Housing and Financial Problems To Last Into 2009

Key Points:

• Housing inventories are still rising
• Mortgages are both harder to get and more expensive
• 2009 profit forecasts continue to be cut on homebuilders and financial companies

My Home Buying Experience

I've been trying to buy a house via a short-sale, and from what I'm hearing and reading, my experience has been typical of many other would-be buyers. It also reaffirms my belief that the housing slump will extend into next year.

Last April, my wife and I made a bid on a house that was selling for less than what was owed (hence the term "short sale"). The owners used 100% financing to purchase the house and have since been unable to keep up with the payments.

In a short sale situation, the lender(s) absorb the difference between the loan amount and the purchase price. Therefore, any purchase offer must be approved by them. The first lender approved our offer in June. The second lender asked us late last week to raise our price, just as the lawyers were proceeding to put the house to auction.

The risk the second lender is taking is that if an agreement is not reached on a sale price, the house will go to auction. Houses don't always sell at auction and even when they do, the sale price can be lower than the offer price previously presented to the bank. In other words, the second lender is taking a big risk by asking us to raise our offer in a market where home prices are declining.

We've countered with a price that is above our previous offer, but below the banks' asking price, which we think is too high. It could be a few weeks before we hear anything.

Now, multiply our situation by thousands of other would-be buyers and it's obvious why the housing slump continues.

Too Much Inventory

Most realtors don't like short sales because they take a long time to close and, at the same time, create competition for other houses. Short sales are certainly contributing to the glut of unsold homes, though the overall drop in the number of buyers is the biggest reason for the rising inventory.

How bad is the inventory problem? Well, last week the overly optimistic National Association of Realtors admitted that the inventory of homes continued to rise, reaching 11.2 months. In other words, if no other homes were put on the market, it would take nearly a year to sell all of the houses currently listed on the MLS.

More homes for sale means more pricing pressure. It's economics 101.

Therefore, it is not surprising to see brokerage analysts continue to cut their fiscal 2009 earnings estimates on the likes of Pulte Homes (PHM - Snapshot Report) and Toll Brothers (TOL - Snapshot Report). The average forecasts now call for PHM, TOL and other homebuilders to post another year of losses in 2009; previously, the brokerage analysts had actually projected profits.

No Money, No Buyers

Even for those who want to buy a house, credit is no longer easy to get. Many mortgage brokers are asking for credit scores of 720 or higher, far above the national average.

Interest rates have also risen. Bankrate.com currently shows the national average for 30-year fixed mortgages at 6.25%.

Even for those of us with good credit, interest rates can vary. Last week, I was given rates for a 30-year fixed mortgage that ranged between 6% and 6.875%. (My experience has been that rates in Illinois are typically higher than the national average.) All of the brokers I talked to blamed the ongoing problems with Fannie Mae (FNM - Snapshot Report) for the higher rates. (One mortgage broker told me business was so bad, she decided to take the summer off.)

The problem is not just with GSEs (Fannie and Freddie Mac (FRE - Analyst Report). There is also the risk that the ongoing implosion within the financial sector will get worse. Consider the following:

• The FDIC's list of problem banks grew to 117 in June, up from 90 during the first quarter.
• The FDIC's insurance fund's reserve ratio dropped so low, 1.01%, that it is being forced to develop a plan for replenishing the safety net for depositors.
• Bloomberg News estimates that banks and securities firms have cut more than 100,000 jobs this year.

And if that wasn't bad enough, many consumers are struggling with debt:

• Nearly 1 million petitions for bankruptcy have been filed during the past 12 months; personal bankruptcies are up 28%.
• Net charge-off rates for Capital One (COF - Analyst Report), and probably several other credit issuers, have been rising for several quarters.

Yet, in the background of this mess, some market observers have actually advised buying financials. These calls contradict the ongoing reductions in profit forecasts: financial companies account for nearly 25% of all negative earnings estimate revisions for 2009.

More importantly, if the problems in the financial sector weren't bad, than why is Lehman Brothers (LEH) going hat-in-hand to the Korea Development Bank?

Trading the Financials and Homebuilders

I realize that some financial and homebuilding stocks have entered into trading ranges. Regardless of what the charts show, the risks of owning these companies continue to outweigh potential rewards.

At some point, the tide will turn. It hasn't yet, however, and investors would be prudent to be cognizant of this fact.

Despite this analysis, some of you will nonetheless choose to be contrarians and attempt to find a bottom in financial and homebuilding stocks. If so, I strongly suggest doing a lot of research and only buy those firms that are both fundamentally sound and trading at discounts to their historic earnings. Even then, dollar cost averaging may be advantageous since a recovery is unlikely to occur until next year, at the earliest.

Related ETFs

Dow Jones U.S. Home Construction iShares (ITB) contains the major homebuilders. S&P Homebuilders SPDR (XHB) is a bit more broad, having exposure to building supply companies and home improvement retailers.

There are various ETFs that focus on the financial sector, from broad ones such as Vanguard Financials (VFH), to those that focus more on regional banks and thrifts, like KBW Regional Banking (KRE).

Zacks Premium and Zacks Elite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.