Now that most U.S.-based manufacturers have reported their mid-year 2011 warranty expenses, we can look at 34 quarters of data to answer a simple question: are we slipping back into a recession?

Since most people would agree that the speculative bubble surrounding home sales and mortgages is what got us there the last time, it would make sense to look at homebuilder data to find an answer.

And the answer seems to be, for some the recession never ended, at least not in housing. New home sales revenue for the top 20 publicly-held homebuilders, which comprise around a quarter of the U.S. market, was down 24% in the second quarter of 2011, compared to the same quarter in 2010. Revenue is down 13% from June 2009, which is when the last recession allegedly ended.

Of those 20 publicly-traded homebuilders, only two -- Toll Brothers Inc. and Skyline Corp. -- showed any organic revenue growth in the past year. A third, Cavco Industries Inc., grew only because it acquired Palm Harbor Homes Inc.

Frightening Sales Declines Continue

Of the 17 that saw sales fall in the past year, some of the declines were downright frightening: Beazer Homes, down 50%; M.D.C. Holdings, down 34%; M/I Homes, down 30%; and D.R. Horton, down 29%. These are not the numbers one would expect during a recovery.

In hindsight, it's pretty clear from the industry's warranty data when the recession began. Warranty claims peaked in the second half of 2006, while warranty accruals peaked at the end of 2005. Warranty reserves peaked at the end of 2006.

In Figure 1 below, one can see that peak, at just over $250 million spent on claims per quarter, followed by declines throughout 2007 and 2008. One might have thought the data hit rock bottom in 2009, but the first quarter of 2011 was even deeper.

So was the first quarter of 2011 the bottom? Warranty Week counted only $70.1 million in warranty claims paid during that quarter. Part of the reason for such a low total is of course the low volume of home sales in the years preceding. And part of the reason is no doubt related to the cold winter. But this new data puts a hole in the theory that 2009-2010 was the bottom of the cycle.

Since there's a bit of lag time between when a home is sold and when it requires some warranty work, and since the industry is very seasonal even when the winters are mild, let's look at a different set of data. Claims are paid when the work is done. Accruals are made when the home is sold. So the accrual data should be much more closely aligned with sales data.

A New Bottom in Early 2011?

In Figure 2, we see the same notch in the early 2011 data. Last time we looked at the new home industry, we compared the eight years from 2003 to 2010. And that data suggested that either 2009 or 2010 was the bottom (claims data suggested 2009 while accrual data suggested 2010).

But when we switch to a quarterly view, we can see that while the first quarters of 2009 and 2010 were low, the first quarter of 2011 was lower. In fact, the first and second quarters of 2011 are the only two of the last 34 in which the industry made less than $50 million in accruals.

With the massive declines of the past few years, it's easy to lose sight of the strong seasonal pattern from year to year. But within each group of four quarters, the final quarter of each year is usually the peak in terms of accruals. The only years in which this was not the case were 2008 and 2010, and that was because sales declined almost continuously those years.

The all-time peak for accruals came in the fourth quarter of 2005, when homebuilders set aside nearly $344 million to finance warranty work. The second-highest total was in the fourth quarter of 2006, when nearly $283 million was set aside.

Percentage of Revenue

Another way to look at claims and accruals is as a percentage of sales revenue. In Figure 3, we've taken the data of Figures 1 and 2 and divided them by home sales, to calculate a percentage. Keep in mind that we first subtracted all finance and land sales revenue, since only the homes are warranted.

This chart appeared in the May 19, 2011 newsletter, minus the 2011 data. At that time, we said the fairly steady accrual rate was a good thing, while the rising claims rate was a symptom of the recession's effect on sales.

The additional six months of data in Figure 3 just prolongs that effect. Accrual rates are still steady. And claims rates are still high. And, we're suggesting, the recession is still continuing, at least in the housing sector.

Measuring Warranty Reserves

There's one more metric we can look at. Imagine that warranty is a bank account, and claims are the withdrawals while accruals are the deposits. There are a few other ways to affect the balance, but let's measure the industry's total warranty reserve fund balance at the end of each quarter since the start of 2003.

As can be seen in Figure 4, the balance peaked at $1.35 billion at the end of 2006, and has been declining more or less continuously ever since. By the end of June 2011, the homebuilders' warranty reserve funds held only $698 million -- a little over half of what they held 4-1/2 years ago.

There is, however, a way to measure these reserves so that they're not declining. We could measure them in terms of their capacity to pay claims. Imagine the reserve balance not as a dollar amount, but as a multiple of the claims payments. So in that peak quarter, when $1.35 billion was in the reserve funds, homebuilders paid out $253 million in claims. That's equal to payments of $84.3 million per month, and $1.35 billion is therefore equal to 16 months of capacity.

Average Reserves/Claims Ratio

Historically, U.S.-based manufacturers have usually kept that ratio between 15 and 18 months. In Figure 5, that's the bright blue line, which remains relatively flat over the past 34 quarters. What it means is that on average, manufacturers have kept their reserve fund balance in a range between what they paid out in claims over the preceding 1-1/4 to 1-1/2 years.

Homebuilders are represented by the purple line. From 2003 to 2007, the ratio between their monthly claims payments and their warranty reserve balance meandered around 15 months. Until 2007, the ratio never exceeded 18 months. But since 2007, it's never been below 18 months. And since then, it's never again been below the average for all manufacturers.

This means, we believe, that homebuilders are keeping more than they need in their reserves. For years, they could get by with less than a year-and-a-half's worth of reserves. But then the recession cut into sales, and for whatever reason, cut even deeper into their claims payments (see Figure 1). Homebuilders, not realizing they needed to reduce accruals, kept those accrual rates steady at around 0.9% (see Figure 3). And inevitably, this led to the increase in the ratio between claims and reserves that we see in Figure 5.

It's only mildly good news. But it's the only good news we could find in all this homebuilder warranty data. Bottom line, some of these builders could safely remove funds from their warranty reserves, in a quantity that would bring them back down to 15 months of capacity.

In other words, their finance chiefs could total up the past five quarters of claims payments, and subtract that amount from their reserves. Anything additional is excess, which could be removed from the reserve and added to the income statement.

Attention, Actuaries & Auditors:

On that basis, then, we calculate that 15 out of the 20 public homebuilders have overaccrued a total of $210 million. That includes $66 million for Hovnanian Enterprises; $33 million for Toll Brothers; $30 million for KB Home; $21 million for M.D.C. Holdings; and $16 million for Standard Pacific Corp.