Fitch assigns CCC/RR6 rating to Hovnanian Enterprises' proposed offering of US$150M principal amount of senior notes due 2019; rating outlook stable
January 7, 2014
– Fitch Ratings has assigned a 'CCC/RR6' rating to Hovnanian Enterprises, Inc.'s (NYSE: HOV) proposed offering of $150 million principal amount of senior notes due 2019. The notes issue will be ranked on a pari passu basis with the company's existing senior unsecured notes. Net proceeds from the offering will be used for general corporate purposes, including land acquisition and land development, and to fund the redemption of all of Hovnanian's outstanding 6.25% senior notes due 2015.
The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The rating for HOV is influenced by the company's execution of its business model, land policies, and geographic, price point and product line diversity. Risk factors include the cyclical nature of the homebuilding industry, the company's high debt load and high leverage.
The Stable Outlook reflects HOV's operating performance, adequate liquidity position, and moderately better prospects for the housing sector in 2014.
In the past, Fitch was concerned that HOV's liquidity target of $170 million - $245 million (cash plus revolver availability) did not provide a large enough cushion in the event that the housing recovery dissipates. Fitch's concern is eased by the fact that the company's liquidity position has been above or at the high-end of its liquidity target during the past few years and its EBITDA is now able to cover
interest incurred on a 1.2x basis. Additionally, Fitch believes that the housing recovery is firmly in place (although the rate of recovery remains below historical levels and will likely occur in fits and starts). Fitch expects management will continue to use its stated liquidity target to govern the company's land and development spending.
Housing metrics have all showed improvement in 2013. For the first 11 months of 2013, single- family housing starts increased 15.9%, new home sales grew 18.1%, and existing home sales gained 10.2%. Fitch's housing estimates for 2013 are as follows: Single-family starts are forecast to grow 16.3% to 622,000, while multifamily starts expand about 22% to 300,000; single-family new-home sales should increase approximately 17.7% to 432,000 and existing home sales advance 8.7% to 5.06 million.
Housing metrics should increase in 2014 due to faster economic growth, and some acceleration of job growth (as unemployment rates decrease to 6.9% for 2014 from an average of 7.5% in 2013), despite somewhat higher interest rates, as well as more measured home price inflation. Single-family starts are projected to improve 20% to 746,000 as multifamily volume grows about 9% to 328,000. Thus, total starts next year should top 1 million. New home sales are forecast to advance about 20% to 518,000, while existing home volume increases 2% to 5.16 million. Average and median new home prices should rise about 3.5% in 2014.
As Fitch noted in the past, the housing recovery will likely occur in fits and starts.
HIGHER INTEREST RATES AND HOUSING ACTIVITY
The most recent Freddie Mac average mortgage rate was 4.53%, up 5 bps sequentially from the previous week and about 108 bps higher than the average rate during the month of April 2013, a recent low point for mortgage rates. While the current rates are still well below historical averages, the sharp increase in rates and rising home prices are moderating affordability.
There has been some short-term volatility in certain housing metrics following the increase in interest rates (and higher home prices) during the past eight months. Existing home sales (on a seasonally adjusted basis) fell 4.3% on a month-over-month basis in November following a 3.2% decline in October and a 1.9% decrease in September. New home sales (on a seasonally-adjusted basis) fell 2.1% month-over-month in November after 17.6% growth in October, 3.9% improvement in September, 4% increase in August and 17.1% decrease in the month of July.
In the case of HOV, new home orders grew 7.9% during fiscal 2013 (ending Oct. 31, 2013) but fell 6.4% year-over-year during the 4Q'13. The company also reported slightly lower net orders during the month of November compared with last year. Cancellation rates (excluding unconsolidated JVs) during 4Q'13 were 20%, flat yoy but increased 600 bps from the 17% reported during the 3Q'13. HOV ended 4Q'13 with 2,167 homes (+14.7% yoy) in backlog (excluding JVs) with a value of $762.4 million (+20.6% yoy).
While there has been some short-term weakness in order trends due to the sharp increase in interest rates, higher home prices and, perhaps, the government shutdown and debt limit concerns, Fitch currently does not expect this trend will persist into the 2014 spring selling season. However, a continued sharp increase in rates could further slow the housing recovery.
Leverage at the end of fiscal 2013 was approximately 10x compared with 16.5x at the end of fiscal 2012. EBITDA to interest coverage was 1.2x for fiscal 2013 compared with 0.7x in fiscal 2012. Fitch expects these credit metrics will improve further in the next 12 months, although leverage is expected to remain weak at around 9x - 10x. Interest coverage is projected to improve to approximately 1.3x - 1.5x during fiscal 2014.
The company ended fiscal 2013 with $319.1 million of unrestricted cash on the balance sheet and $49.2 million of availability under its $75 million unsecured revolving credit facility maturing in 2018.
The proposed $150 million debt offering will further enhance the company's liquidity position. On a pro forma basis (assuming the company redeems $21 million of its 6.25% senior notes due 2015), HOV will only have $60 million of senior notes coming due in the next two years. The company has about $260 million of debt maturing in 2016.
At Oct. 31, 2013, the company controlled 34,710 lots (including unconsolidated joint ventures), of which 47% were owned and the remaining lots controlled through options and joint venture partnerships. Based on total LTM closings (including unconsolidated JVs), HOV controlled 5.8 years of land. The company owned roughly 3.1 years of land based on consolidated LTM closings.
As is the case with other public homebuilders, the company is rebuilding its land position and trying to opportunistically acquire land at attractive prices. Total lots controlled increased 16.5% yoy and grew 5.9% compared with the previous quarter. HOV spent roughly $502 million on land purchases and development activities during fiscal 2013 compared with $364 million expended during fiscal 2012.
During fiscal 2013, HOV reported cash flow from operations of $9.3 million. Fitch expects HOV will be cash flow negative in fiscal 2014 as it continues to build its land position. However, Fitch expects the company will have liquidity that is comfortably within or perhaps above its stated target range.
Future ratings and Outlooks will be influenced by broad housing-market trends as well as company specific activity, such as trends in land and development spending, general inventory levels, speculative inventory activity (including the impact of high cancellation rates on such activity), gross and net new order activity, debt levels and especially free cash flow trends and uses, and the company's cash position.
HOV's ratings are constrained in the intermediate term because of relatively high leverage metrics. However, additional positive rating actions may be considered if the recovery in housing is maintained and is meaningfully better than Fitch's current outlook, HOV shows continuous improvement in credit metrics (particularly debt-to-EBITDA consistently below 8x and interest coverage above 2x), and preserves a healthy liquidity position.
A negative rating action could be triggered if the industry recovery dissipates; HOV's 2014 revenues drop high-teens while the pretax loss approaches 2012 levels; and HOV's liquidity position falls sharply, perhaps below $125 million.
Fitch currently rates HOV as follows with a Stable Outlook:
--Long-term IDR 'B-';
--Senior secured first lien notes due 2020 'B+/RR2';
--Senior secured notes due 2021 'CCC+/RR5';
--Senior secured second lien notes due 2020 'CCC/RR6';
--Senior unsecured notes 'CCC/RR6';
--Exchangeable note units due 2017 'CCC/RR6';
--Series A perpetual preferred stock 'CCC-/RR6'.
Fitch's Recovery Rating (RR) of 'RR2' on HOV's senior secured first-lien notes indicates good recovery prospects for holders of these debt issues. The 'RR5' on the senior secured notes due 2021 indicates below-average recovery prospects in a default scenario. The 'RR6' on HOV's senior secured second-lien notes, senior unsecured notes, senior subordinated notes and preferred stock indicates poor recovery prospects in a default scenario. HOV's exposure to claims made pursuant to performance bonds and the possibility that part of these contingent liabilities would have a claim against the company's assets were considered in determining the recovery for the unsecured debtholders. Fitch applied a going concern valuation analysis for these RRs.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Liquidity Considerations for Corporate Issuers' (June 12, 2007).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
Liquidity Considerations for Corporate Issuers http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666