CBS Year End Review: Standard Pacific

Standard Pacific is down 84% since I initiated coverage on March 30, 2007. (Red S indicates blog posts where "sell" is reiterated.)

In my first SPF post, I talked about how the assets on the balance sheet were greatly overvalued, and would require significant further writedowns. I also brought up the issue of the two layers of financial leverage thanks to the joint-venture deals.

Also, this observation proved to be an understatement:

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.

On October 3, I questioned the reasoning behind a huge homebuilder rally sparked by Citigroup analyst Stephen Kim. Sure enough, that was not the bottom for the homebuilders.

This is an industry suffering from huge over-investment, and it needs a restructuring.

I am still short Standard Pacific, and I believe that their common stockholders will be wiped out within one year from today.

Backlog and Market Cap to Debt Ratios for Major Homebuilders

Following up on posts One and Two about homebuilder ratios.

Debt-to-backlog. Having debt that is a higher multiple of backlog (the dollar amount of outstanding orders for homes) is troublesome. Consider that the amount of cash for paying down debt is going to be a fraction of the backlog

Debt-to-market cap. A measure of the amount of financial leverage.


One thing to keep in mind is that the data not consider off-balance sheet debt, so the amount of debt is understated. The understatement is not necessarily equal - certain builders use more joint ventures to control land. Also, certain builders have more contingent liability for their off-balance sheet debt.

Also, significant numbers of orders in the backlogs will probably cancel. Some builders are better than others at converting the backlog into cash.

Homebuilder Ratio Analysis

In September, I put together a ranking of public homebuilders by their debt to backlog, enterprise value to market cap, debt to market cap, and Altman Z-Score ratios.

I am going to update that ranking, but first I wanted to measure its efficacy at predicting changes in stock prices.

This is a scatter plot of the relationship between the debt to market cap ratio on September 18, and the decline in price since then.


Similar scatter plot showing the relationship between price decline and debt to backlog ratio.

Weak October Retail Sales in California

From the California State Controller's Office:

The actual year-over-year increase [in California General Fund revenue was] $72 million (1.5%). Retail sales tax receipts were $94 million (-8.7%) below last October.

The General Fund revenue increase was clearly below inflation, so negative in real terms. October's year-over-year sales tax decline follows a 7% y-o-y decline in September.

California's GDP is larger than all but seven countries in the world. The last time California sales tax receipts dipped (2001), there was a recession in the U.S.

From a Census Bureau statistical brief (.pdf, July 1993):

The 1990-1991 recession was particularly challenging for State government finances. For fiscal year 1991, States experienced only a 3.3 percent rate of tax growth - the smallest rate of increase following the 1957-58 recession.

Now that SPF is all over but the crying (subordinated note is yielding 46.6%!), I am going to start shifting focus to weak retailers and manufacturers that cater to what Russ Winter calls "Joe Soccer Mom."

Downey Financial NPAs Continue Exponential Trend; StanPac Bonds Down

Downey Financial NPAs
Today Downey released another Thirteen Month Selected Financial Data report. The rate of increase of their non-performing assets increases every time it is reported:


Downey reports NPAs as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

The graph above shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.

I have consistently maintained a "Sell" on Downey since March 15 when it was selling for $64.87. It is down 51% since then.

Take a look at this writeup from April 2007 on Downey's underwriting quality.

I have a prediction: Downey NPAs will be sharply higher in their next data release. You can confirm that using the first chart in this post.

Standard Pacific Troubles
Today we had four people come to Credit Bubble Stocks searching for "Standard Pacific bankruptcy," which has to be some kind of record. Ouch!

The StanPac subordinated note is now yielding over 35%. Take a look at the price action:


I continue be short DSL and SPF.

Weekend Roundup: Standard Pacific, Dollar Lows, Phoenix Residential Stagnation

Quick facts before the weekend:

• Dollar index hit an all time low today. It has lost about 3% since the September rate cut. I am long Euros through FXE, which is yielding 3.36%.
  
• Someone from a Standard Pacific Homes IP address just did a Google search for "standard pacific bankruptcy." For those of you new to the site, Credit Bubble Stocks does offer continuing coverage of Standard Pacific. I have continually rated SPF a "sell" since March and still own the puts. The homebuilder stocks rallied today on the strength of a 12% rise in orders at NVR. Points:
  
• A 12% rise in orders is not that meaningful. How many will close?
• NVR is the best positioned builder. Their slight strength doesn't imply anything about SPF. They build in practically opposite markets. I bought puts into the SPF and Beazer strength today.
  
• Valley resale market enters holiday slowdown. Matches the projection from my October 3 post, meaning that Phoenix metro has a massive inventory overhang.
  

No Bids for SoCal Land

This is an interview published on the OC Register site with Tom Reimers, executive VP at land broker O’Donnell/Atkins from Irvine.

What’s the market for raw land in SoCal and Orange County today? What’s the outlook?
Tom: In general, the residential raw land market is non-existent. Land values and deal flow for other types of product are more stable right now, but the credit/financing crunch is squeezing those values as well.

How are prices?
Tom: It’s hard to say. With few to no buyers, it’s hard to say what land is worth. There are no transactions to set a benchmark. In some tertiary markets, the land is worthless from a residential development standpoint due to costs to develop being higher than the land value.

Related: Homebuilders Liquidate Assets in Desperation Sales.

Hovnanian spokesman Jeff O'Keefe said the company offered discounts as high as 30 percent.

D.R. Horton also threw in a washer-dryer and $2,500 toward closing costs, Moran said.

``Adding a credit toward closing costs still allows them to show the highest selling price they can,'' Moran said.

Next, Mortgage Slump Hits Home Decor Industry.

At the Annual Furniture Mart, Worried Manufacturers See the Mortgage Slump's Effects.

HIGH POINT, N.C. (AP) -- Doug Schock shook his head in disbelief while gazing at the empty bank of elevators, typically full as they shuttle thousands of buyers between dozens of showrooms filled with the latest styles in sofas, bedroom sets, and dining room tables and chairs.

Phoenix Inventory Explodes in September

Bubble Markets Inventory Tracking (BMIT) reports that Phoenix has "officially reached beyond the prior population adjusted inventory record of 65,079 set back in 1995. Current inventory is at 66,229 SFR, condos, MFR, and land parcels." BMIT is an essential blog to read.

According to Housing Doom, Phoenix metro home sales were 3,176 as of September 29, with one day left in the month and probably a several day lag before sales are reported.

Key points:

• If September sales total 3250, that is a drop of 25% month-to-month and 46% year-over-year.
• Assuming those sales, that is over 20 months of inventory.

Las Vegas inventory is also 20 months. Orange County is 8.8 months.

Need I mention that these are Standard Pacific markets?

Debunking Another Absurd Stephen Kim Homebuilder Rally

Wondering why the homebuilders are up huge this week? Surprisingly simple explanation:

NEW YORK (AP) -- Housing stocks rallied for a third consecutive day Wednesday, as sentiment increased that the long-battered shares may have reached a bottom, even if the beleaguered housing market has not. With no industry data to guide them, investors appear to be taking their cue from an analyst who earlier in the week upgraded the entire sector.

Citigroup Global Markets analyst Stephen Kim wrote in a client report Monday he does not foresee the stocks falling much more. However, he does not expect conditions in the industry to improve anytime soon.

"We are not trying to suggest that trends in the homebuilding sector are about to get much better," he said. "It is precisely when things have gotten this bad that the stocks start looking good."

For a moment, I thought I had been transported back in time to December 6, 2006, date of a previous Stephen Kim research report.

Citigroup recommended that investors buy shares of homebuilders now as order trends are expected to turn positive in the first quarter of 2007. "While many wait for an improvement in fundamental data such as prices or inventory to signal an 'entry point' in the stocks, we urge investors to look back to prior cycles, when the group rallied far ahead of fundamentals," Citigroup analyst Stephen Kim said in a research note. The brokerage firm raised its price targets on the following companies:

Pulte Homes Inc. - $45 [now $16.25, off by 64%]
D.R.Horton Inc. - $48 [now $14.84, off by 69%]
Lennar Corp. - $88 [now $25.90, off by 71%]
Centex Corp. - $83 [now $29.28, off by 65%]
Toll Brothers Inc. - $42 [now $22.79, off by 45%]
KB Home - $92 [now $28.60, off by 69%]
MDC Holdings Inc. - $85 [now $43.52, off by 49%]
Ryland Group - $95 [now $25.5, off by 73%]
Beazer Homes USA Inc. - $80 [now $10.08, off by 87%]
Hovnanian Enterprises Inc. - $63 [now $13, off by 79%]
Standard Pacific Corp. - $43 [now $6.24, off by 85%]
Meritage Homes Corp. - $87 [now $16.62, off by 81%]
Technical Olympic USA Inc. - $18 [now $1.94, off by 89%]

Stephen Kim sounds like a guy you should listen to if you want to lose two-thirds of your money.

Here's how the builders have done since he called the bottom on December 6, 2006:


See that tiny blip upwards on the very far left? That was the effect of his report. The bullishness carried through until it became clear that the "spring selling (buying?) season" was never going to materialize.

I worked in the industry and I remember what people were thinking. They honestly thought that spring of 2007 would come and the real estate market would kick right back into high gear.

That didn't happen, and now there are key problems that make it even less likely that we have reached the bottom of the housing market.

• Lending is tight. Homebuilders do great when there is no-questions-asked lending.
  
• Prices are still too high. High relative to rents, high relative to median incomes, high relative to other goods' historical increases, high relative to building costs. They need to come down much further - and the Case-Shiller HPI futures markets are predicting it.
• Inventory is huge in absolute numbers and in number of months' sales, and keeps getting bigger by both measures.
  

Given these challenges, and the tarnished balance sheets of the builders (with high debt, loads of difficult to sell homes, staggering amounts of lots and land, and problematic off-balance sheet vehicles loaded with land and debt), it's unlikely that the builders' stocks have reached bottom.

Mr. Kim: We have not reached the end of the housing bust. We are only now reaching "the end of the beginning."

Standard Pacific Troubled; Hovnanian Almost as Bad

Standard Pacific announced today that they are going to offer $100 million of convertible notes.

The Company intends to use the net proceeds of the notes offering to repay a portion of the outstanding indebtedness under its revolving credit facility.

The notes will bear interest at a rate of 6.0% per year... an initial conversion price of approximately $8.75 per share of common stock...

Concurrently with the offering of the notes and the convertible note hedge transactions, the Company intends to enter into a share lending agreement with an affiliate of Credit Suisse, pursuant to which the Company will lend shares of its common stock to such affiliate. Under the share lending agreement, the share borrower will offer and sell the borrowed shares in a registered public offering and will use the short position resulting from the sale of such shares to facilitate the establishment of hedge positions by investors in the notes to be offered.

On September 14, 2007, and in contemplation of the proposed notes offering, the Board of Directors of the Company eliminated the Company's quarterly cash dividend. This action will save the Company approximately $10 million per year.

It looks like an extremely ugly way of raising money. SPF is going to lend its own shares to whomever buys the notes, so that the buyer can sell the stock short. I don't think SPF is long for this world.

Standard Pacific is one of the worst homebuilders based on three key metrics:

• Debt-to-backlog. Having debt that is a higher multiple of backlog (the dollar amount of outstanding orders for homes) is troublesome. Consider that the amount of cash for paying down debt is going to be a fraction of the backlog, and that significant numbers of orders in the backlog will probably cancel.
  
• Debt-to-market cap. A measure of the amount of financial leverage.
  
• Altman Z-Score. Lower scores are worse; used to forecast the likelihood of bankruptcy.
  

(click to enlarge) Z-Scores are from this article.

One thing to keep in mind is that this table does not consider off-balance sheet debt. Standard Pacific, for example, has loads of debt in special purpose joint-ventures that they may be liable for.

Also, it looks like Hovnanian is the next worst of these builders after SPF. (Not counting TOA, BHS, or BZH, since they are so difficult to short.)

Finally, I took a stab at what SPF's equity would be after hypothetical markdowns.
(Keep in mind, they amended their Consolidated Tangible Net Worth covenant to require "the sum of (a) $1,000,000,000 plus" a proportion of net income and equity sales.)

For this experiment, I made the following major assumptions:

• Land owned is worth 50% of book value. My understanding is the bids for lots and land in SPF's markets are very, very low.
• Completed and model homes are worth 80% of book value.
• They will be walking away from all land options.
  
• A generous assumption that they will be able to walk away from the JV's and such at only a complete loss, when they may actually have to pay those structures' debt, and thereby be liable for more than their initial investment.
  
• Mortgage loans in the portfolio are worth book value. If it turned out that SPF was writing shoddy loans in order to move houses, the loans would require a huge discount.

(click to enlarge)

In this scenario, their book value is negative $1.28 per share.

Standard Pacific: "Buyer be where?"

Incredible article in this weekend's LA Times about Standard Pacific's "Mission: Possible" sale in Southern California.

For days, the Irvine company has been touting its "Mission: Possible" extravaganza in 49 communities throughout Southern California, with bonuses for buyers totaling as much as $20 million. Standard Pacific is aiming to sell 200 homes by offering mortgage loans with rates of less than 6% and other perks, including a free 42-inch plasma-screen television with every home purchase.

But in Victorville on Friday, the blowout looked more like a washout. Only a trickle of potential buyers showed up on the first day of the 10-day event.

Only a handful of prospects, although more than usual for a Friday, stopped by the sales offices of neighboring communities Diamond Ridge and Crystal Spring, which were decorated with colorful banners and posters proclaiming the event.

Bubble Markets Inventory Tracking checked out the StanPac community "Avaron at Del Sur."
StanPac has lowered prices by 10-20% since spring 2007, and evidently that is failing to sell houses.

By the way, if we are "near the bottom" of the housing market, as people keep saying, then why are builders trying to dump inventory?

Standard Pacific Joint Ventures

How about that preposterous rumor (from CNBC, of course) that Buffet would buy part of Hovnanian? The giveaway was that they chose the builder with the highest short interest.

My trade was to fade that rally (17%!) by sellling stock into it and also picking up the August 17.5 puts. Worked great and I'm looking for HOV to slump further. Ditto SPF.

The housing bottom is not going to come until inventory adjusts to normal (the market starts clearing again). That will happen when sellers give up on their wishing prices and hit the bids.

This article by Mish is helpful in understanding what kind of land the builders were buying and putting in joint-venture deals.

Meanwhile, I'm looking further into SPF's JVs:

We enter into land development and homebuilding joint ventures... [We] typically obtain secured acquisition, development and construction financing, which reduce the use of funds from our revolving credit facility...

At March 31, 2007, our unconsolidated joint ventures had borrowings outstanding that totaled approximately $1,245.3 million that, in accordance with U.S. generally accepted accounting principles, are not recorded in the accompanying condensed consolidated balance sheets, and equity that totaled $816.4 million.
We and our joint venture partners generally provide credit enhancements in connection with these borrowings in the form of loan-to-value maintenance agreements, which require us under certain circumstances to repay the venture’s borrowings to the extent such borrowings plus, in certain circumstances, construction completion costs exceed a specified percentage of the value of the property securing the loan.

At March 31, 2007, approximately $658.6 million of our unconsolidated joint venture borrowings were subject to these credit enhancements by us (of which $155.0 million we would be solely responsible for and $503.6 million which we would be jointly and severally responsible with our partners). During the three months ended March 31, 2007, we were not required to make remargin payments under any loan-to-value maintenance agreement. However, subsequent to the end of the 2007 first quarter, we made an additional investment to one of our Southern California joint ventures totaling $9.7 million, which represented our 50% share of the venture’s project loan remargin requirement. [We] expect that, over the next several quarters, we and our joint venture partners will be required to make additional remargin payments with respect to certain joint venture loans and will be required to restructure or extend others.

If our joint venture partners fail to make their required capital contributions, in addition to making our own required capital contribution, we may find it necessary to make an additional capital contribution equal to the amount the partner was required to contribute. Making capital contributions on behalf of our partners could result in our being required to consolidate the operations of the applicable joint venture into our consolidated financial statements which may negatively impact our leverage covenants. Also, if we have a dispute with one of our joint venture partners and are unable to resolve it, the buy-sell provision in the applicable joint venture agreement may be triggered. In such an instance, we may be required to either sell our interest to our partner or purchase our partner’s interest.

Another issue for SPF is the performance guarantees that they and the JV's have given:

We and our joint venture partners have also agreed to indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures. If a joint venture does not perform its obligations, the surety bond could be called. If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners would be obligated to indemnify the surety. At March 31, 2007, our joint ventures had approximately $130.0 million of surety bonds outstanding...

I realized that I have been neglecting a category of capital mis-allocator besides the crazed flipper: people who only needed a 2000 square foot house but bought a 3500 sf one, because, of course, the more money you spend on real estate, the more money you make in appreciation.

This was perhaps the more pernicious type, because it was an enormous misallocation of capital.

As with any bubble, it will take a while for the effects of that misallocation to ripple through the system. See this chart for more about that.

Know When to Fold 'em: Standard Pacific

"On June 21st, hedge fund Lone Pine Capital disclosed that it sold out of its entire 5.974M-share, or 9.23% stake, in the California-based homebuilder."

The other institutional holders should check out Bubble Markets Inventory Tracking to find out what is really going on in SPF's markets.

Inventory in Phoenix metro just hit 11.9 months of sales. Riverside County is 9.7; Las Vegas is 15.3 months! San Diego County has a "healthy" 6.6 months. Orange County is 7.2.

Note that SPF was a latecomer to the Las Vegas market, and land prices were astronomical when they started buying.

Check out the foreclosure stats for these cities as well: increasing exponentially.

New Short Possibilities: MBI and NCT

This is from Deep Survival by Laurence Gonzales:

The stages of getting lost apply to more than just hiking in the woods. A company, such as Xerox, ignores cues from a changing world and from inside its own research facility in Palo Alto and nearly destroys itself. In 1959, Xerox introduced its 914 copier. Fortune said it was "the most successful product ever marketed in America." By 1969, Xerox passed $1 billion in sales. In 1971, flushed with success (an emotional state of high arousal), the company's officers were in a state of deep denial. The world was changing and they weren't taking in any new information... Xerox's leaders had decided to take on IBM, despite all the clear evidence that it would most likely kill them to do so. They were like snowmobilers, flushed with emotion, who went up that hill, despite the clear evidence that it would probably kill them. They were bending the map, too...

Xerox spent $1 billion to purchase a computer company... In the meantime, scientists and engineers at PARC were inventing the mouse, Ethernet, the [GUI], the flat-panel display, and the laser printer. Others got rich off of those inventions. Xerox, busy with its mental models that did not match the real world, saw none of that profit.

I was surprised by the magnitude of this decrease in land prices:

The slowdown in housing construction has led to a sharp fall in residential land prices in the [Minneapolis-St. Paul] metropolitan area, according to a midyear market study by Bloomington-based United Properties.

Values for developable residential land in the metro area are down about 35 percent from 2005, United said... some residential developers were carrying 18- to 36-month supplies of land on their books, compared with a typical four- to six-month supply.

SPF's land positions are in markets that were far more overheated than Minneapolis-St.Paul. They have a high degree of leverage, and the recent revelation that their joint ventures are subject to margin calls and recourse to the company is stunning. Only a fool would buy their stock when you are going to be able to buy lots from them and other builders at a pittance.

Another name I am paying attention to is MBI. They are an insurance company that guarantees the performance of "municipal bonds, asset-backed and mortgage-backed securities, investor-owned utility bonds, bonds backed by publicly or privately funded public-purpose projects," etc. Mish has given some great MBI coverage on his blog. See also MBI on Seeking Alpha.

The degree of leverage in bond insurers like MBI is astonishing. From their capital base of approximately $7B, they guarantee the performance of over $600 billion in debt.

The great thing about MBI in terms of blow-up potential is that because of the high leverage, you don't need to be very specific about the possible cause. Will it be a few municipal defaults? That would be enough, and every housing collapse has caused some. Or will it be from the mortgage securities?

Take a look at Newcastle (NCT), a REIT of high-yield, asset-backed bonds. It's run by Fortress Investment Group, which gives me pause. You would think they would know what they are doing, but maybe FIG is using this as a vehicle to dump sludge-quality paper on retail investors.

That seems to be what was happening with Everquest Financial, the fund that Bear Stearns was going to IPO. They were essentially forced to cancel it once people recognized the moral hazard problem.

The stock has a 10.4% dividend, which has attracted quite a few yield-hungry investors and funds. It trades at 1.5x book, and it’s levered almost 10:1. Market cap is $1.45B.

My issue is with the credit quality: the securities have a weighted average rating of BBB+.; 41% is rated BELOW BBB- or is unrated, etc.

Worrisome parts of the portfolio:

• $77M in manufactured housing backed loans.
• $629M in home equity loans rated BBB+.
• $978M in unsecured REIT debt rated BBB-.
• $300M in BB rated commercial loans.
• $1B in subprime loans.

My final thought today is regarding the perception of a "subprime" menace.

It's wishful thinking to believe that the only problems are with low-FICO, "subprime" borrowers. Eventually, the market will realize that these problems extend to alt-a borrowers and beyond.

Standard Pacific Update

I'm still short Standard Pacific (SPF), which gave an investor presentation yesterday.

"Net new home orders for [Apr & May 2007] were down 16% from the year earlier period and nearly 20% below the Company's business plan for the two-month period. The Company's cancellation rate for the 2007 two-month period was 28% compared to 35% in the year earlier period. The overall decrease in orders was driven by continued weakness in Florida and Arizona, while order activity was up over 13% year over year in California. The improvement in the California order comparisons was primarily a result of an increase in the number of active selling communities."

From the presentation:

• They have been somewhat successful at squeezing their contractors.
• 57,000 lots controlled; down 25% from Dec 2005. 60% of these are owned. They expect to sell about 8000 units this year, so they have a 7 year supply of lots. (That's assuming sales don't slow further - which they probably will.)
  
• They have only impaired one-third of owned lots.
• They expect to pay off the $350M revolver by the end of the year. The revolver expires May 2011. They renegotiated, trading a lower leverage covenant for a more flexible interest coverage covenant.
• They take impairments only once a community has a negative operating margin.
• They have 730 completed and unsold units, which is 3.17 per community.
• The JVs have an average 58% leverage.
• SPF is subject to LTV maintenance on the JVs. They are required to post additional equity as the value of the land/lots in the JV falls. Evidently the lenders on these JVs can slap SPF with a low appraisal and demand more equity. Their only "remargin call" so far was in SoCal during Q1.

Standard Pacific's Model Homes and Options

Standard Pacific is already dumping Model Homes at auctions:

"Desperate to avoid still more losses, home builder Standard Pacific sent upgraded model homes to auction last Saturday with a bargain price tage."

"'These homes are priced well below anything in Elk Grove,' said Keith McLane of West Coast Home Auctions. 'The seller is looking to sell 6-homes very quickly.'"

"They sold alright: a 4 bedroom home went for $440,000, a good $150,000 less than it sold for 18 months ago."

They have $155M model homes as of 31-Dec. Unfortunately, we don't know exactly what the 25% discounts to retail mean for BV impact. (Although we could estimate based on historical profit margins.)

Next, I was pretty close on my land/lot option leverage factors, with 10 and 15, respectively:

"At December 31, 2005, we had cash deposits and letters of credit outstanding of approximately $134.3 million on land purchase contracts having a total remaining purchase price of approximately $1,433.6 million.," and, "cash deposits and letters of credit outstanding of approximately $49.6 million on option contracts having a total remaining purchase price of approximately $718.2 million."

It occured to me that SPF is in a double bind on the lot options since they will either (i) walk away from the deposits or (ii) exercise them and cause even more economic damage, since the options are out of the money.

I have known land acquisitions people (both for landbanks and builders), and I have never known them to walk away from options readily. Even if exercising them meant throwing good money after bad, sunk costs.

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.