Speculation abounds that the housing downturn which began in mid-2005 and accelerated during 2006 has yet to hit bottom. News reports documenting weak trends in the U.S. housing market, the overall decline in housing values and the corresponding impact on consumer wealth permeate the media. Conditions for sub-prime borrowers have continued to tighten, and the fallout to sub-prime mortgage lenders has become a hot topic.

The effects of the housing downturn are far reaching. Some economists have observed that the housing recession is shaving an entire percentage point from national GDP growth, and are predicting that the impact on consumer spending and the residential investment overhang has yet to peak. Lenders and investors whose portfolio companies are affected by the housing downturn should be exploring its impact.

One industry that has been especially hard hit is homebuilding. Homebuilders experiencing dropping sales and increasing cancellation rates have been scaling back and cutting costs. To this point, Toll Brothers Inc., a major developer of luxury residential homes, reported a 19 percent drop in sales and a 30 percent rise in cancellations (an improvement from the 40 percent recorded in the prior year period) for its first quarter ended January 31, 2007. Similarly, D.R. Horton, a major builder of single-family homes, announced in February that it reduced its number of homes under construction by 30 percent for its fourth quarter ended December 31, 2006. In an unsurprising corollary, the major home improvement retailers have reported softening same-store sales, attributing the decline to the slowdown in the residential housing market. Likewise, building material and supply companies, including those that service professional contractors and builders, are facing related issues.

With these downward trends in place, lenders should monitor how the companies within their portfolios, and these companies' competitors, suppliers and customers, plan to weather this period. For instance, some distributors have announced restructuring plans to reduce costs and increase efficiencies. Huttig Building Products, a national distributor of building and wood products based in St. Louis, Missouri, announced an expanded restructuring plan following a 2 percent drop in sales and 244 percent drop in income from continuing operations for its third quarter ended September 30, 2006. In response to dampened spending on remodeling, some manufacturers have introduced cheaper alternatives. To this point, according to The Wall Street Journal, Formica Corporation, which manufactures and markets laminated and surfacing products, recently introduced laminated countertops at prices ranging from $11 to $24 per square foot installed; historically, its more expensive counters cost $28 to $48.

The knock-down effect of the housing downturn has implications for a number of related sectors, including furniture, home furnishings, appliances, consumer electronics, renovation products, household paint and garden supply. With fewer consumers buying, furnishing or fixing up homes, lenders and investors working with clients in these and related sectors need to understand how companies are navigating their way through the economic downturn.

Sources:

Standard & Poor's Industry Surveys: Trends & Projections, Sam Stovall and David Wyss, February 15, 2007.

Economic & Market Analysis, "Negative Fallout From Housing? Who Would've Thought!" Steven Wieting, Citigroup Portfolio Strategist, February 15, 2007.

"Home Improvement Lite - As Market Chills, Owners Try Cheaper Renovations: "I Made Some Bad Decisions," June Fletcher, The Wall Street Journal, February 16, 2007.

US Economics Weekly, "Will Housing Drag Down the Consumer Too?," Deutsche Bank Global Markets Research, February 16, 2007.