“Fitch’s forecast for the housing sector in 2007 has become more bearish.” Their words, not mine. Fitch Ratings released a doozy of a report on the housing market tonight — and even went so far as to put the entire report within its press release. Essentially, the report amounts to an admission that things are worse than previously thought, and puts a 30 percent chance on what could best be described as the “doomsday scenario” that many so-called housing bubble bloggers have been writing about. On Fitch’s general take:

Fitch Ratings expects the contraction will be more severe (than anticipated earlier) during the balance of 2007, mainly due to tighter mortgage standards and disrupted mortgage markets. More importantly, it is likely that 2008 will be another challenging year for this sector. Fitch has assessed various realistic macroeconomic scenarios for next year and concludes that operational and financial pressures will persist and, perhaps, intensify for the public homebuilders …

On inventory:

Perhaps, the most challenging issue for housing, both new and existing, is excess inventory. The houses for sale monthly statistic rose above 500,000 during the past 21 months, a level that has often presaged major industry downturns. And, of course, a downturn clearly has been underway. The new homes month’s supply approximated 7.7 months in June and 7.5 months in July. The existing homes months’ supply was 9.1 months in June and 9.6 months in July. It is generally believed that 5.5 months to 6.0 months’ of supply would represent a rough equilibrium of supply relative to demand for new and existing home inventories. The inclusion of homes left with builders through sales cancellations, along with consideration of an expanded level of vacant for-sale homes in the existing housing stock, suggest that the inventory overhang as measured by the Census Bureau’s new homes months’ supply ratio is understated. The current overhang of vacant homes for sales (new plus existing) may not be the whole story. The single-family rental vacancy rate recently climbed to a record level, presumably reflecting difficulties being encountered by investors who are biding their time before putting single-family homes back on the market.

Fitch now expects total housing starts to come in at 1.30 million in 2007, as compared to 1.46 million in an earlier forecast. Further, Fitch expects to see prices drop:

The average single family new home price is expected to drop 2.5% in 2007, while the median new home price slips 1.5%. The ‘real’ price reductions surely are larger than shown by transaction prices (and Fitch forecasts) as sales incentives are not included. However, this year a greater portion of the ‘real’ price reduction likely will be overt sales price decreases. Unfortunately, home prices have not yet reached market-clearing levels in most places. Home prices (especially existing home prices) definitely have been ‘sticky’ on the downside. This pattern is similar to price behavior exhibited in earlier major housing corrections.

All of which means that Fitch is expecting homebuilders to continue to take hits. And lots of them:

Given Fitch’s new forecast for the balance of 2007, it appears likely that builders’ financial pressures will continue unabated. For the full year revenues could drop 30-35%, on average, while pretax profits, before real estate charges, could plummet 75-80%.

And to close, I thought this little tidbit was interesting as well — sort of the all-bets-are-off clause:

Fitch rates the builders within the context of a typical cycle. In the midst of a non-typical upcycle, as took place in the 1992-2005 period, a number of builders realized higher credit ratings. Conversely, in this sharper than expected contraction, which now appears will last longer, and as builders’ credit metrics (despite their new ‘operating models’) will be even more stressed, ratings will have to be adjusted.

It might be time to get tin-foil hats for the analysts over at Fitch, don’t you think? Update: Fitch has downgraded the senior debt of nearly every US homebuilder in the wake of this report. I couldn’t even begin to list all of the downgrades — think of a builder, and they’ve been downgraded.