Troubled situations challenge CFOs.

• Author: Heffes, Ellen M.
• Position: Chief financial officers - Dialogue with Ellen M. Heffes - Interview

So you think your job is hard? Consider how you'd fare if you were CFO of a storied homebuilding company that for the first time in its 57-year history has seen earnings declines for the past five quarters--with no end in sight. Consider, too, if you were CFO of the New Orleans school district, simultaneously working on restructuring and rebuilding.

Financial Executive Executive Editor Ellen M. Heffes spoke with the two CFOs dealing with the situations just described. They are FEI members Roger A. Cregg, executive vice president and CFO for Bloomfield Hills, Mich.-based Pulte Homes Inc., and Stan Smith, COO/CFO of the Orleans Parish School Board in New Orleans. What follows are brief vignettes describing their situations and how these CFOs are managing through some unusually challenging times.

Roger A. Cregg Executive Vice President and CFO Pulte Homes Inc.

"The homebuilding industry continues to face an extremely difficult environment that includes record existing and new home inventory levels, intense price competition and weak consumer sentiment for housing," said Richard J. Dugas, Jr., president and CEO of Pulte Homes, in the press release reporting Pulte's second-quarter 2007 financial results.

Indeed, along with the overall homebuilding industry, $14.3 billion (2006 revenues) Pulte has been experiencing one of its roughest patches since the company was started in 1950 by 18-year-old William J. Pulte, when he and two friends built a five-room bungalow near the Detroit City Airport and sold it for $10,000. Now building homes in 51 markets in 26 states, Pulte has delivered nearly a half-million homes to America, from first-time buyers to retirees.

Sure, CFO and Executive Vice President Roger Cregg understands that housing is a cyclical industry. He well understands that some markets have experienced "outrageous price appreciation, relative to the growth of wages;" that "pockets around the country were not going to be sustainable at those levels" and that it was "just a matter of how long it would continue."

And, he concedes: "the affordability index certainly got out of whack with the ability to maintain that price appreciation and volume," noting that certain markets, such as Northern California, have always been higher relative to the rest of the country.

A big difference in the cycle this time, says Cregg, is that "it's the first time in almost the history of housing where the economy was still doing well in general and the housing industry started to perform very poorly."

He's referring to market activity that in 2004-05 showed exceptional buyer demand and limited inventory of new and existing homes, creating rapid price appreciation across the U.S., [along with] historically very low cancellation rates. Also, during that time, the federal government boosted home ownership nationwide through Fannie Mae and Freddie Mac.

Farther back, exiting the dot-com bubble, in 2000-01, investor demand for real estate picked up as people were looking for tangible investments and flocked to what Cregg characterizes as "sticks and bricks." This brought real estate investors into the industry--until a pullback began in early 2006 in many markets. As those investors stopped buying and began selling, inventories of both new and existing homes began to increase sharply. Cancellation rates accelerated as home buyers dropped out of deals in order to take advantage of larger incentives and price reductions elsewhere, or because they were unable to sell their existing home. Hardest hit were markets that rose most, such as Florida and California.

Also, then, and spilling into 2007, foreclosures and delinquency rates began to rise. And, Cregg reiterates, while rises and falls are cyclical, a key difference now is that "these changes occurred while the U.S. economy was strong. Job growth was positive, interest rates were moderate." Typically, he says, "Those are the first conditions to deteriorate when there's a housing slowdown."

Then, in early 2007, and continuing to some degree, concerns developed around the subprime market and mortgage lending, resulting in the tightening of mortgage market liquidity and the inability of some homebuyers to secure financing. In turn, that hurt consumers' confidence in their ability to purchase homes.

"We've seen almost all the different things that could possibly happen in the industry happen to us almost in the last two years," Cregg laments.

Indeed, Pulte posted a second-quarter loss of $508 million, and its second-quarter earnings release underscored the depth of the downturn: "The homebuilding pre-tax loss for the period reflects a decline in gross margins to -18.6 percent from 21.1 percent in the prior-year period, combined with an increase in SG & A as a percentage of home sale revenues to 15.5 percent, compared with 8.0 percent for the same period last year."

Even though Pulte is a diversified builder--catering to different classes of buyers (first-time buyers, move-ups and retirees)--the decline has impacted potential buyers of all of its brands--Pulte, Del Webb...