By Zach Fox

Recent legislation that increased the net operating loss carryback provision to five years from two years added billions of dollars to homebuilders' earnings reports during their most recent quarters, turning losses into profits for several builders. And according to some industry observers, the provision was so lucrative that it might have kept a pair of weaker builders out of bankruptcy court.

In all, homebuilders recorded $2.30 billion in income tax benefits during their most recent quarters, according to SNL Financial. That figure does not represent the net operating loss carryback benefits alone; rather, it shows all income taxes and benefits combined. It includes some builders that actually paid taxes, such as NVR Inc., which reported a loss during just one quarter in the last three years — meaning the company did not have many losses to carry back.

The tax benefit was so large that it might have been the only reason two builders did not go under, Vicki Bryan, a senior high-yield analyst at Gimme Credit, told SNL.

"This is so important that it might have saved the weakest ones, Hovnanian [Enterprises Inc.], Beazer [Homes USA Inc.] They looked like they were headed to bankruptcy," she said.

Robert Curran, managing director at Fitch Ratings, does not quite agree that Hovnanian and Beazer might have been headed for bankruptcy court if not for the carryback expansion to five years, which was included in the homebuyer tax credit extension and expansion. However, Curran told SNL that the pair of struggling builders might have been forced to file for bankruptcy protection if not for earlier tax benefit legislation.

"That's certainly a possibility if you take into account earlier tax refunds. The current tax refund is not so much the issue, but in the past, [tax benefits] contributed to the liquidity position, and [Hovnanian and Beazer] have been in, particularly earlier, rather tentative positions," Curran said.

Curran and Bryan both said tax benefits distorted earnings during the builders' most recent quarters.

According to SNL, nine builders reported pretax losses but swung to profits after accounting for the tax benefits. All but one of the builders covered by SNL beat Street estimates, many by large margins. Hovnanian, which recorded an income tax benefit of $291.2 million, posted the largest EPS beat at $3.42.

Pulte Homes Inc. was the only miss, falling short of the Street estimate by 12 cents per share. The company reported the sector's largest income tax benefit at $800.3 million; Pulte also reported significant impairment charges, totaling roughly $925 million.

Curran and Bryan both declined to call the builders' most recent quarters profitable.

"They're still losing money," Curran said. "This is just because of a tax benefit, so the typical builder, although they may have slimmed their loss, they're still losing money. And these are the public companies; the private builders, for the most part, are in much worse shape."

Bryan echoed that sentiment, adding that she is also concerned the cash infusion from the tax benefit might cause builders to stray from the conservative tack they should be taking.

"My problem is I think their behavior is being altered with these tax refunds coming in," she said. "It's not their money; it's somebody else's money."

In particular, Bryan pointed to Hovnanian, noting that the company plans to spend $140 million on land in 2010 while the company's annual interest cost is $194 million. The builder's debt is 116% of revenue, according to Bryan.

"They're spending almost as much in land as they have in interest costs that they're not covering," she said. "So that's why I focus on cash flow from operations … and what do you got? You've got a big-time negative for Hovnanian when you net out the tax refund. But they're shopping. Yay! Credit card! Hoo-hoo!" And with appetite for land already high, Bryan is worried the extra infusion of cash from the tax credit could create artificially high land prices.

Still, Curran said few land deals have closed, meaning the extra cash might not translate to land spending. Yet hoarding cash appears to be the modus operandi for builders, and the tax benefit has aided that effort. As an example, Curran points to M.D.C. Holdings Inc., which has a large cash position and still issued debt recently to further increase cash holdings. "That could be from the perspective that companies think things will potentially remain uncertain for a number of years yet to come. It could also be a case where the companies would be welcoming in the capital to help fund land purchases down the road to take advantage of a recovery. So it's two-pronged in that regard: It's insurance, if you will, and also ammunition."

A pair of housing experts in California, home to some of the largest housing crashes in the nation, said the net operating loss carryback extension and expansion will do nothing to mend the housing market.

"Of course not. They're not building any homes; there's still too many of them kicking around," Christopher Thornberg, a principal at Beacon Economics in Los Angeles, told SNL. "Permits, starts are still flat; they're still at a bottom. It's a bailout. It's a bailout for builders. It's a bailout for Robert Toll. They're bailing out Robert Toll. Repeat after me, they are bailing out Robert Toll. What's wrong with this picture?"

When asked whether there were any positives to come out of the net operating loss carryback extension and expansion, Thornberg said, "No, no, no, no, no, no, no. No. Nothing. There's nothing to build; there's an oversupply. If anything, they're making it worse because they're encouraging construction when we need to burn off our existing supply first."

Though it might not seem possible, San Diego-based real estate consultant Ramsey Su was even harsher. "It's a total freebie. It's one of the worst policies. It's a total payoff. There was hardly any discussion and it was snuck into that other bill. It just got passed because everybody got paid off," Su told SNL. "It's probably the worst act of corruption, but how are you going to show that? If you go near someone, they're going to say, 'We have to stimulate construction jobs.'"

And even with the cash infusion, builders might have a rough time moving forward. Fitch's Curran expects an "uneven recovery" for housing. Bryan, the Gimme Credit analyst, agreed that a return to sustained profitability will take awhile.

"At the end of the year, the builders were in worse financial shape than they've been in decades, maybe ever. … This year I, like just about everyone else, think they'll probably do better than last year," Bryan said. "But jeez, that's kind of like, 'my left arm was shlopped off with a machete [and] this year I don't think my right arm will be.' Is that better? We're still kind of bad off."