With the heat on from its creditors, troubled Florida condo developer WCI Communities ( WCI) is scrambling to look as healthy as possible.

While the company can't hide its weak cash flows, it may be employing unusual accounting assumptions to delay large land impairment charges that would reduce book value further.

WCI's shares have plunged 75% in 2007, as the company recorded $119 million in losses for the first nine months of the year. Not even an equity investment and a board shake-up by billionaire Carl Icahn could help the stock.

At around $4 per share, WCI trades at just 20% of book value, reflecting investors' liquidity concerns and skepticism over the value of the company's assets. It has a market capitalization of about $191 million.

Last week, Moody's cut WCI's credit rating to junk, citing the builder's weaker-than-expected cash flow generation and continued violations of bank covenants in its third quarter.

Most of WCI's single-family homes and condos are located in Florida, where the housing market went from red-hot to over-cooked in recent years, sending housing prices and land prices plummeting.

As prices drop in Florida and other formerly hot markets, homebuilders have been forced to record billions of dollars in inventory impairment charges to reflect the deteriorating value of housing communities and land investments.

Since the beginning of 2006, WCI has recorded $217 million of impairment charges, says Alex Barron, a homebuilder analyst with Agency Trading Group.

But Barron expected even more impairment charges from WCI, given the company's heavy exposure to the deteriorating Florida market.

"Florida is the hardest-hit market in the country. It has the highest number of homes for sale and prices have fallen 25% to 40% from peak levels," Barron says. "Thus most builders are no longer profitable."

What has surprised Barron and other analysts is that nearly all of WCI's impairments to date have been for finished homes (also known as "standing inventory"), not raw land or homes/communities under development. This differs from many other homebuilders such as Lennar ( LEN) and D.R. Horton ( DHI), which have recorded meaningful impairments of raw land and communities under development.

"Every other builder, when they start to lose money in a community, not only do they impair standing inventory, they also impair the work in progress, they also impair every lot associated with that community going forward," Barron says.

For example, in its most recent quarter D.R. Horton said about 75% of its impairment charges nationally were recorded to residential land and lots and land held for development. Only 25% was for homes under development and finished homes in inventory.

Unclear Assumptions

So why is WCI following a different path and not recording many impairment charges for its land?

Jim Dietz, WCI's chief financial officer, says the accounting rules differ for valuing finished goods vs. those still under production.

While finished goods require using present values of future cash flows, raw land can be valued using a company's internal model, rather than market prices, he says.

Under FAS Rule 144, long-lived assets like inventory are required to be tested for impairment each quarter. The test is to look at the future undiscounted cash flows from an investment to see if they cover the costs of the investment. If the expected future cash flows do not cover the cost, then the inventory is written down based on a discounted cash flow valuation.

In the case of WCI, gross margins have fallen for many land investments and communities under development, and the builder expects it to take longer to develop the sites. But the company still believes the projects will eventually cover the costs as stated on the balance sheet, Dietz says.

Under such assumptions, "the total cash flow before discounting may not change very much," Dietz says. Thus there's no need for an impairment charge.

Of course, investors don't know the exact assumptions WCI is using in its models, since the company is not sharing that information.

WCI has continually pointed to the fact that much of its land was purchased prior to when land and home prices reached a feverish peak in 2004 to 2005. About 60% of WCI's raw land was purchased prior to 2004, the company says.

In essence, WCI's argument is that in the future the company could build on this older, cheaper land and make a profit, based on various assumptions of housing prices stabilizing and development costs dropping.

But, again, this appears to be a much different story than what other companies are saying. D.R. Horton, in its most recent quarter, said it used more conservative assumptions in its impairment analysis to reflect its "expectation that the challenging conditions in the homebuilding industry will last longer and have a greater impact than we believed in prior periods," according to its latest 10-Q filing.

While land valuation models may be a black box for investors, they're presumably not for auditors. WCI and D.R. Horton share the same auditor: Ernst & Young. The question is how close the auditors are looking at the various impairment assumptions.

"Most homebuilders have Ernst & Young as auditors. The same team goes around and does impairment tests and charges," says Joseph Snider, a credit analyst with Moody's.

"You may find some modest differences in terms of timing and magnitude of impairment charges taken among builders, but in the end, they kind of come close to each other," he says.

Ernst & Young officials couldn't be reached for comment.

Reasons for Delay

The issue of only impairing completed homes was raised on a Toll Brothers ( TOL) conference call last week. (Toll Brothers also has Ernst & Young as its auditor.)

Without naming WCI, Barron, the analyst at Agency Trading, explained a situation to Toll management in which a builder argued that most of its impairments were for standing inventory, or completed homes.

Barron said this builder's recovery model assumed cash flows on raw land would be positive in the future. He asked whether this would prevent an impairment of the raw land.

Robert Toll, chairman and CEO of Toll Brothers, replied, "That is absolutely correct, but you've got to find an accountant that would buy that, and I'm not sure I would even sell it. Why would I want to sell that unless I had some kind of covenant that didn't permit me to go further?" Toll said.

Of course, for those looking to be skeptical, WCI does have reasons to be selling this story to its auditors. The company has already violated covenants with its banks.

WCI recently received a temporary waiver from its banks until Dec. 7 because it was not in compliance with its fixed-charge covenant. Any further impairment charges could put the company in violation of tangible net worth covenants.

As of the end of September, WCI had $2 billion of real estate inventories on its balance sheet. Of those, $961 million relate to land and land improvements (which have not seen many impairments).

At some point, if WCI decides to be like the rest of the builders and impair some land, there could be a very large writedown looming.

Until then, investors will be left wondering just exactly what WCI is assuming.

"I don't think assumptions going into impairment analysis should be left up to management," says Barron. "They should be based on observable facts in the marketplace, such as sales pace, pricing, margins. There needs to be more scrutiny and some level of minimum standards that apply across all the builders so that basically the level of impairments are not that subjective."

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