Here's yet another reason I'd rather my Foolish friends avoid getting ahead of themselves by taking positions in the homebuilders: There's more than a slim likelihood that the builders will be figuratively rounded up in the weeks to come to be trudged off to wherever junk-bond ratings are meted out.
As you can tell, I'm one who doesn't believe that the builders' picture is likely to brighten anytime soon. Indeed, it now looks like a trio of big builders -- Lennar (NYSE:LEN), Centex (NYSE:CTX), and Pulte (NYSE:PHM) -- are being scrutinized by Moody's with an eye toward possible downgrades into the netherworld of junk. Indeed, for the first two, getting dumped into the junk cauldron would necessitate a couple of reductions by the agency.
Such a fate could make it tough for Centex by interrupting the company's ability to use its mortgage unit to fund home loans. In its most recent interim report to shareholders, Centex said that it would look to alternative sources for funding in the event that its own credit ratings made borrowing and lending difficult, or even impossible. Meanwhile, the cost to insure the company's debt with default swaps has risen in just the past week to the point where it'd set you back about $1.3 million to obtain insurance for $10 million of debt over five years.
Still other companies seemingly could be downgraded as well. While they are currently accorded investment-grade ratings, Ryland (NYSE:RYL) and D.R. Horton (NYSE:DHI) also could be cut to junk, depending on the length and ultimate severity of the current housing crisis.
For the sake of perspective: A year ago, housing had begun to slow materially, but that slowing was generally treated as a short-term phenomenon. But by early 2007, we began to learn all too well that "subprime" did not refer to a substandard grade of beef. Next, as we moved into the summer, the subprime contagion spread in earnest and credit was tightened severely for many types of borrowers. The likely next phase of the current debacle will involve a substantial intensification of home foreclosure based at least in part on an increasing rate of adjustable-rate mortgage resets.
Since I'm convinced that, depending upon the health of the overall economy, that fourth phase could last into much of 2008 -- or perhaps beyond -- I entreat my Foolish friends to find other areas than the homebuilders for their hard-earned shekels. You may miss housing's ultimate bottom, but your capital will thank you for it.
For related Foolishness:
- The Great, Exploding Housing Demand
- Don't Neglect Builders FirstSource
- It's Not Time for Toll Brothers
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Fool contributor David Lee Smith does not own shares in any of the builders mentioned and hopes Fools won't, either. He welcomes your comments. The Motley Fool has built a strict disclosure policy.
