Jeremy Warner's Outlook: Bankers have little option but to keep our beleaguered housebuilders on life support

Another day, another über-bearish broker's note on the beleaguered housebuilding sector – this one from Credit Suisse. There's good reason to be gloomy. Even seasoned practitioners with experience going back to the mid-1970s cannot remember a crisis quite as traumatic as the present one.

For most housebuilders, sales are running at less than 50 per cent of last year's levels, and for some it is a great deal worse. In this respect, the crisis is already worse than the early 1990s, or even the mid 1970s, when there was a similar mortgage famine to the one we are seeing today.

In the early 1990s, the damage was done by a combination of oversupply, steeply rising unemployment and exceptionally high interest rates. None of these influences are present today, or not yet, in any case. Rather, the prevailing problem is an acute lack of mortgage finance, which has approximately halved over the last year.

Most housebuilders report a far less serious fall in genuine inquiries, but the squeeze in financing means that few viewings are translating into outright sales. The curiosity is that whereas in the early 1990s it was a sharply deteriorating economy that caused the housing crisis, today it seems to be the other way around. The housing crisis shows every sign of causing a possibly quite severe economic slowdown as the contraction in activity works its way down through the supply chain.

Nothing is for ever, and in Britain it is presumably the case that the reasonably positive fundamentals of the housing market, with an excess of demand over quite limited supply, will eventually reassert themselves. These supply constraints are already manifesting themselves in rising rents, as frustrated housebuyers are forced into the rental market as an alternative to ownership.

Yet in the meantime there is potential for extreme dislocation. The stock market value of the housebuilding sector has shrunk to a pale shadow of its former self. Once a member of the FTSE 100, Barratt Developments is today valued at just £232m.

As has been observed elsewhere, this is little more than Lakshmi Mittal, the Indian steel tycoon, has forked out for two houses on millionaire's row in London's Kensington over the past year.

This for a company with a landbank that at the last count was valued at £3.8bn. Subtracting debt gives net assets of £2.1bn. Even assuming the extreme impairment of 64 per cent envisaged by Credit Suisse to take account of falling house prices, the company would still appear to have substantial underlying value.

Yet the problem lies rather in the debt than the assets. After piling a further £900m of the stuff on to the balance sheet a year ago in part payment for Wm Bowden, Barratt now has £1.7bn of it hanging like a millstone around its neck.

With the benefit of hindsight, this top-of-the-market purchase was folly, yet we easily forget the climate of the times when companies such as Barratt Developments were being urged by the City to leverage themselves up to the hilt, à la private equity.

The upshot is that, though banking covenants are not yet breached as the company hits its 30 June year end, there's every possibility they will be next year. Interest cover will almost certainly be breached, and, in the present environment, Barratt will struggle to repay the £400m of debt that falls due next year.

Fortunately for Barratt's chief executive, Mark Clare, his bankers are in even worse shape than he is. They are in no position to accommodate the write-offs they would have to take if they pulled the plug.

No doubt they will demand their pound of flesh in return for rolling over the £400m and waiving the interest-cover covenant, but essentially they have no option now but to put Barratt and others like it into intensive care, and apply life support. It's too late to raise anything meaningful from a rights issue, and bankers will do all they can to avoid a debt-for-equity swap.

In this way, everyone hopes simply to sweat it out until the market recovers. Barratt is under pressure to provide clarity on write-offs with its results on 10 July. The steeper the expected fall in house prices, the higher the haircut on the landbank will have to be.

Housebuilders such as Barratt have made themselves extraordinarily flexible on costs, with virtually all building work outsourced to sub-contractors. Costs can therefore be easily adjusted to lower levels of activity. Even so, for all involved, it may be a long wait. A nuclear winter is settling on this industry, similar to the one that engulfed telecommunications in the aftermath of the tech bubble. There's unlikely to be an early bounce back.

Interesting? Click here to explore further