Fitch assigns rating of B+/RR4 to KB Home's proposed offering of US$300M of senior unsecured notes due March 2019; homebuilder has also proposed concurrent offering of US$125M of common stock

Allison Oesterle

NEW YORK , March 20, 2014 (press release) – Fitch Ratings has assigned a 'B+/RR4' rating to KB Home's (NYSE: KBH) proposed offering of $300 million of senior unsecured notes due March 2019. The new issue will be equal in right of payment with all other senior unsecured debt. KBH is also offering $125 million of common stock. The company intends to use the proceeds of these issuances for general corporate purposes, including land acquisitions and development.

The Rating Outlook is Stable.

A complete list of ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings and Outlook for KBH are based on the company's geographic diversity, customer and product focus, conservative building practices and effective utilization of return on invested capital (ROIC) criteria as a key element of its operating model, as well as the on-going housing recovery. The company did a good job in reducing its inventory exposure and generating positive operating cash flow during the severe industry downturn. Since its peak in the third quarter of 2006 (3Q'06), homebuilding debt has been reduced from $7.89 billion to $2.18 billion currently.

The ratings also reflect KBH's business model and marketing prowess. The ratings take into account the company's current heavy exposure to entry-level and, to a lesser degree, first-step trade-up housing (the deepest segments of the market), its leadership role in constructing energy-efficient homes, its reemphasis of the value-engineered Open Series of home designs, its conservative building practices, utilization of ROIC criteria as a key element of its operating model and its capital structure.

THE INDUSTRY

Housing metrics showed improvement in 2013. Single-family housing starts grew 15.4%, while new-home sales increased 16.3%. Existing home sales advanced 9.2% in 2013. The most recent Freddie Mac 30-year interest rate was 4.37%, 106 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 174.2, well below the all-time high of 213.6, but still meaningfully above the 20-year average. Housing metrics should increase in 2014 due to faster economic growth (prompted by improved household net worth, industrial production and consumer spending), and consequently, some acceleration in 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. A combination of tax increases and spending cuts in 2013 shaved about 1.5pp off annual economic growth, according to the Congressional Budget Office. Many forecasters expect the fiscal drag in 2014 to be one-third that amount or less.

Fitch's housing estimates for 2014 are as follows: Single-family starts are forecast to grow almost 20% to 741,000, while multifamily starts expand about 8% to 333,000; single-family new-home sales should grow approximately 20% to 513,000 as existing home sales advance 2.0% to 5.19 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 new-home prices expanded 2.4% in 2011 and grew 7.9% in 2012. Average and median new-home prices improved 9.8% and 8.4%, respectively, in 2013.

New-home price inflation should moderate in 2014, at least partially because of higher interest rates. Average and median new-home prices should rise about 3.5% this year.

As Fitch noted in the past, the housing recovery will likely occur in fits and starts.

REAL ESTATE

At the end of the first quarter of 2014, KBH controlled 57,438 lots, a 21.4% increase from the end of the first quarter of 2013 but a 70.8% decrease from a peak of 197,000 lots at the end of 1Q'06 (February 2006). Based on LTM closings, the company controlled 8.1 years of land (up from 5.1 years at the end of 2005); KBH has 5.6 years of owned land. The current options share of total lots controlled (approximately 30%) is down sharply from the peak of 53.7% (4Q'05). KBH is expected to maintain substantial land spending this year. The company expended about $354 million on land and development during the 1Q'14. For the full fiscal year 2014, KBH is currently projected to spend in excess of $1.1 billion for the combination of land and development. The company expended $1.14 billion on land and development in 2013, $564.9 million in 2012, $553 million in 2011 (including the $75 million South Edge JV investment)and $560 million in 2010.

FINANCIAL METRICS AND LIQUIDITY

KBH's most recent credit metrics, while improving in certain cases, remain stressed. Debt-to- capitalization was 82.1% as of year-end 2012. The ratio was 80.0% as of Feb. 28, 2014. Net debt (debt less unrestricted homebuilding cash)-to-capitalization was 77.4% at the end of 1Q'14, up from 75.1% as of Nov. 30, 2013. Debt-to-LTM EBITDA, excluding real estate impairments, was 11.2x at Nov. 30, 2013, and 17.5x at the same date the prior year. Interest coverage was 1.3x as of Nov. 30, 2013 and 0.7x as of Nov. 30, 2012.

During 2012, KBH refinanced a substantial amount of debt scheduled to mature in 2014 and 2015. In February 2012, the company issued $350 million of senior unsecured notes maturing in 2020 and applied the proceeds to the tender of $340 million for a portion of the $1 billion in debt due in 2014 and 2015. In early August 2012, KBH issued another $350 million of senior unsecured notes maturing in 2022, and tendered for $244.9 million of 2014 and 2015 debt. This activity reduced 2014 public debt maturities to less than $76 million. The company also boosted liquidity by adding $105 million of unrestricted cash to the balance sheet.

On Feb. 4, 2013, the company issued an underwritten public offering of $230 million in aggregate principal amount of its 1.375% convertible senior notes due 2019. Also, on Feb. 4, 2013, KBH completed the sale of 6.325 million shares of its common stock. The company received total net proceeds of $332.9 million from the convertible and stock offerings.

On Oct. 29, 2013, KBH issued $450 million in aggregate principal amount of 7.00% senior notes due 2021. The company used $225.4 million of the net proceeds from this issuance to purchase $19.7 million in aggregate principal amount of the 5.75% senior notes due 2014, $91.1 million in aggregate principal amount of the 5.875% senior notes due 2015 and $37 million in aggregate principal amount of the 6.25% senior notes due 2015, and to redeem the remaining $56.3 million in aggregate principal amount of the 5.75% senior notes due 2014 and $11 million in aggregate principal amount of the 5.875% senior notes due 2015.

KBH currently has solid liquidity with unrestricted homebuilding cash of $303.3 million as of Feb. 28, 2014. In addition to its cash and equivalents, KBH has funds available from a revolving credit facility. On March 12, 2013, the company entered into a new $200 million unsecured revolving credit facility. The credit facility contains an accordion feature under which the aggregate commitment may be increased up to $300 million, subject to certain conditions and the availability of additional bank commitments. The company had no borrowings outstanding under the facility as of Feb. 28, 2014.

KBH previously had an unsecured credit facility that it voluntarily terminated March 31, 2010 in order to reduce costs associated with the facility.

The company reported negative $443.4 million of cash flow from operations (CFFO) during 2013 after investing roughly $1.1 billion in land and development during the year. For all of fiscal 2013, Fitch expects KBH will increase its land and development spending relative to 2013 as it continues its 'going on offense' initiative. CFFO could approach negative $400 million if KBH is able to spend as planned on land and development this year.

Fitch is comfortable with this strategy given the company's liquidity position. Fitch expects KBH to end fiscal 2014 with homebuilding unrestricted cash of $300-350 million.

RATINGS SENSITIVITIES

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, free cash flow trends and uses, and the company's cash position.

KBH's ratings are constrained in the intermediate term because of relatively high leverage metrics. However, a positive rating action may be considered if the recovery in housing is meaningfully better than Fitch's current outlook, KBH shows continuous improvement in credit metrics, and maintains a healthy liquidity position. In particular, debt leverage would need to approach 4x and interest coverage would need to exceed 4x in order to take a positive rating action.

Negative rating actions could be triggered if the industry recovery dissipates, if there is a material shortfall in KBH's financials, and if KBH maintains an overly aggressive land and development spending program which meaningfully diminishes its liquidity position (below $300 million).

Fitch currently rates KBH with a Stable Outlook as follows:

--Issuer Default Rating 'B+';
--Senior unsecured debt 'B+/RR4'.

The Recovery Rating (RR) of 'RR4' on KBH's senior unsecured notes indicates average recovery prospects for holders of these debt issues. KBH'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 debt holders. 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 - Effective from 8 August 2012 - 5 August 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460 Liquidity Considerations for Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666

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