Transeastern troubles drag down Technical Olympic earnings; investment written off

By Paul Deckelman

New York, Nov.14 - Technical Olympic USA Inc. fell into the red in the third quarter, dragged down by the continuing problems of its Transeastern homebuilding joint venture. The Hollywood, Fla.-based home builder said Tuesday that it would write off its $143.6 million investment in the ill-fated operation.

Technical Olympic also reiterated its rejection of Transeastern agent lender Deutsche Bank's recent demand for payment of all the joint venture's $625 million of outstanding bank debt, calling it "an attempt to expand the scope of the guarantees" that the joint venture partners previously gave the lenders.

The company said that at this juncture, its potential additional exposure to Transeastern was about $25 million under a completion agreement that Technical Olympic and its partner in the Coral Springs, Fla.-based joint venture, The Falcone Group, signed with the lender group when Transeastern was launched last year with the $826.2 million purchase of the assets of the former Transeastern Properties Inc.

Transeastern turns into debacle

In retrospect, that acquisition proved to be a major mistake.

On the company's conference call following the release of its numbers for the quarter ended Sept. 30, Technical Olympic's president and chief executive officer Antonio B. Mon acknowledged that "with the benefit of hindsight" the acquisition transaction took place "near the peak of the market."

No one knew it at the time, but the Florida housing market, which Mon said was at the time robust, would soon deteriorate sharply, to the point that it is now "one of the most challenging" homebuilder markets in the United States, affecting not only Transeastern, but Technical Olympic's own Florida operations, carried out by the company itself or through other joint ventures.

But Transeastern clearly was the hardest hit. Its debt-to-capitalization ratio was 80%, well above that of other Technical Olympic joint ventures - but it was thought that the ambitious project would produce annual sales of 3,500 to 4,000 homes.

The downturn in the Sunshine State has forced Technical Olympic to lower that estimate to just 1,000 to 1,500.

'It just does not work'

With annual carrying costs on its debt of $60 million, Mon said, doing the math shows that each of the 1,500 homes the joint venture now expects to sell would have to have $40,000 of debt service priced in at a time when sales are already lagging and prices are being cut to lure buyers.

"It just does not work," he said.

That caused the company to meet with Transeastern's lenders in late September to seek modifications in the joint venture's loan agreement. News of that meeting, when it got out, smacked the joint venture's bank debt down to its current levels in the lower 80s from around par bid originally, and Technical Olympic's own bonds and shares have been taking a pounding since then on investor fears that the parent may be left holding the bag should Transeastern slide into insolvency.

Says exposure limited

During the conference call, Mon and Technical Olympic's interim chief financial officer Randy Kotler said that the debt would be full recourse back to Technical Olympic and Falcone only in the event of a voluntary Chapter 11 filing.

Limited recourse, meaning the partners would be liable for only part of the amount, would be the case if there were misrepresentation or certain other matters, and Technical Olympic would only be responsible for damages or losses suffered by the lenders as a result of the misrepresentation.

The debt would be non-recourse in the event of an involuntary bankruptcy filing, say by disgruntled debtholders. When asked what the situation would be were an involuntary filing to be converted by the courts to a voluntary one, Mon replied that there had been no discussions of any Transeastern bankruptcy scenarios.

The $625 million of Transeastern debt consists of $335 million of senior debt, as stipulated in its borrowing agreement, $65 million of revolving credit debt out of the originally available $115 million, and $225 million of mezzanine debt. The debt is secured by the company's assets, although Kotler acknowledged that while the book value of Transaeastern's assets, before any potential impairments now being evaluated, stood at $980 million as of Sept. 30, only $428 million is in tangible assets such as land and construction in progress.

Mon said that interest payments on the senior mezzanine debt "are current at this time." Kotler added that an interest payment is due at the end of the month.

The acting CFO was asked during the question-and-answer period following the company's official presentation whether Technical Olympic might decide that it was better to put more money into Transeastern rather than let the whole operation go belly up.

He said that while "we haven't ruled out anything," the amended terms of its own $800 million credit facility that Technical Olympic agreed to last month, "there are limitations on TOUSA putting in or making any advances to the Transeastern joint venture without our lender approval - so we would have to work through that."

No plans for bond buyback

Technical Olympic said in its 10-K report filed with the Securities and Exchange Commission that as a result of Transeastern's deteriorating situation, which constituted a material adverse change under the terms of the credit facility, what had previously been an unsecured facility became a secured revolver, with a borrowing base and mortgage requirements on the borrowing base assets, as well as the limitations on any investments the company might want to make in Transeastern.

An analyst asked whether Technical Olympic had any plans to buy back bonds as a way of de-levering the balance sheet. Kotler said that while the company has the ability to do so under the terms of its credit facility - there is no restriction on buying back its senior notes, although there are restrictions on repurchases of subordinated debt - "but right now, we're focusing on improving our balance sheet and stockpiling cash, preserving our capacity. So I don't think that's something that is currently on the table," although he added that it was matter for the company's board to decide.

"Right now, I don't believe that's our intended plan to use with any cash, at this point," he reiterated.

As of Sept. 30, TOUSA had consolidated borrowings of $1.1 billion, up from $911.7 million at the end of the 2005 fiscal year on Dec. 31.

The debt included $300 million of 9% senior notes due 2010, $250 million of 8¼% senior notes due 2011, $185 million of 10 3/8% senior subordinated notes due 2012, $125 million of 7½% senior subordinated notes due 2011 and $200 million of 7½% senior subordinated notes due 2015. The company had no sums drawn under its $800 million revolver and had issued letters of credit totaling $307.8 million.

Under the amended terms of the credit facility, the company had $100 million of revolver availability through Nov. 6, which then increased to $150 million. The company would have a theoretical maximum availability under the borrowing base restrictions set by the amendment of $492.1 million, which would require all liens and security interests be filed. Technical Olympic said it is currently in the process of doing so and anticipates completion by Dec. 31.

As of Sept. 30, the company had unrestricted cash and equivalents of $34.1 million.

Slide into the red

During the quarter, Technical Olympic reported a net loss of $80 million ($1.34 per share), compared with net income of $70.3 million, or $1.18 per share, a year earlier.

The loss was primarily attributable to $203.9 million of charges resulting from the write-down of assets including investments in joint ventures - notably the $143.6 million stake in Transeastern - write-off of deposits and abandonment costs and inventory and goodwill impairments.

Given the difficulties in the housing market and the problems the Transeastern joint venture has run into, the company lowered its 2006 full-year earnings guidance to between $62 million and $72 million ($1 to $1.13 per diluted share) based on 62 million fully diluted shares outstanding. It declined to issue 2007 guidance, in view of the unsettled market conditions.

Looking at the overall housing market, Mon said that while the current downturn manifests all of the effects of prior downturns, such as lower traffic levels of potential homebuyers, higher levels of sales incentives needed to move unsold houses, high sales and marketing expenditures, lower absolute prices and "essentially a crunch in profits" for homebuilders, "the current correction represents one of the rare cases where the housing markets are correcting without the usual macroeconomic-type factors," such as recessions, high interest rates, high unemployment rates or other national or regional factors.

This time 'it's different'

"This time around, it's different," he declared, as the larger economy still appears strong and mortgage rates remain at affordable levels. The problem, he said, is one of simple supply and demand - "too many houses for sale and not enough buyers for them."

The current downturn, he said, originated with sharp deterioration of the housing market in July and August, which continued to worsen in the following months. "In most of our markets, we have seen no sign of stabilization yet," Mon said, "and we fear that we have yet to find a bottom."

He warned that the current supply and demand imbalance "will take some time to resolve, and it will take a longer, rather than a shorter period of time to sort this out."

Anticipating no end soon to the industry's problems, Mon said "we continue to manage TOUSA accordingly. We are focused on maintaining liquidity, and on protecting our balance sheet for offensive and defensive reasons." The company has already undergone "multiple" reductions in personnel and has cut discretionary spending.

"We have some more work to do in this area," he said, "but we believe we are close to where we need to be."

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