| The Toll of Subprime Exposure |
| Written by Jonathan Smoke | ||
| 05.10.2007 | ||
|
Discuss this article on the forums. (0 posts) In the MarketBeat blog yesterday afternoon, David Gaffen posted the following comment on Toll Brother’s second quarter earnings release: “There’s an interesting little note out of Toll Brothers today, saying that subprime lending problems are, in fact, hurting the luxury home builder, if in a roundabout way. Despite the small percentage of Toll’s customers who use subprime loans, ‘the impact of stricter lending standards arising from problems in the subprime market is negatively affecting affordability at lower price points,’ the CEO said. But of course, everything is contained, as some want people to believe.”
That’s no surprise to me. I have been flabbergasted that Toll has stuck to reporting publicly that their exposure to subprime financing in 2006 was only 2%. And they aren’t the only builders reporting these low levels of exposure. Standard Pacific claims 2% as well. And both Ryland and Pulte claim exposure of only 3%. No matter how you look at the possible numbers, this exposure level doesn’t make sense. The only way exposure could have been this low would be that these builders sold homes exclusively to perfect credit, high income older families with plenty of cash for the down payment in highly affordable markets like Topeka, Kansas, and managed to capture nearly 100% of all mortgages in their associated mortgage companies. That, of course, was not the case. Builders are heavily weighted in high growth markets that have appreciated heavily in 2002-2005. Is there even a public builder in Topeka? Builders go where the returns are. The customer mix at all ends of the product spectrum has included people who were interested in and used subprime financing as the market share of subprime financing skyrocketed. And no builder captured more than 85% of the mortgages used to finance their products in 2006. In fact, according to the NAHB, the median capture was 65% and some builders captured less than 50%.
Our research also indicates that potentially 150,000 new homes sold in 2005 and 2006 were enabled only by subprime financing. In other words, if through tighter credit standards subprime falls to levels more like the 1990s, 10-15% of the demand at the margins of credit and affordability may have disappeared. If 15% of the market is gone, is it rational to think that any builder only has 1% exposure? And then there’s the little fact that trade-up buyers need to sell their existing homes, so even if subprime has no direct impact on a builder’s target customer, the builder’s sales are likely to be impacted by custo  mers’ needing to sell their homes to people who may be impacted.I don’t blame Toll for not knowing their real exposure. I give them the benefit of the doubt that their affiliated mortgage company only processed 2% of subprime mortgages in 2006. But let’s do a little math. Toll closed 8,601 homes in 2006. According to an April report from Citigroup Global Markets, 7% of Tolls homes were paid in cash. That leaves 7,999 homes to be financed. Toll hasn’t revealed a mortgage capture rate, but let’s assume it’s the median of 65%. That means 2,800 loans were handled externally, yet Toll likely doesn’t even know the details of this financing. We believe that 30-50% of these outside loans were subprime. If we take the low end of that range, that would mean 840 of Toll’s externally financed loans were likely subprime. So if we add to that number the 2% they know about from their affiliated mortgage company, we have a more realistic conservative estimate of 1,000 subprime financed loans or 12% of Toll’s 2006 closings. Another way to look at this is from the aggregate statistics. The NAHB has estimated that 15% of home sales in 2006 were financed by subprime lending products. Because of the distribution of new homes is weighted towards high growth and high appreciation markets, new homes were likely more impacted by subprime. Further, NAHB survey data seem to suggest that larger builders have been impacted more severely by credit tightening than smaller builders. So, 15% may be a low number for the public builders’ average exposure. And the above estimate of 12% for Toll is below average exposure. But 12% is a heck of a lot more than 2%. 
We're always looking for feedback from our readers.
|
||
| < Prev | Next > |
|---|
