I’m re-posting the message from yahoo board:
Longs keep calling the bottom by pointing to valuations they don’t understand.
Here it is…the HB’s are not letting BV fall for a reason…
THE LENDER’S LOAN COVENANTS
This comes down to evaluating the builder’s assets
It’s common to see a HB parcel out a three phase development and borrow money to construct the first phase by using the land equity from the next two phases as equity leverage. The lender gives the builder set releases prices. For example; the market says the homes in the first phase will sell for $350,000 on average, the lender will set it’s release prices at 70-90% of the sales price, depending on risk. Release price meaning the builder must pay the lender 70-90% of the sales price before the lender releases title to the new owner.
The loan covenants for the lender typically tie down the builder in two ways.
1. The overall loan to value covenant, which will state that if at any given time the Loan to Value of the lender’s collateral goes below X%, the builder will be required to remargin the loan (come up with cash to correct the loan to value back to X% or less).
2. The release price % covenant, will allow the lender increase the release price to prevent future remarging. This means that the builder will receive even less cash on every sale. Basically the lender gets out of the deal faster if things are going south.
If the builder starts lowering their sales prices (lowering their asset value) and selling land for less than originally appraised. The lender’s covenants require them to put up more money that they don’t have, or take it they have cash and assets are drawn down further to remargin the loan. Even worse, release percentages rise and delay money they would have received to keep operations running.
So the game is played:
Say the builder thought they could sell a particle board box for $350,000. The market now wants more than just a pb box for that price, so the builder decides they’ll try and keep the price at $350,000 but offer a new car and an upgrade package. It is much easier to screw the greedy uncollateralized supplier of the upgrade material or greedy auto dealer than it is to lower the price and default on one of the loan covenants with the lender.
Sometimes builders use a mix of upgrades and price lowering, but they are calculating it very carefully. They know that violating a covenant is like being caught by a boa constrictor, the lender will definitely suffocate them.
In my opinion we’re now at the point that upgrades are not moving homes and prices must fall…when they do, they will collapse them to the break even point…the “every man for himself” mentality.
BV on HBs will collapse within the next 12 months…the game is officially over!