Some Builders Feel Heat
From Holders, Lenders

Most U.S. home builders are suffering declining profits and sluggish sales. But some companies are experiencing more serious hurt -- including pressure from activist shareholders, increasingly nervous lenders, large layoffs and at least one sizable bankruptcy.

At WCI Communities Inc. of Bonita Springs, Fla., not only are orders for new homes expected to have dropped 80% in the third quarter from a year earlier, but one of its large shareholders is getting antsy. New York hedge fund Basswood Capital Management LLC, which owns a 5% stake, sent WCI's chairman a letter dated Oct. 17, saying it had "grown increasingly concerned with the performance and strategy of the company."

Basswood is frustrated that WCI, even though it has a valuable supply of land in coastal Florida, is more leveraged than many other builders. Basswood said WCI's net debt-to-capitalization ratio was 62%, compared with an average ratio of 44.5% for its peers.

Basswood also wrote in its Oct. 17 letter that WCI stock is trading 16.5% below its March 2002 initial-public-offering price, while its peer group is up 88.9% over that same period. The stock closed yesterday at $16.12, up nine cents, in New York Stock Exchange composite trading at 4 p.m. Basswood is asking for a seat on WCI's board, a request the firm says was previously ignored. WCI declined to comment on Basswood's letter.

Limited Activism

For now, analysts believe this kind of shareholder activism may be limited. "The difference between WCI and the rest of the industry is that WCI is significantly" leveraged, says Credit Suisse analyst Ivy Zelman.

It's not the first demand on a home builder from a large shareholder. In October 2005, Tontine Partners sent a letter to Beazer Homes USA Inc., asking the Atlanta-based builder to expand its stock repurchases. About a month later, Beazer said it was increasing its buyback to a total of 10 million shares from two million shares.

Lenders also are beginning to take a harder line with builders as the risks in the industry increase amid the slowdown. "We are hearing that a lot of banks are paying close attention to the terms of the loan agreements and are being more aggressive than usual because the apparent risk to loans is higher than a year ago," says Todd Vencil, an analyst at BB&T Capital Markets, based in Richmond, Va.

Comstock Homebuilding Cos., Reston, Va., said it has received a letter "purporting" to be a notice of default from Bank of America Corp. on a loan to develop a condo project in Leesburg, Va. Comstock is disputing the notice, saying it has met all repayment requirements. The dispute appears to center on the builder's claim that it has only drawn $43 million on a loan that originally made $46 million available for Comstock to use. Bank of America declined to comment.

Large publicly traded builders, which analysts believe have relatively healthy balance sheets despite their declining revenue, aren't immune to layoffs. Last week, Pulte Homes Inc. of Bloomfield Hills, Mich., said it has reduced its work force by about 10%, or 1,400 full-time jobs, since Jan. 1. Centex Corp., based in Dallas, said it has cut its salaried work force by about 10% since April 1 to around 6,400 employees.

Meantime, D.R. Horton Inc. said on Oct. 17 that it had eliminated three chief operating officer positions, each focused on different areas of the country. Two of the former operating chiefs have become regional presidents. The third resigned from his position with Horton, based in Fort Worth, Texas.

Rapid Growth

Also last month, privately held New Jersey builder Kara Homes Inc. filed for Chapter 11 bankruptcy protection. Industry observers suspect the company, founded in 1999, may have grown too quickly and been caught off guard by the slowdown. According to bankruptcy filings, the company has $350 million in assets and $297 million in liabilities, including millions owed to a few banks. Kara didn't return phone calls seeking comment.

Analysts predict future quarters of shrinking profits, but believe the large public builders aren't in immediate danger of bankruptcy because they aren't as highly leveraged as companies in the sector were during the last market downturn. They also have been increasingly using options to secure land, allowing them to walk away from parcels they are unable to develop.

"Bankruptcies will be the extreme exception, not the rule. Generally speaking, the large public builders are well-capitalized," says Steven Friedman, who co-heads the home-building practice at Ernst & Young. "The likelihood of a material default is highly remote."

These troubles could also become opportunities for large builders to buy out beleaguered companies and their land holdings, leading to more consolidation in the industry. But it could take more time before larger builders have enough cash to buy up the distressed companies. "When you are in a free fall, you cannot step up and use cash," says Credit Suisse's Ms. Zelman. "If anything, you are trying to bring more cash in the door."

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