RPT-Fitch affirms NVR's IDR at 'BBB+'; outlook stable

Wed Jun 26, 2013 9:15am EDT

June 26 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has affirmed the ratings for NVR, Inc. (NYSE: NVR), including the company's Issuer Default Rating (IDR) at 'BBB+'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The rating and Outlook for NVR reflect the strong credit protection measures, solid free cash flow generation and balance sheet liquidity that results from its unique operating model. The ratings also reflect NVR's capacity to withstand a meaningful housing downturn and manage effectively in an often challenging housing environment. The cyclical nature of homebuilding is reflected in the ratings as are NVR's relatively heavy exposure to Washington D.C. and Baltimore markets. Fitch also takes into account NVR's track record through the past few recessions, and its, at times, active share repurchase program.

The rating also considers NVR's capital structure, solid liquidity position and Fitch's level of confidence with regard to its operating model under various economic conditions. Debt to EBITDA of 1.75x and proforma EBITDA to interest expense (assuming full year of interest expense) of 14.2x and extensive liquidity (cash and equivalents) are supportive of the 'BBB+' rating level. Fitch expects these credit metrics will improve slightly during 2013.

THE INDUSTRY

Housing metrics all showed improvement so far in 2013. For the first five months of the year, single-family housing starts improved 23.6% and existing home sales expanded 11%. New home sales increased 29.2% during the January-May period in 2013. The most recent Freddie Mac 30-year interest rate was 3.93%, 62 bps above the all-time low of 3.31% set the week of Nov. 21, 2012. The NAHB's latest existing home affordability index was 183.1, short of the all-time high of 207.3. Fitch's housing estimates for 2013 are as follows: single-family starts are forecast to grow 18.3% to 633,000 while multifamily starts expand about 19% to 292,000; single-family new home sales should increase approximately 22% to 448,000 as existing home sales advance 7.5% to 5.01 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 5.0% and 4.0%, respectively, in 2013.

Challenges (although somewhat muted) remain, including continued relatively high levels of delinquencies, potential for short-term acceleration in foreclosures, and consequent meaningful distressed sales, and restrictive credit qualification standards.

OPERATING MODEL

NVR utilizes an operating model in which land is primarily controlled through rolling options with fixed deposits sourced from independent land developers. Land is not purchased until construction is set to begin. As a consequence, NVR occasionally may be able to participate in land appreciation, while minimizing capital outlays. This enables NVR to significantly reduce the risk of downside volatility.

On a limited basis NVR has acquired several raw parcels of land to be developed into finished lots. Additionally, the company has also obtained finished lots using joint ventures. This does not represent a change in NVR's disciplined approach in controlling finished lots through options, but is representative of several unique strategic opportunities.

Over 75% of NVR's inventory is represented by relatively liquid pre-sold work in process that is less vulnerable to significant declines in value in periods of economic stress. In a downturn, write-downs would primarily be limited to forfeiture of option deposits, a fraction of total land value (typically 5% - 10%). Alternatively, NVR seeks to renegotiate option contracts to realign the proposed land purchase price with prevailing market conditions, thereby averting severe gross margin compression.

On the contrary, NVR's gross margins may lag some of its peers during this housing recovery as most of the large public builders started to rebuild their land positions during 2010 and are delivering homes currently that have favorable land cost basis, including land that was impaired during the downturn. NVR's just in time operating model necessitates that the company pays current market value for the land in its delivery pipeline.

NVR's short-dated inventory position turns over rapidly (about four-to-five times), enhancing operating cash flow. NVR's inventory turnover ratios are consistently and considerably higher than those of its peers.

Because of its operating model, NVR is reliant on third party land developers to prepare finished lots and sell them under option to NVR. This strategy may restrict growth only to markets where such a strategy is viable. However, NVR has expanded its strategy to six new markets over the past five years. By establishing a significant presence in its markets, NVR positions itself as the preferred land purchaser and forges relationships with key local developers.

Fitch believes that, if options were to become unattainable in NVR's markets, bondholders would be well protected due to the strong cash flow dynamics of NVR's model. Without land reinvestment requirements, NVR produces significant cash with which to retire its debt. For the latest-twelve-month (LTM) period ending March 31, 2013, cash flow from operations totaled $95.5 million. This compares with $264.4 million of cash flow from operations during 2012. Fitch currently projects cash flow from operations will be in the $150 million - $200 million range during 2013.

SHARE REPURCHASES

NVR has historically been an aggressive purchaser of its stock, buying back approximately $3.1 billion of its stock from 2001 through 2007. From fourth quarter-2007 (4Q'07) through 1Q'10, NVR refrained from buying its stock.

NVR resumed share repurchase activity later in 2010 buying $417.1 million. The company repurchased $689.3 million of stock in 2011 and $227.3 million during 2012. NVR did not repurchase stock during the 1Q'13. As of March 31, 2013, the company had $392.6 million remaining under its share repurchase authorization program. Fitch currently projects share repurchases during 2013 will be somewhat similar to 2012 levels. Fitch expects NVR will remain disciplined in its share repurchase activity in the period ahead, especially while the housing recovery remains relatively fragile.

LIQUIDITY

NVR ended 1Q'13 with $1.08 billion of unrestricted cash and cash equivalents and $600 million of debt.

Effective Oct. 27, 2010, NVR voluntarily terminated its $300 million unsecured revolving credit facility, which was scheduled to mature on Dec. 6, 2010. Fitch expects NVR to re-establish a credit facility at some point. However, Fitch anticipates that the company will keep more cash on the balance sheet than in the past.

RATING 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.

Fitch currently does not expect the company's ratings and/or Outlook to change in the next 12 - 18 months. However, a Positive Outlook may be considered if the recovery in housing is significantly better than Fitch's current outlook and the company is able to demonstrate that it can sustain, over the intermediate term, credit metrics that are meaningfully better than Fitch's current expectations, while continuing to maintain a solid liquidity position.

Negative rating actions could occur if the recovery in housing dissipates and NVR maintains an overly aggressive share repurchase program and/or diverges meaningfully from its land operating model. This could lead to consistent and significant negative quarterly cash flow from operations and meaningfully diminished liquidity position (below $300 million).

Fitch has affirmed NVR's ratings as follows:

--Issuer Default Rating at 'BBB+';

--Senior unsecured debt at 'BBB+'.

The Rating Outlook is Stable.

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