In light of the ongoing difficult operating environment for U.S.-based homebuilders, investors have raised several questions about S&P Ratings' views on the sector's credit quality over the next several quarters -- and the probability of more rating actions. Here, we present our responses to key questions:
We're nearly three years into a housing downturn that is already longer and more severe than many anticipated. When do you expect the cycle to bottom?
Calling a bottom to this severe, and in many ways, unprecedented housing cycle is certainly challenging. Single-family starts have already fallen as sharply and as broadly as any time since World War II. The road to this point in the cycle has been difficult. First, many investors abruptly exited the housing markets, which contributed to pockets of oversupply. Then, prices began a downward trend as each successive round of price cuts by builders further softened consumer sentiment and demand. Deflating home prices pushed mortgages underwater, which contributed to rising delinquencies and foreclosures. And, finally, mortgage financing abruptly tightened for many willing buyers.
Now with the economy likely in a recession and lenders under pressure, the road ahead appears rough. The one encouraging sign we can point to is the fact that new single-family construction has already slowed considerably, to roughly one-third the 1.7 million unit cyclical peak in 2005. Our base-case scenario now assumes that starts will finally bottom out in the third quarter of this year, and we expect to end the year at a little over 600,000 single-family starts.
Prices, however, will continue their downward trend in our view. Our chief economist expects that home prices will continue to fall, perhaps by another 10% through the middle of 2009. Since the S&P/Case-Shiller price index is already down 18%, we're looking at a 25% to 30% peak-to-trough correction. Furthermore, home prices in the "bubble states" of Florida, California, Arizona, and Nevada will likely continue to fare worse relative to the nation as a whole.
This is particularly problematic for many rated homebuilders and building products companies because those states accounted for a significant piece of business at the height of the housing boom. Therefore, while the broader housing market may begin showing signs of firming next year, under our base-case scenario many rated homebuilders and building products companies will continue to face challenging conditions into 2009.
What principal metric will indicate that conditions are finally starting to improve?
We are looking for a sustained, positive absorption of inventory. There's currently a very large, 11-month supply of both new and existing homes for sale, while equilibrium between supply and demand has historically been closer to six months.
