Toll Brothers (TOL)

The largest U.S. luxury homebuilder had the rating on its senior unsecured notes cut to junk by Moody’s ( July 3) , now at Ba1 from Baa3. “While the company is one of the only remaining homebuilders that is currently generating earnings before impairment charges, Moody’s does not expect this to continue, as falling prices and lower absorption rates continue to imact margins,” said the agency in a statement.

In early June,the Toll reported its third straight quarterly loss, losing $93.7 million, or $0.59 per share, for the period ended April 30. At the time, CEO Robert Toll described housing prices as a “downward spiral”.

Home Prices Still Falling

April’s S&P/Case-Shiller 20 Home Index posted its worst monthly decline ever, dropping 15.3%. It wouldn’t be a stretch to expect May and June to have degenerated further.

U.S. consumer-confidence has hit its fifth lowest reading ever as the Conference Board’s confidence index fell to 50.4 in June, below 57.2 in May.

According to a recent New York Times article entitled “Banks Trimming Limits for many on Credit Cards,” the easy money that led Americans to depend on credit cards to pay their bills appears to be drying up. Many financial companies are cutting the credit limits held by million of Americans, sometimes without warning. Customers that have the biggest debts, live in places hardest hit by the housing bubble pop, or who work for themselves in troubled industries, are the main targets for credit limit reductions. A family therapist with a stable six-figure income was cited in the article, having seen the limit on two of her credit cards reduced in a matter of months despite having missed only “a few” payments in the past. Worse, having credit reduced can cause a consumer’s credit score to drop, forcing the person to pay higher interest rates and making it harder to obtain new loans. It can be an ugly spiral. For what it is worth (which hopefully isn’t much), Greenspan believes the financial market turmoil “is going to be with us for a while,” either for a “good number of months or into next year.”

The subprime mortgage crisis will have a long term effect on new home building. Prior to the mortgage meltdown, a significant portion of new home buyers were of subprime credit. It will be quite a while before these types of buyers can qualify for a mortgage, putting a big dent in homebuilder's future sales prospects.

Macroeconomic indicators suggeting the possibility of an impending recession suggest tough times ahead for Toll Brothers. Higher interest rates and lower job growth reduce confidence in the economy and lead to a reduction in demand for housing.

The U.S. housing market will continue to face pressure as a result of the subprime lending crisis. This should result in decreased sales for Toll Brothers.