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| Digging Further into Off-Balance Sheet Financing |
| Written by Jonathan Smoke | |
| 08.02.2007 | |
Discuss this article on the forums. (0 posts) Thanks to some commentary from a few public builder insiders and yesterday’s explanation from Gary Saykaly, I now have a better understanding of what the various forms of off-balance sheet investing may mean to public builders in a time of declining prices.As I mentioned yesterday, these vehicles should be even more popular for builders of all types in this sort of market as they generally share risk and potential return among parties. That said, I have learned that these off-balance sheet vehicles would make it far more difficult to analyze the value of public builders as there are implications that could be hidden from traditional balance sheet analysis. I’ve been told to think about financing land investments in five main categories: 1. traditional investment on the books funded by company’s overall capital; The first three categories are the easiest to understand. Here land assets are reported in inventory and the option contracts are held as assets. We hear about market impacts to these categories through impairments as builders revalue inventory based on lower land prices and absorption pace, and through charges for walking away from option contracts. Beyond these three categories, public builders report the lots owned and under control, which should include land held even through off-balance sheet JVs and land banks. But to understand financial implications of the latter two categories you have to dig through the footnotes in the 10Qs and annual reports, and even then the picture isn’t necessarily clear. Here’s why. Even though the builder is but one party to the joint venture, the builder is often on the hook for repayment and loan-to-value guarantees for the joint venture’s financing. Again in the footnotes you can find that sometimes builders recognize a liability for these guarantees, but in other cases they are not deemed material. Finally, the land bank agreements could also pose a risk in that depending on the terms of the agreements, a builder may face a situation where they are obligated to take down lots at prices that are no longer realistic. I expect most builders have other contingencies in place to avoid this situation through loss of deposits, payment penalty, renegotiation of terms, etc. I have faith in the reporting requirements in our post-Enron world that most of the big risks have been documented and made public somewhere. I will put a big caveat on all I have described here that without weeks of time to parse through filings on Edgar, it’s unclear to me just how much has been disclosed and to what extent they have been used, but at least I was able to shed some more light on the question posed by a member of our HousingIntelligence community. In theory, these vehicles make economic sense, so builders shouldn’t be discouraged from using them. But, if someone was trying to analyze the value of public builders through simple balance sheet analysis, these ventures complicate matters. By the way, housing derivatives would make a perfect complement to these vehicles. If one of the major downside risks is a decline in prices, a well-crafted hedging strategy could contain that risk. But I will save my thoughts on that for another day. 
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