[NYTr] Housing Bust: Bonfire of the homebuilders

Wed Aug 8 18:36:36 EDT 2007

Business Week via MSNBC - Aug 6, 2007
http://www.msnbc.msn.com/id/20145724/

Bonfire of the homebuilders

By Mara Der Hovanesian

Elizabeth and Armando Motto are living a real estate nightmare with a
new breed of monster: the big homebuilder as lender. In November, 2005,
the couple, who have four children, agreed to pay $540,000 for a newly
built three-bedroom house in suburban Clarksburg, Md., near Washington,
D.C. Rather than send them to a bank, the builder, Beazer Homes USA
Inc., offered to provide a mortgage itself in an arrangement of the
sort that helped fuel the long housing boom across the country.

But when it appeared that the Mottos might not qualify financially for
the loan, things took a troubling turn. Beazer, according to the couple,
inflated the pair's earnings in loan-application documents by
incorrectly stating they were collecting rental income from the house
they were leaving. "I don't want to misrepresent myself," Elizabeth
said in e-mail correspondence with Beazer's outside mortgage service,
dated July 14, 2006. But in the end, the couple signed the documents,
and soon after they closed on the Clarksburg house.

They now regret it. The Mottos moved to Clarksburg, but they haven't
succeeded in unloading their previous home in Rockville, Md. They have
nearly $1 million in mortgage debt on the two dwellings. With $145,000
in family income, Elizabeth says, they are "on the brink of
foreclosure" on both houses. "We are so broke."

Beazer, one of the dozen or so large publicly traded builders that have
started or stepped up mortgage-lending businesses to put more buyers in
freshly finished houses, declines to discuss specific customers. The
Atlanta company has much more than the Mottos to worry about. On Aug. 1
its stock fell nearly 18 percent on rumors that it was preparing to
file for Chapter 11 bankruptcy court protection - which Beazer swiftly
denied, calling the Wall Street gossip "scurrilous and unfounded." Just
five days earlier, Beazer revealed that the Securities & Exchange
Commission had elevated an informal inquiry into its mortgage business
to a formal investigation. The company warned that criminal penalties
could follow. Earlier this year, Beazer received a subpoena from the
Justice Dept. seeking documents related to its home loans, and the
company is also under civil investigation by the North Carolina
Attorney General's office.

Leslie H. Kratcoski, Beazer's vice-president for investor relations and
corporate communications, says in an e-mail that the company "intends to
continue to fully cooperate with all related inquiries but does not have
further comment at this time."

Egged on by Wall Street

A diverse cast of characters combined to launch the once-in-a-lifetime
housing boom of the past five years. Traditional mortgage companies and
banks unleashed a barrage of loans, many to borrowers with iffy credit
histories who didn't bother to read the fine print about upwardly mobile
interest rates. Wall Street egged on the often-reckless underwriting by
buying vast quantities of home loans for repackaging as securities. Now
that the boom has fizzled and foreclosure rates are rising, the
important role of large homebuilders as lenders is also coming into
sharper focus.

In addition to spitting out subdivisions, many of which now stand
half-empty, builders jumped into the mortgage business to a degree they
never had. Wall Street provided the same encouragement it offered other
lenders. Even as the housing supply began to exceed demand last year,
builders kept sales brisk by pushing adjustable-rate, interest-only, and
other risky loans. In some cases they attracted clientele who couldn't
afford conventional mortgages. In others, builders allegedly violated
federal lending standards to get customers to sign on the dotted line.
KB Home paid a record $3.2 million settlement in July, 2005, to resolve
allegations by the Housing & Urban Development Dept. that the builder's
mortgage unit overstated borrowers' income, among other practices, to
obtain loan approvals. KB, which denied wrongdoing, sold its loan
business before settling.

"Homebuilders really started to push these more aggressive mortgages
down the throats of potential buyers to boost sales," says G. Hunter
Haas IV, who as head of mortgage research and trading for Opteum
Financial Services had an insider's perspective on the proceedings.
Opteum has served as a middleman between Wall Street and builders. The
Paramus, N.J. firm provided developers with financing for their
mortgage operations, then resold the loans to investment banks, which
packaged them as securities and hawked them to hedge funds and
insurance companies. The whole process added liquidity to the market
and made it easier for developers to build and sell expansively.

But by early this year, Opteum's home-loan business was going sour. The
investment banks and their clients were rejecting builder-originated
loans as too shaky and likely to go into default, Haas explains. Some
homes were turning out to be worth less than builders had claimed, and
some borrowers didn't have the income noted on applications.
"Homebuilders were getting sloppy, and Wall Street was giving more
scrutiny," Haas says. In June, Opteum decided to get out of home-loan
brokering.

Until the market turned, the growing heft of the largest developers
made it easier for them to obtain Wall Street financing for their
mortgage businesses. Once dominated by modest local firms, the industry
in the past two decades has seen the emergence of sizable publicly
traded corporations such as Pulte Homes, Lennar, and Centex, each of
which has a market capitalization of $7.5 billion to $8.5 billion. The
10 largest builders together had revenues of $98.8 billion last year,
up from only $9.3 billion in 1992. Public companies built 27 percent of
all new homes in 2006, compared with 8 percent in 1992. And in Denver,
Las Vegas, and Phoenix-markets that were scorching hot until
recently-public companies put up 55 percent or more of the new houses.

Busy developers that provided Wall Street with equity-underwriting
business discovered they had friends in the investment banking world.
"Once builders got larger and a little bit more predictable, they were
able to borrow money from various credit markets, borrow from Wall
Street, and expand more easily," says Thomas W. Smith, a building
industry analyst with Standard & Poor's Equity Research, which like
BusinessWeek is owned by The McGraw-Hill Companies.

For a while during the boom the big builders could do no wrong in Wall
Street's eyes. The Dow Jones U.S. Select Home Builders Index surged 290
percent from October, 2002, to July, 2005, as the profits of the 10
biggest developers more than tripled. But the pressure to beat quarterly
expectations didn't relent when more and more new subdivision homes
remained empty. Providing loans to financially marginal buyers was one
way some developers tried to prop up their financial performance, says
S&P's Smith. "You're trying to support earnings at high levels, so it's
conceivable that greed gets into people's minds," he adds.

Now the bust is taking a brutal toll. In January, industry analysts
predicted that the 10 biggest builders would have average earnings per
share of $3.69 for 2007; the latest forecast is for a loss of $1.18.

Sheer overbuilding, a symptom of every housing bubble, is the most
obvious explanation for the new ghost towns sprinkled around the
country. But increased builder lending helped feed the trend.
Statistics are scarce because developers don't break out their lending
revenues, but some analysts track "capture rates," or the percentage of
home sales financed by builders themselves. Pulte Homes, the largest
developer by market cap, had a capture rate of 90 percent last year, up
from 64 percent in 2000, according to Daniel Oppenheim of Banc of
America Securities. No. 3 Centex had a rate of 80 percent for the
fiscal year that ended in March, up from 61 percent.

By the time marginal buyers fall behind on their payments, the builder
has usually sold off their loans to Wall Street. But the human fallout
can be found in neighborhoods around the country.

Several developments built recently near Columbus, Ohio, by Dominion
Homes Inc., are scarred with empty houses, overgrown yards, and front
windows with neon-orange foreclosure stickers. Dominion often offered
"buy-down" mortgages in which it forgave or reduced early payments,
according to borrowers. One young couple, Travis and Kelly Gunther, say
this enticement helped persuade them to borrow all of the $180,300 they
paid in 2004 for a Dominion home in a neighborhood called Williams
Creek. Kelly has worked intermittently as an executive assistant; her
husband, a plumber, recently went to Iraq to work for a private
contractor. Kelly claims Dominion told her the couple's initial monthly
payment of $1,160 would rise $100 a year, to $1,360 in 2006. In fact,
the payment rose by more than $200 a month each year, to $1,599. She
says Dominion salespeople described annual homeowner association fees
of $50 a year that ballooned to $285, while taxes turned out to be
double the company's projection.

Although she feels misled, Kelly concedes that she and Travis didn't
carefully scrutinize the fine print spelling out their loan terms. "I
wanted the house with the tree-lined streets," she says. Earlier this
year the Gunthers lost their Dominion home in a foreclosure and are
moving to a nearby rental apartment.

Adrian Lee, a firefighter in Pataskala, Ohio, is negotiating to avoid
foreclosure on the new four-bedroom house he bought from Dominion in
2004. "I know I'm in too much house for what I can afford," he says.
Admitting that he shares blame for his predicament, Lee says of the
Dominion sales team: "They didn't explain the [$163,800] loan to me. I
didn't know after the buy-down mortgage that my payment would be so
high. The same people who help you get a home won't help you maintain
and keep it."

The foreclosure next door

Lori M. Steiner, a senior vice-president with Dominion, says in an
e-mail that the Dublin, Ohio company doesn't discuss individual
customers. But Dominion says it diligently reviews each sale to make
sure buyers are financially prepared to take on the mortgages they
seek. The company says it has done extensive research in the Columbus
area and that the spike in foreclosures there reflects broader economic
problems that have nothing to do with its financing business. Ohio,
hurt by a loss of manufacturing jobs, has one of the highest
foreclosure rates in the nation, along with California, Florida,
Michigan, and Texas.

Even some home buyers who are content with their loans claim they've
been injured by builders' lending to others. Robert V. Phillips, a
lawyer in Rock Hill, S.C., represents residents of a subdivision in
Columbia, S.C., who allege in a federal court suit that the value of
their homes has fallen as a result of foreclosures stemming from
Beazer's reckless mortgage practices with other customers. The suit,
which seeks class-action status, claims that Beazer salespeople
encouraged prospective buyers to "falsify information on loan
applications." This made it "inevitable that the subdivisions...would
experience a foreclosure rate which significantly exceeds the statewide
average," and that has hurt the value of the plaintiffs' houses, the
suit alleges.

Beazer has filed a motion to dismiss the action, noting that the
plaintiffs don't claim to have been misled or directly harmed by the
company. "The complaint," Beazer argues, "is based upon speculative
allegations of causation and conclusory statements."