Value of Standard Pacific's Land Owned

Some insightful commenters are debating the SPF book value post:

"Need to know how much of the land they owned was purchased before 2004. This land probably appreciated 50% and has no chance of going underwater and might be understated on balance sheet. Perhaps $400 million of the land on the balance sheet is from pre 2003 and is actually worth closer to $1 billion. You need to check this out. But I suspect you are right that book value is somewhere under $20 but may not be as bad as you think. Without being able to do a detailed analysis of their land holdings you have no clue what the land might be worth."

Of course I wish that SPF would give us a list of their land holdings. But until they do, we can only make educated guesses.

First of all, builders do not use LIFO or FIFO accounting for land inventory because land is not fungible. Each parcel is unique.

I think we can say that SPF's landholdings are skewed to the more recent. In a sense, the first-in land is the first-out, because they 1)buy it 2)entitle it 3)build it 4)sell it. They buy land to replace what they get rid of through home sales.

That is why land developers exist. They take the highest risks in order to get in front of the homebuilders and sell land into the builders' pipelines.

Indeed, SPF is not in the business of investing in land for the long term. From the 2006 10-K: "We generally purchase land only when either substantially all material entitlements have been obtained or our management team has determined that no material impediments exist to obtaining such entitlements, and we anticipate commencing development or construction within a relatively short period of time."

We know that they bought $1B land in 2006, at least that much in 2005, and they've never had more than $4B in inventory. I get the sense that they turn over their land in under four years, so I question how much of the land on the balance sheet is from pre-2003. (They do have JV lots that are as old as 1997.)

Second, land bought pre-2003 might have been worth 2.5x during the height of the mania, but now it is probably worth par. Possibly even less. This real estate bubble has been going on longer than four years. And when land values fall, they fall hard. They are a bet on home prices and builder profit margins.

I grant that the old JV land, and the old land owned (if any), are undervalued on the books. But my suspicion is that the amount of that land is dwarfed by the way overpriced land.

Standard Pacific (SPF) Book Value Impairment Scenerio

Standard Pacific is a largish homebuilder whose top four markets have been CA, FL, AZ, and TX, which together account for 86% of their home deliveries (excluding deliveries by unconsolidated joint ventures).

At yesterday's closing price of 20.90, SPF ostensibly trades at 0.75 times book value, compared to the 1.46 multiple for the Residential Construction sector. I think it's worth examining whether $20 for SPF stock is a price where you could pick up cheap land, or whether there is still risk of significant impairment to the book value.

We know (from CEO Scarborough's Wachovia presentation this month) that SPF bought $1B worth of land in '06 and, incredibly, plans to buy $500M more in '07.

For the entire year 2006 (which is the first year that the builders have really marked down land and walked away from options), SPF took charges of $370.6 million: $255.8 million for consolidated real estate inventories, $52.6 million related to the write-off of option deposits and preacquisition costs for abandoned projects, $42.5 million JV's, and $19.6 million of goodwill.



Let's look at this balance sheet and decide what a good bid would be as real estate bottomfishers.

1. Writeoff the goodwill: -$1.59/sh.
2. The JV investments. JV's are between SPF and land developers and other builders. The homebuilders leverage their equity investment by obtaining bank financing at the joint venture level. The JV's are probably levered 5 or 10 to 1. Let's take a look at an SPF JV: "In November 2005, our Las Vegas division entered into a JV... to acquire and develop a 2,675-acre community located in North Las Vegas. This JV plans to develop 15,750 homes... Construction is expected to begin in late 2007 and to continue over a six to eight year period." (10-k) SPF has already taken down 750 of these lots. The JV has 9300 left to sell. SPF carries its interest in the JV at $43.7 million. All told, SPF's JVs have 13,850 lots they need to get rid of. What if the value of the JVs' assets only depreciates 10% further, and they are only levered 5:1? That is a 50% haircut to the $310M balance sheet entry. -$2.41/sh
3. Mortgage loans. Although I wouldn't touch them with a 10 foot pole, let's assume they have already been marked to a reasonable market value.
4. Land owned. Interestingly, SPF's outright land purchases are most likely to be in the markets that were most overheated. Land sellers in those markets generally were not wiling to offer options or terms. That means that this position is unlevered. Still, land values are a residual of home values and builder profit margins. The residential RE market has worsened substantially since 31-Dec-06. Imagine if they only have to mark this land down 20% (and keep in mind that urban fringe land was going for 10x the late 90's prices). That's -$6.6/sh.
5. Homes completed and model homes: perhaps a 10% off sale to get these out the door? -$1.77/sh
6. The lot options. These are probably leveraged 10 or 20 to 1. I'm assuming these are essentially worthless (i.e. SPF is just going to walk away from the deposits because they (i) are out-of-the-money and (ii) don't have hundreds of millions in cash needed to exercise them). -$3.16/sh

That totals impairments of $16.35/sh, putting our bid at $11.04 - a 45% discount to yesterday's market value.

NYTimes on Foreclosures in Cleveland

Check out the slideshow from the article:

"SHAKER HEIGHTS, Ohio — In a sign of the spreading economic fallout of mortgage foreclosures, several suburbs of Cleveland, one of the nation’s hardest-hit cities, are spending millions of dollars to maintain vacant houses as they try to contain blight and real-estate panic.

"In suburbs like this one, officials are installing alarms, fixing broken windows and mowing lawns at the vacant houses in hopes of preventing a snowball effect, in which surrounding property values suffer and worried neighbors move away. The officials are also working with financially troubled homeowners to renegotiate debts or, when eviction is unavoidable, to find apartments."

Notice how someone felt they had to spraypaint "NO COPPER - PVC" on the plywood covering the window in the first picture.

This is why loss severities will be so bad.

What will banks' REO be worth when the "owners" take out the copper plumbing, appliances, and maybe the windows on the way out?

Or when the bank finds that the McMansion's "owners," who purchased with zero-down, "gutted interiors and used every inch to grow pot, knocking down some walls and cutting holes in others to run water lines and ducts. They installed irrigation systems with timing devices and brought in water tanks, pumps, generators and power packs. They built scaffolding to raise plants 2 feet off the floor." (USA Today)

How much are houses 2 hours from LA worth if gas prices increase and credit tightens, even if the houses are intact?

Option ARM Analogue from the Tech Bubble

Fascinating article from Market Ticker about an Option ARM Analogue from the Tech Bubble:

"So Lucent came up with an innovative plan - they sold you the gear on a long-term capital lease, and allowed you to pay only the interest on the lease, or in some cases, even less than the actual interest! The deal was that when your cash flow improved, and you became profitable, you could pay off the principle on the lease and/or just buy the gear outright."

"Doesn't this sound suspiciously similar to what's going on right now? It should. It's exactly the same deal that has been offered to all these homeowners - pay less than the interest cost and/or the fully amortized cost of the hardware now, and when your economic situation improves, which we're sure it will in a few years - you'll have less debt, you'll have a better job, whatever - you can pay off the principle or roll it over into some other form of financing."

Bearish on Downey Financial (DSL), a California S&L

The worldwide glut of capital has caused low quality debt to be bid up to outrageous levels. Subprime debt has already had a severe correction. I believe this will spread to the "Alt-A" market, which is defined by slightly higher credit scores but similar programs and underwriting.

I think that Downey Financial (DSL), a California savings and loan is another possible play. Downey has branches in CA and AZ, and focuses on residential mortgage lending.

• As of June 2006, 89% of DSL’s approximate $15.4 billion residential real estate portfolio was secured by properties located in southern California
• 78% of the residential mortgages were based on borrower stated income. 10% were underwritten with no verification of borrower income and/or assets.
• This is especially bad because mortgage fraud is so prevalent in southern California.
• 19% of the Company’s loans were originated in 2006 and 40% were originated in 2005
• In 2005, approximately 81% DSL’s one-to-four unit residential real estate loans were originated or purchased through outside mortgage brokers. Of course, this creates severe moral hazard.
• 85% of its residential portfolio consists of adjustable rate mortgages subject to negative amortization with the majority structured as option-ARMs
• They sell the conservative, fixed rate loans and keep the toxic loans as investments.
• They claim to have mortgage insurance for the portions of any loans that exceeded 80% LTV when originated. However, they do not purchase mortgage insurance when negative amortization pushes loan balances above 80% LTV, nor when declining property values increase the LTV. Furthermore, we know how pervasive bad appraisals are. Finally, the mortgage insurers will be able to claim fraud and negligence on Downey's part. Downey's insurers will be able to stall and avoid paying claims when Downey needs liquidity. Also, the mortgage insurers might themselves go bankrupt.
• Property values are set to fall so far in CA that even the uninsured 80% will experience losses.
• For every dollar's worth of assets, the company has $0.91 cents in debt. In itself, this is a reasonable amount of leverage for a bank to have. However, if the assets depreciate by 9%, the company's equity will be wiped out.

Risks to the trade:

• Trades at about 1.3 times book value. Publicly traded S&L's trade at about 2.9x BV and financials at about 3x. (Track these multiples here.) People could look at DSL as a "deal" and so it is a takeover candidate. Of course, there were rumors about a New Century buyout [at a multiple of book value] as recently as December 2006.
• High short interest.
• Hedge fund presence. (I think it's clear by now that some of these managers were out of touch with residential real estate conditions on the ground in the southwestern US.)
• The real estate market might have bottomed. We might be entering a strong selling season.

Downey has fallen only 15.5% from its all time high. I'm short.