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Homebuilders Still Rotting Despite Fed Cuts

Despite a swath of interest rate cuts since September, the industry has continued to decline. So what's eating these stocks?

Now that the

Federal Reserve

may be done cutting interest rates, it's worth taking a look at how the 325 basis points of cuts so far have helped the homebuilder stocks.

The answer: very little ... if at all.

Since Sept. 17, 2007, the day before the Fed first cut the fed-funds rate by 50 basis points to 4.75%, to

Wednesday's 25-bp cut

resulting in the current 2% rate, the

SPDR S&P Homebuilders ETF

(XHB) - Get SPDR S&P Homebuilders ETF Report

has fallen 6.4% vs. a 6.2% decline in the

S&P 500


At first glance, this seems rather surprising since the rate cuts were supposed to help the homebuilder stocks.

One stubborn problem is the 10-year Treasury note, which has not fallen as much as the short-term fed funds rate. The 10-year note is now at 3.76%, vs. 4.47% back in September, prior to the first Fed cut.

As the market moved from an inverted yield curve in fall 2007, which signaled a recession, to a now steeper yield curve, which signals an eventual recovery in the economy, homeowners have not seen much lower mortgage rates (since these are generally tied to the 10-year note).

The average 30-year mortgage rate in the U.S. is now 6%, down from 6.38% back in September 2007, but rates have been rising over the past two months.

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A Tax Credit Farther

This is why the National Association of Home Builders on Wednesday applauded the latest Fed rate cut but called for more action by Congress to enact a temporary tax credit for home buyers.

Implicitly, this is an admission by the industry that monetary policy hasn't helped the builders much, and now fiscal policy must be used to bail out the industry.

A temporary tax credit "will provide an immediate shot in the arm," says NAHB President Sandy Dunn, a homebuilder from Point Pleasant, W. Va. "It will get consumers off the fence, stimulate home buying and reduce excess supply in housing markets. The home buyer tax credit worked in the 1970s when the economy was in recession. We need it now."

There is no doubt that the public homebuilders need some sort of shot in the arm. The Fed cuts haven't helped. Just look at the sharp new-order declines recently reported by

Pulte Homes

(PHM) - Get PulteGroup, Inc. Report








After Wednesday's close, Centex reported a loss from continuing operations of $908 million for its quarter ending in March. This amounted to $7.34 a share, much worse than the $2.43 a share analysts expected, according to Thomson Financial.

Earlier this week, the S&P Case-Shiller Index reported that

national home prices fell 12.7% year-over-year in February


One analyst, who remains bearish on housing, says the stock market is pricing in negative news to homebuilder stocks, but he feels people do not understand the magnitude of the problems.

It's like saying, "I know this person has cancer, but I don't believe they are going to die," the source says.

While land impairment charges have clearly ravaged the industry, it's important to look at how homebuilders are now reporting operating losses, even if you add back the impairment charges.

For example, Centex reported an $853.4 million operating loss in its homebuilder division in the first quarter. If you add back the $362 million of impairment charges and the $395 million loss on a land sale, then Centex still booked a $96 million operating loss.

Pulte Homes recently reported a $705 million homebuilding operating loss on $663 million of impairments, which again shows a builder losing money even adding back the impairments.

Declining Home Prices

So how exactly do the builders start making money again?

There are only a couple of ways: home prices rise, or expenses get cut further.

The latter method is pretty unrealistic, since many builders have already laid off much of their staff and are not gaining much traction in getting suppliers to cut material costs.

The other issue -- home prices -- doesn't look to be getting better anytime soon. Inventories of homes remain high, partly due to the wave of foreclosures across the country that are pressuring home prices even further. RealtyTrac earlier this week released its U.S. Foreclosure Market Report, showing a whopping 112% year-over-year increase in first-quarter foreclosures.

Moody's on Thursday said it does not expect a housing recovery to begin until well into 2009 at the earliest. It also raised worries about the credit issues facing the industry. Moody's said it also "expects homebuilders to face growing resistance from lenders when requesting financial covenant waivers or amendments, making violations harder to resolve."

If home prices don't recover until late 2009, then that likely means more impairment charges for publicly traded homebuilders. But even if impairments have ended, builders today are still reporting losses, as evidenced by the Centex and Pulte results.

Now that the Fed cut mania is over -- and the rate cuts haven't even helped the builder stocks -- investors would be wise to pay close attention to the deteriorating fundamentals of the group.

Know What You Own:

Among the stocks tracked by the SPDR S&P Homebuilders ETF are Centex and Ryland as well as


(HOV) - Get Hovnanian Enterprises, Inc. Class A Report


KB Home

(KBH) - Get KB Home Report



(LEN) - Get Lennar Corporation Class A Report