Fitch assigns BB-/RR3 rating to Meritage Homes' proposed offering of US$100M of 7.15% senior unsecured notes due 2020; rating outlook positive
November 21, 2013
– Fitch Ratings has assigned a 'BB-/RR3' rating to Meritage Homes Corporation's (NYSE: MTH), proposed offering of $100 million of senior unsecured notes. The offering is an add-on to its existing 7.15% senior unsecured notes due 2020. The issuance will be equal in right of payment with all other senior unsecured debt. Meritage intends to use the proceeds of the notes offering for general corporate purposes, including the acquisition and development of land and home construction.
The Rating Outlook is Positive. A complete list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings and Outlook for MTH are influenced by the company's execution of its business model, conservative land policies, geographic diversity and healthy liquidity position. The Positive Outlook also takes into account Fitch's expectation of further moderate improvement in the housing market in 2013 and 2014, share gains by MTH and hence volume outperformance relative to industry trends as the market continues its shift to trade-up housing (Meritage's strength) and much better profitability and sharply improved credit metrics.
MTH's sales are reasonably dispersed among its 15 metropolitan markets within seven states. During 2012, the company ranked among the top 10 builders in such markets as Dallas/Fort Worth, San Antonio and Austin, TX; Orlando, FL; Phoenix, AZ; Riverside/San Bernardino, CA; Denver, CO; and San Francisco/Oakland/Fremont and Sacramento, CA. The company also builds in the Central Valley, CA; Houston, TX; Inland Empire, CA; Tucson, AZ; Tampa, FL; and Raleigh-Durham and Charlotte, NC. MTH also announced its entry into the Nashville, Tennessee market with its August 2013 acquisition of Phillips Builders. Currently, Fitch estimates about 65% -70% of MTH's home deliveries are to first- and second-time trade-up buyers, 30%-35% to entry-level buyers, less than 5% are to luxury and active adult (retiree) homebuyers.
IMPROVING HOUSING MARKET
Housing metrics have all showed improvement so far in 2013. For the first eight months of the year, single-family housing starts improved 19.3%, while new-home sales increased 20.4%. Existing home sales improved 11.8% for the first nine months of 2013. The most recent Freddie Mac 30-year interest rate was 4.35%, 104 bps above the all-time low of 3.31% set the week of Nov. 21, 2012. The NAR's latest monthly existing home affordability index was 164.3, moderately below the all-time high of 213.6.
Fitch's housing forecasts for 2013 assume a continued moderate rise off the bottom of 2011. New-home inventories are well below the norm and affordability is near record highs. In a slowly growing economy with still above-average distressed home sales competition, less competitive rental cost alternatives and low mortgage rates (on average), the housing recovery will be maintained this year and in 2014.
Fitch's housing estimates for 2013 follow: Single-family starts are forecast to grow 16.8% to 625,000, while multifamily starts expand about 20% to 295,000; single-family new-home sales should grow approximately 20% to 439,000 as existing home sales advance 8.5% to 5.05 million.
Average single-family new-home prices (as measured by the Census Bureau), which dropped 1.8% in 2011, increased 8.7% in 2012. Median home prices expanded 2.4% in 2011 and grew 7.9% in 2012. Average and median home prices should improve approximately 8% and 7.2%, respectively, in 2013.
As Fitch noted in the past, the housing recovery will likely occur in fits and starts.
HIGHER MORTGAGE RATES AND HOME PRICES
The most recent Freddie Mac average mortgage rate was 4.35%, up 19 bps sequentially from the previous week and about 90 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. In the case of MTH, whose average home price is roughly $340,700, assuming a 20% down payment, a 100 bps rise in current mortgage rates will increase principal and interest payment by about $165 each month or a 12.2% impact.
A couple of August and September housing metrics showed some weakness following the increase in interest rates during the past six months. The Pending Home Sales Index declined 5.6% to 101.6 in September from 107.6 in August and is 1.2% lower than the 102.8 recorded in September 2012. New home sales in August grew 7.9% on a seasonally-adjusted basis to 421,000, compared with 390,000 during the previous month. The July 2013 new home sales were 14.1% lower relative to June 2013. Additionally, the August 2013 estimate is the second lowest seasonally-adjusted sales level so far this year. While Fitch does not expect the current higher mortgage rates to derail the housing recovery, a continued sharp increase in rates could further slow it down.
MTH employs conservative land and construction strategies. The company typically options or purchases land only after necessary entitlements have been obtained so that development or construction may begin as market conditions dictate.
Under normal circumstances MTH extensively uses lot options, and that is expected to be the future strategy in markets where it is able to do so. The use of non-specific performance rolling options gives the company the ability to renegotiate price/terms or void the option, which limits downside risk in market downturns and provides the opportunity to hold land with minimal investment.
However, as of September 30, 2013, only 29% of MTH's lots were controlled through options - a much lower than typical percentage due to considerable option abandonments and write-offs in recent years. Additionally, there are currently fewer opportunities to option lots and, in certain cases, the returns for purchasing lots outright are far better than optioning lots from third parties.
Total lots controlled, including those optioned, were 25,046 at Sept. 30, 2013. This represents a 5-year supply of total lots controlled based on trailing 12-months deliveries. On the same basis, MTH's owned lots represent a supply of 3.5 years.
MTH successfully managed its balance sheet during the severe housing downturn, allowing the company to accumulate cash and pay down its debt as it pared down inventory. The company had unrestricted cash of $177.6 million and investments and securities of $92.8 million at Sept. 30, 2013. The company's debt totaled $798.3 million at the end of the first quarter.
MTH's debt maturities are well-laddered, with the next debt maturity on March 2018, when its 4.50% $175 million senior notes become due.
In July 2012, the company entered into a new $125 million unsecured revolving credit facility maturing in 2015. The facility was amended during the second quarter of 2013, which increased the commitment to $135 million and extended the maturity to 2016. There were no outstandings under the revolver as of Sept. 30, 2013.
MTH generated negative cash flow from operations during the past two years as the company started to rebuild its land position. The company had negative cash flow of $220.5 million during 2012 after spending $480 million on land and development during the year. Fitch expects the company to moderately increase its land and development spending during 2013, resulting in negative cash flow of about $75 million - $125 million this year.
Fitch is comfortable with this strategy given the company's liquidity position and debt maturity schedule. Fitch expects MTH over the next few years will maintain liquidity (consisting of cash and investments and the revolving credit facility) of at least $225 million - $250 million, a level which Fitch believes is appropriate given the challenges still facing the industry.
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;
--Free cash flow trends and uses; and
--MTH's cash position.
A ratings upgrade may be considered if the recovery in housing continues at a healthy pace and shows durability; MTH shows sustained improvement in credit metrics (such as homebuilding debt to EBITDA consistently below 5x); and the company continues to maintain a healthy liquidity position (above $250 million).
A negative rating action could be triggered if the industry recovery dissipates; 2014 revenues drop high-teens or greater while the pretax loss is higher than 2011 levels; and MTH's liquidity position falls sharply, perhaps below $200 million as the company maintains an overly aggressive land and development spending program.
Fitch rates the following with a Positive Outlook:
--Long-term Issuer Default Rating (IDR) 'B+';
--Senior unsecured debt 'BB-/RR3'.
The Recovery Rating (RR) of 'RR3' on the company's senior unsecured debt indicates good recovery prospects for holders of these debt issues. MTH's exposure to claims made pursuant to performance bonds and joint venture debt 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 liquidation value analysis for the RR.
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).