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Toll Brothers Profit Falls Sharply; Pool of Homebuyers Shrinking

Toll Brothers, the largest U.S. luxury home builder, Wednesday reported a better-than-expected, yet sharply lower, quarterly profit amid tightening credit standards it said would likely shrink the number of potential home buyers.

George Widman

U.S. home builders have been suffering though a severe downturn initially fueled by soaring home prices and a rise in mortgage rates that drove some buyers out of the market. The industry's problems have recently worsened, due to the credit crunch derived from rising defaults by subprime borrowers -- those with the riskiest credit.

"We, along with many others, are concerned about the dislocation in the secondary mortgage market," Chief Executive Robert Toll said in a statement.

However, Toll's results and speculation that the Federal Reserve may cut its benchmark interest rate helped send Toll shares up nearly 4 percent to $21.91 in trading on the New York Stock Exchange.

Shares of high-end home and condominium builder WCI Communities, which also reported results on Wednesday, rose 1 percent to $8.04. The optimism spread throughout the sector, as the benchmark Dow Jones U.S. Home Construction Index rose 1.26 percent.

"I imagine that some of the people who shorted (the stock) are probably running for cover," said Alex Barron, Agency Trading Group senior analyst.

Tighter mortgage standards have spread to those likely to buy homes from Toll and WCI.

In the third quarter that ended July 31, Toll's net income fell to $26.5 million, or 16 cents per share, from $174.6 million, or $1.07 per share, a year earlier.

The results include pretax write-downs of $147.3 million for operating communities, land and land options. Better margins helped Toll beat the 5 cents per share expected by analysts, according to Reuters Estimates.

WCI, whose business is concentrated in Florida and focuses on building high-rise condos, posted a second-quarter loss of $33.2 million, or 79 cents per share, compared with a year-earlier profit of $22.7 million, or 52 cents per share.

Mortgage rates, especially for jumbo mortgages of more than $417,000, have soared in the past month as credit fears have spread to loans to higher credited borrowers, the typical luxury home buyer.

To weather the downturn, home builders have been shoring up their balance sheets and conserving cash. Reducing home production until the current oversupply is absorbed is a key step to bringing housing markets back into equilibrium, Toll said.

The company reiterated it would not issue any projections, citing uncertainties in the mortgage market, impairments and sales paces.

Toll said that through the third quarter, its buyers were generally able to obtain both standard and larger loans. "Nevertheless, tightening credit standards will likely shrink the pool of potential home buyers," Robert Toll said. "Mortgage market liquidity issues and higher borrowing rates may impede some customers from closing, while others may find it more difficult to sell their existing homes.

"However, we believe that our buyers generally should be able to continue to secure mortgages, due to their typically lower loan-to-value ratios and attractive credit profiles."

Bank of America, which recently downgraded Toll shares to "sell" from "neutral," said Toll's language does not bode well for the company's current quarter, which so far has seen a more severe tightening of credit.

"We think the lack of liquidity in the mortgage market and resulting higher spreads will negatively impact sales going forward," Daniel Oppenheim wrote in a research note.

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