Home builder debt could be hurt by capital raising

NEW YORK Mon Jun 9, 2008 4:03pm EDT

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NEW YORK (Reuters) - Capital raising by U.S. home builders is supporting their debt valuations even as rating agencies downgrade their credit ratings, however additional fund raising risks weakening the value of their outstanding bonds.

Moody's Investors Service on Monday cut its ratings on Centex Corp (CTX.N), D.R. Horton Inc (DHI.N), KB Home (KBH.N), Pulte Homes (PHM.N), Ryland Group Inc (RYL.N) and Lennar Corp (LEN.N) deeper into junk territory.

"All of the companies have been, or have begun, generating quarterly losses before impairments and other charges, and a return to pre-impairment profitability may be difficult, given Moody's expectations of declining deliveries, revenues, and prices in 2008," Moody's said in a statement.

The move follows similar rating cuts in the sector by Standard & Poor's in May, even as capital raising by some builders helped buoy the sectors' debt.

"Bond returns for the major homebuilders were generally better in May, driven by an improved credit tone as several builders embarked on strategic alternatives to secure additional liquidity and operating flexibility," CreditSights analysts Frank Lee and Jeffrey Wichmann said in a report on Friday.

Hovnanian Enterprises (HOV.N) on May 16 saw strong demand for its $600 million sale of secured debt as part of a refinancing, following a stock sale earlier in the month that raised $126 million.

Standard Pacific Corp (SPF.N) also surprised the markets on May 27, when it said it will receive an equity investment of more than $530 million from MatlinPatterson Global Advisers LLC to strengthen its balance sheet and fund growth.

D.R. Horton also last month commenced a debt exchange offer, in which it replaced bonds maturing in 2010 with new notes with less restrictive covenants.

CreditSights' high yield homebuilder index, which includes bonds of 15 junk-rated home builders and the subordinated debt of one investment grade home builder, tightened 119 basis points in May, though it has since given up some of these gains in line with the broader market sell-off.

However, "while these strategic alternatives have been relatively helpful from a credit perspective, not all strategic options are in the best interest of credit holders," CreditSights said.

"A recapitalization or restructuring of a builder that involved more secured debt, unfavorable debt exchanges or coercive tenders -- or a chapter filing -- would increase credit risks and depress valuations for credit holders," they said. "We are actually surprised that Hovnanian and Standard Pacific were able to secure new capitalization, especially fresh equity."

Hovnanian's unsecured debt has slipped since it sold the new, secured debt that sits above the old bonds in the capital structure, they noted. Hovnanian's 7.5 percent bond due 2016 and 6.25 percent bonds due 2016 have each fallen around 4 cents since the new secured bonds were announced.

Meanwhile continued deterioration in the U.S. housing markets will continue to pressure cash flows of builders, and create challenges in their ability to meet terms and conditions in their bank credit agreements.

Both Moody's and S&P retain negative outlook on the builders, meaning it's more likely that the companies will face additional downgrades over the next two years.

"The negative ratings outlook for all six companies reflects Moody's expectation that many of the company's credit metrics will continue eroding as homebuilding industry conditions remain challenging into next year, with any recovery likely to be sluggish at first, thus prolonging underperformance until early in the next decade," Moody's said.

(Editing by James Dalgleish)

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