Fitch Ratings Sees Better Times for Builders in 2010

Written by: Steve Cook   Tue, December 15, 2009 Beyond Today's News, Forecasts


A four-year downturn has evidently come to an end for U.S. homebuilders, according to Fitch Ratings in its outlook report for the sector.

While Fitch maintains a negative outlook for U.S. homebuilding in 2010, the homebuyer tax credit has positively influenced housing over the last few months. Pending home sales, existing home sales, single family housing starts and single family new home sales have all been generally showing improvement after bottoming out earlier this year. The same holds true for new home inventories, home pricing and consumer and builder sentiment. Moreover, the U.S. economy apparently moved from recession to expansion in third quarter-2009.

However, challenges remain, especially the expected upcoming surge in delinquencies and foreclosures for both Alt-A and option adjustable-rate mortgages (ARMs).

Fitch raised its forecasts for starts and new home sales earlier this year, the first positive adjustments in these metrics in over three years. Nevertheless, the rating service anticipates that the early stages of the expansion may be more muted than the average.

During the first 12 to 15 months, the recovery may appear jaw-toothed as substantial foreclosures now in the pipeline become distressed sales, and as meaningful new foreclosures arise from Alt-A and option ARM resets. High unemployment rates and the probable tightening of certain FHA loan standards (higher minimum credit scores for new borrowers and greater upfront cash requirements) will slow recovery.

‘The continuation and expansion of the national housing credit should partially help offset expected seasonal declines during the winter months through the spring of 2010,’ said Managing Director and lead U.S. homebuilding analyst Robert Curran. ‘The federal government’s continuing efforts to moderate foreclosures may also show some success in 2010.’

Despite having fewer competitors, publicly held builders will continue to be challenged and need to maintain tight controls over costs and expenses during 2010.

Housing continues to be weak. Fitch expects that the public builders by and large to typically stabilize their aggregate land positions over the next 6-to-12 months or selectively add to owned, developed lot holdings. The still irregular flow of appropriately priced land from banks and others tends to support this conclusion.

‘With operational and financial pressures moderating to some extent, most public homebuilders have to operate successfully within this still challenging environment or wither away,’ said Curran. Companies have to at least maintain current cost profiles or continue to downsize to the point where they can remain/be profitable (excluding nonrecurring real estate charges). That means possible further moderate cuts in staffing and other overhead, as well as other cost reductions.

Despite the negative outlook for the sector, continued progress in industry and company metrics could prompt a reassessment and possible revision of some of the U.S. homebuilder rating outlooks.

Fitch expects the economy to return to positive growth next year, primarily reflecting the impact of the fiscal stimulus package, but also some likely stabilization in housing investment and a weakening inventory overhang. The CBO predicts federal government spending grew by 34 percent in nominal terms in fiscal 2009 (ending September), which should have an important subsequent multiplier effect on wider spending. Lower household tax rates should also help ease the pace at which consumers deleverage through cutting expenditures, while lower commodity prices will also support consumers’ real income.

Rates on 30-year fixed mortgages averaged 6.03 percent in 2008, off 31 basis points (bps) from the 6.41 percent in 2006 (and 6.34 percent in 2007). Fitch expects rates to decline as much as 90-100 bps for all of 2009 as the Fed continues to execute its plan to buy mortgage securities and the economy struggles.

Fitch’s initial outlook for the housing sector in 2009 started quite bearish due to the influence of a softening economy, even tighter credit standards for homebuyers and the effect of late 2008 disruptions in the credit markets. However, by mid-year the outlook brightened, prompting lesser forecast declines for a number of housing metrics. Fitch most recently forecast a contracting economy during first half-2009, with a mild recovery beginning in 3Q’09 and continuing through 2010. Real GDP is forecast to decrease 2.5 percent for all of 2009. Investment is expected to plunge 17.6 percent, with consumer spending to fall 1percent, exports to drop 11.6 percent and imports to see a 16.6 percent decline.

Given Fitch’s macroeconomic forecast for 2010, public builders are likely to experience a mild recovery next year. On average, revenues should expand low double digit despite lower home prices due to a mix shift to smaller, often entry level homes. Gross margins should improve 150-200 basis points reflecting earlier real estate charges and lesser selling incentives. With higher volume the typical SG&A expense/sales ratio may diminish.


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