlanta-based company's lending practices

Homebuilders came under fire in the market again on Mar. 28 after news that the North Carolina field offices of the Federal Bureau of Investigation, the Internal Revenue Service, Inspector General of Housing & Urban Development, and the Justice Dept. have opened a criminal probe into lending practices, some financial transactions, and other dealings at Beazer Homes USA (BZH) (see BusinessWeek.com, 3/27/07, "Feds Are Investigating Homebuilder Beazer"). The headline reignited investor fears during recent weeks about industries that are feeling the pain from the housing slowdown.

Atlanta-based Beazer, the nation's sixth-largest residential homebuilder, said in a statement Mar. 28 that it believes articles recently published in the Charlotte Observer fueled a request by the U.S. Attorney's Office for documents about Beazer's mortgage business, as reported by BusinessWeek.com on Mar. 27. The company has been in contact and is cooperating with the U.S. Attorney's Office, but so far there have been no allegations of wrongdoing or evidence found in internal investigations to support claims in recent articles, Beazer says.

Market players took the news seriously. In one example, Morningstar analyst Eric Landry put his fair value estimate on Beazer Homes under review, pending additional information. "Details about the investigation have been sparse, but numerous media reports suggest the Federal Bureau of Investigation, Internal Revenue Service, and Department of Housing and Urban Development are looking into possible fraud at the company's mortgage lending unit," Landry said in a note.

Investors dumped Beazer Homes stock by 10.2% to $28.21 per share in early afternoon trading on the New York Stock Exchange March 28. Others in the sector moved in sympathy. Shares of the largest builder by volume, Fort Worth-based D.R. Horton (DHI), sank 2.2% to $21.98 per share; Toll Brothers (TOL) shed 2.1%, to $27.80, and KB Home (KBH) fell 2.9% to $44.

After the homebuilding industry grew sharply during the first half of the decade and added employees at a rampant pace, those companies have struggled to maintain quality controls, AG Edwards analyst Gregory Gieber pointed out in a Mar. 28 research note. Today's news about Beazer Homes is an extension of the broader subprime issue, Gieber says.

As foreclosure rates rise, the market has been barraged with bad news from companies that lend to people with poor credit. In one of the latest examples, the New York Times reported March 28 that the Irvine, Calif. subprime mortgage company New Century Financial (NEW) could file for bankruptcy protection as early as the end of this week. (The article sourced people briefed on the company's plans.)

But New Century isn't the only one in trouble. Uncertainty has roiled the mortgage industry during recent weeks, as subprime specialists ranging from Accredited Home Lenders (LEND) to Fremont General (FMT) also struggle with their finances.

Concern has been growing that the fallout will hurt consumers, homebuilders, lenders and the broader economy. In one recent example, the Miami homebuilder Lennar (LEN) on Mar. 27 said its profits fell more than 73% in the three months ended February as potential customers balked at buying homes. The company withdrew an earlier promise that its 2007 earnings would top last year's.

"Given the state of the market, we do not expect to achieve our previously stated 2007 earnings goal, and we are not comfortable providing a new earnings goal at this time," Lennar CEO Stuart Miller said in a press release (03/27/2007, "Lennar Report Adds to Homebuilders' Gloom", http://www.businessweek.com/investor/content/mar2007/pi20070327_445486.htm?chan=search.) After having already taken hits the previous day, Lennar shares fell 2.9% to $43.23 per share on March 28.

Barney Brodie contributed to this report