Subprime Defaults Blamed for U.S. Earnings Setbacks (Update3)
By Daniel Taub and Nick Baker
Aug. 1 (Bloomberg) -- Railroads, chemical producers and insurance companies are blaming the worst U.S. housing slump in 16 years for their earnings woes.
Burlington Northern Santa Fe Corp., the second-biggest U.S. railroad, said lower shipments of housing products and lumber reduced second-quarter earnings. DuPont Co., the third-largest chemical maker, said slumping demand for kitchen and bathroom countertops was partly responsible for its profit drop. Genworth Financial Inc., the former insurance unit of General Electric Co., said earnings will be at the ``lower end'' of its forecast this year as mortgage-insurance claims increase.
``The subprime slime is oozing,'' said Gary Shilling, president of A. Gary Shilling & Co. in Springfield, New Jersey, who correctly predicted the recession in 2001. ``As home equity evaporates, that takes out the foundation of strong consumer spending growth, which has been the mainstay of the economy.''
U.S. profit growth has been cut by more than two-thirds because of the housing slowdown, according to David Rosenberg, chief North America economist at Merrill Lynch & Co. Earnings growth is running at 6 percent and would be 19 percent, he said. Business is suffering as home sales plunge more than economists estimate and foreclosure filings in the U.S. jumped 58 percent to 573,397 in the first half, according to RealtyTrac Inc.
Dwindling Property Values
``Companies that make anything that goes into a home, all the wiring, plumbing, anything related to coatings and fixtures, will certainly be suffering,'' said Gene Pisasale, who helps manage $25 billion, including DuPont shares, at PNC Wealth Management in Baltimore.
The fallout may be even broader, as dwindling property values erode shoppers' savings. Sales at 53 retail chains rose 2.3 percent from a year earlier from February to June, down from 3.9 percent growth a year ago, according to the International Council of Shopping Centers in New York.
Federal Reserve policy makers have said housing is the biggest risk to the six-year economic expansion. The link with the property market is inextricable as housing and related industries account for almost 25 percent of gross domestic product, according to the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts.
``Clearly it's having an impact,'' said Nicolas Retsinas, director of the Harvard center, referring to housing. ``How much of an impact, at this point, is easier to understate than overstate.''
Subprime Lending
About a third of job creation and almost half of consumer spending since the 2001 recession stems from housing, according to Shilling, who expects an economic contraction by the end of the year.
During the five-year housing boom, lenders gave mortgages to borrowers with poor or limited credit histories, asking for little or no money down, and requiring limited or no documentation about their incomes and financial obligations.
Originations of those loans, known as subprime mortgages, reached a record $805 billion in 2005, according to estimates from New York-based JPMorgan Chase & Co., the third-biggest U.S. bank. At the same time, rising home values and low interest rates spurred consumers to take out home-equity loans to buy cars, pay for home improvements and make other purchases. They also encouraged borrowers to choose riskier adjustable loans to afford pricier real estate.
Home Sales Fall
First American CoreLogic, a unit of Santa Ana, California- based insurer First American Corp., estimated in March that $326 billion of adjustable-rate mortgages extended between 2004 and 2006 will lead to 1.1 million foreclosures over the next six to seven years.
Many foreclosures are occurring because home sales and values are falling. Sales of new homes dropped 6.6 percent in June, the most since January, according to the U.S. Commerce Department. Existing home sales will fall 5.6 percent to a 6.11 million annual rate in 2007 and prices will drop 1.4 percent, according to the Chicago-based National Association of Realtors.
A lack of demand for homes has pushed homebuilders to report losses. D.R. Horton Inc. of Fort Worth, Texas, and Atlanta-based Beazer Homes USA Inc. last week reported quarterly losses on writedowns for unsold homes and options for land.
Pulte's Loss
Pulte Homes Inc. of Bloomfield Hills, Michigan, Ryland Group Inc. of Calabasas, California, and KB Home in Los Angeles also had net losses. Beazer shares today plunged the most ever on speculation the homebuilder may file for bankruptcy protection. The company called the rumors ``unfounded.''
The losses have taken a toll on share prices. The Standard and Poor's Supercomposite Homebuilding Index has dropped 37 percent this year. Today, it fell as much as 8.4 percent, spurred by the decline in Beazer.
Companies in industries ranging from transportation to chemical manufacturing are blaming the housing slump for slashing profits. A Bloomberg index of 82 housing-related stocks has dropped 7.1 percent this year, compared with a 3.4 percent rise in the S&P 500. The companies are members of the S&P 500.
Fort Worth-based Burlington Northern said on July 24 that second-quarter profit fell 8.1 percent, partly because industrial- product shipments, including lumber and other housing materials, slipped 0.5 percent.
DuPont Chief Executive Officer Charles O. Holliday Jr. said last week the housing recession eroded demand for Tyvek weather barriers, used in 40 percent of new homes, and Corian countertops.
No Improvement
``I'm not assuming anything improving in North American housing until well into 2008,'' Holliday said in a conference call.
Genworth said last week that full-year operating earnings would be at the ``lower end'' of the previously forecast range of $3.15 to $3.25 a share after its unit that protects homes loans against defaults paid higher claims in the second quarter.
Given ``the dynamics of the U.S. housing market, we feel a conservative stance is appropriate,'' CEO Michael Fraizer said in a July 26 statement.
Caterpillar Inc., the world's biggest maker of heavy-duty diesel engines and earth-moving equipment, said profit dropped 21 percent partly because ``weak construction activity in North America, notably U.S. housing-related markets, resulted in lower sales.''
Like homebuilders, the performance of financial companies is tied to the home market. Banks and mortgage companies said second- quarter earnings have been affected by declines in their loan- origination businesses and rising defaults.
Countrywide Signal
Countrywide Financial Corp., the nation's biggest mortgage lender, said last week that a growing number of consumers fell behind on home-equity payments, adding to signs that the market rout is spreading from subprime borrowers to people with more reliable records.
The Calabasas, California-based company set aside $292.9 million for loan losses in the quarter, compared with $61.9 million a year earlier. It reported a third straight quarterly earnings decline and reduced its 2007 forecast.
Wells Fargo & Co., the second-biggest U.S. mortgage lender, said it will stop processing and funding subprime home loans for independent mortgage brokers. The bank also on June 29 shut a unit that buys subprime home loans from other lenders. Tighter loan standards imposed this year led to more than 500 job cuts.
``This is going to be a multiyear problem and not just for us but for the industry,'' Jeffrey Peek, CEO of CIT Group Inc., said on a conference call last month. CIT decided to quit the home-loan business, which accounts for about 10 percent of its income, after losses rose more than expected. The unit focused on subprime borrowers.
American Home
American Home Mortgage Investment Corp. shares yesterday plunged 90 percent after the Melville, New York-based lender said it doesn't have cash to fund new loans, stranding thousands of home buyers and putting the company on the brink of failure.
Bear Stearns Cos., the New York-based manager of two hedge funds that collapsed last month, blocked investors from pulling money out of a third fund as losses in the credit markets expand beyond securities related to subprime mortgages.
Retailers also are feeling the effects of the housing slump. Office Depot Inc., the Delray Beach, Florida-based office-supplies company, said last week that its second-quarter profit fell 7.8 percent. Chuck Rubin, the company's North American retail president, said ``the impact of this housing slump has adversely affected a broad range of small businesses and resulted in a reduction in our customers' overall spending patterns.''
`No Longer an ATM'
The worst is yet to come for retailers, said Mark Kiesel, executive vice president and money manager at Newport Beach, California-based Pacific Investment Management Co., where he oversees $80 billion of corporate bonds. In the past year, consumers have taken about $400 billion less equity out of their homes than in the previous year, he said.
``Because the house is no longer an ATM machine, the profits of these companies are going to be affected,'' Kiesel said.
While overall U.S. employment remains high -- U.S. employers added 132,000 workers in June, keeping the unemployment rate at 4.5 percent, close to a six-year low --industries with ties to homebuilding and housing sales have fired workers.
Furniture Brands International Inc., the maker of the Broyhill and Thomasville brands, said in April that it would cut 330 jobs and close three North Carolina plants.
Gasoline Prices
U.S. furniture retailers have cut their workforce by 5,900 workers in the past year, while building-material and garden- supply stores have cut 18,900 jobs and residential building finishing contractors have eliminated 24,700 positions, according to the Bureau of Labor Statistics in Washington.
While companies are blaming the housing recession for their misfortune, some analysts aren't so sure it's hurting other parts of the U.S. economy.
The decline in consumer spending can be ``entirely explained by what we saw as the run up in gasoline prices,'' said Haseeb Ahmed, an economist at New York-based JPMorgan Chase.
Crude oil reached a record of $78.77 a barrel in New York today.
Federal Reserve Chairman Ben S. Bernanke told the Senate Banking Committee last month that ``we have not seen significant spillovers from the housing sector into other parts of the economy.''
While companies such as Caterpillar that have direct business ties to homebuilding can legitimately claim they are being hurt by housing, others may be using it as a scapegoat, said JPMorgan's Ahmed.
Misplaced Blame
``Some people may just be blaming this without any real scientific basis or data basis,'' Ahmed said. ``If someone in the retail industry is blaming housing, I don't think that's a well- founded argument.''
It's not unusual for companies to blame poor earnings performance on economic issues far removed from their industries.
Phoenix-based PetSmart Inc., the largest U.S. pet-store chain, in March 2003 blamed a quarterly profit drop in part on the run-up to the Iraq War. ``A combination of political uncertainty in the Middle East and some very tough winter weather'' hurt sales, CEO Philip Francis said at the time.
Homeowners with adjustable-rate mortgages will have even less money to spend over the next six to 12 months as their payments reset at higher interest rates, boosting their living expenses, Pimco's Kiesel said.
``It is absolutely no surprise to me at all that these earnings are starting to come in weaker,'' Kiesel said in an interview. ``This problem is getting worse. It's not getting better.'' |
