This week, we are checking to see if the bust has proven to be systemic or has spread to one of HOUSE's main rivals in the mass housing space, namely Vista Land & Lifescapes Inc. (VLL). VLL is not as dependent on ICRs to finance sales. Its ICRs represent 347 days sales in 2014 vs. 661 days sales for HOUSE. As a result, VLL is less leveraged than HOUSE in terms of ICRs. ICRs as a percentage of Stockholders Equity amounted to only 40.93% as of 2014, less than half the level of HOUSE (94.79%) for the same period.
Like HOUSE, VLL has experienced a significant uptick in both the absolute and relative values of its Past Due But Not Impaired ICRs, particularly the ICRs that are more than 90 days past due.
Total Past Due but Unimpaired ICRs now stand at 8.83% as of 2014.
But unlike HOUSE, the relative value of its Impaired ICRs is still tiny - only 0.63% as of year-end 2014.
What is troubling is that all of VLL's ICRs are classified as Level 3, meaning that the technique used to value the asset (discounted cash flow analysis) are based on unobservable data. In VLLs case, the particular unobservable data is the discount rate.
In Note 31 of VLL's financial statements, VLL uses the following heirarchy for determining and disclosing the fair value of its financial assets by valuation technique. There are three levels:
Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities;
Level 2: other valuation techniques involving inputs other than quoted prices included in
Level 1 that are observable for the asset or liability, either directly or indirectly; and
Level 3: other valuation techniques involving inputs for the asset or liability that are not
based on observable market data (unobservable inputs)
"...recognized initially at fair value, which normally pertains to the billable amount. After initial measurement, loans and receivables are subsequently measured at cost or at amortized cost using the effective interest method, less allowance for impairment losses. Amortized cost is calculated by taking into account any discount or premium on acquisition and fees that are an integral part of the effective interest rate (EIR). The amortization, if any, is included in profit or loss. The losses arising from impairment of receivables are recognized in profit or loss."The fair value of VLL's ICRs are valued using a discount rate which is not observable and which is significantly lower than the discount rate used on HOUSE ICRs (which is the interest rate of the receivables being valued). "The difference between transaction price and model value is only recognized in profit or loss when the inputs become observable or when the instrument is derecognized."
Significant increases in the discount rate would undoubtedly result in significantly lower fair values of the installment contract receivables.
Two mass housing developers who operate in roughly the same space and provide in-house financing to a similar customer base have vastly different methods of arriving at the fair value of their installment contract receivables. Both methods are acceptable under current financial reporting standards. But one is more transparent and the other is murkier.
Which one would you trust?