We find ourselves in a market that doesn’t trust what companies are saying. Other than mortgage lenders and home builders, company conference calls this quarter have emphasized that things are not as bad as the markets are indicating. However, investors are scared and are selling indiscriminately, regardless of what companies are actually saying their exposure is. People just don’t believe them.
Should they believe them? It depends. If a senior management figure gives their opinion as to when the dust will settle and how bad things will get, you might not want to simply take what they say at face value because, after all, it is simply an opinion. What you can take to the bank though are statistics that companies give you. What kind of exposure they have to mortgages and other types of credit. Remember, numbers don’t lie, people do.
Fear is king right now. Somebody started a rumor that Beazer Homes (BZH) might go under. The stock fell 40% this morning within minutes. Some people might be bottom fishing in the home building sector, based in large part to their seemingly attractive price-to-book ratios. Beazer’s book value is $38 but the stock traded as low as $8 today (it has since rebounded to $11 as investors bet the rumors are untrue).
This shows you that you can’t always trust book values. Land values are often carried on the balance sheet at cost. However, the actual value of the land may be far below what a company paid for it. I don’t know if BZH will go under or not, but I have not purchased any home builders and have no plans to do so. They are simply too hard to value, in my view, since stated book values might not be anywhere close to accurate.
Conversely, when Citigroup (C) tells investors that perceived risky loans make up only 5% of their exposure to the credit markets, you can put things into perspective. You can find out what percentage of the big banks’ loan portfolios come from mortgages, or investment banking, or sub-prime borrowers. We don’t know exactly how many of these loans will go bad, but you can make aggressive assumptions and still realize where the overreactions are in today’s market environment.
Personally, I still stand by my opinion that the mortgage mess will not spill over into every other credit area. This is not to say that people aren’t losing their houses when interest rates reset to levels above a threshold that they can afford on a monthly basis. They will lose their houses, the banks will be on the hook for the loans, housing inventories will rise, and lower home values will result. But will these consumers default on their credit card bills, student loan bills, and file bankruptcy as a result?
I don’t think so, in the vast majority of cases. They will simply lose their house and be forced to move somewhere they can actually afford. Employment remains tight, so the ability of consumer to pay their everyday bills really shouldn’t questioned at this point. I feel confident about this view because when I look at credit card payment statistics, for instance, people aren’t defaulting at above-average rates.
If the sky was really falling, you would see deteriorating credit in every segment, not just housing related loans. As long as people keep their jobs, I am confident they will be able to make regular credit card and student loan payments, even if they are forced to move into a smaller house after their adjustable rate mortgage resets. After all, they should not have been in the other house to begin with.
Full Disclosure: No positions in the companies mentioned at the time of writing