Fitch Upgrades Hovnanian's IDR to 'B-'; Outlook Stable

Thu Dec 5, 2013 1:53pm EST

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(The following statement was released by the rating agency) NEW YORK, December 05 (Fitch) Fitch Ratings has upgraded the Issuer Default Rating (IDR) of Hovnanian Enterprises, Inc. (NYSE: HOV) to 'B-' from 'CCC'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS The upgrade and the Stable Outlook reflects HOV's operating performance year-to-date (YTD), adequate liquidity position, and moderately better prospects for the housing sector during the remainder of this year and 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 1x 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. The rating for HOV is also 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 INDUSTRY 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%. Existing home sales improved 11.2% for the first ten months of 2013 while new home sales grew 15.8%. Fitch's housing estimates for 2013 are as follows: Single-family starts are forecast to grow 15% to 615,000, while multifamily starts expand about 20% to 295,000; single-family new-home sales should grow approximately 15.3% to 423,000 and 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 new home prices expanded 2.4% in 2011 and grew 7.9% in 2012. Average and median new home prices should improve approximately 8.0% in 2013. Housing metrics should expand in 2014 due to the economy growing more rapidly next year, job growth moderately expanding (and unemployment rates decreasing to 7.0% 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 20.0% to 738,000 as multifamily volume grows about 9% to 322,000. Thus, total starts next year should top 1 million. New home sales are forecast to advance about 20% to 508,000, while existing home volume increases 2.0% to 5.16 million. New home price inflation should moderate next year, at least partially because of higher interest rates. 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 MORTGAGE RATES Mortgage rates have increased from levels earlier in the year. The most recent Freddie Mac average mortgage rate was 4.29%, up 7 bps sequentially from the previous week and about 84 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. The NAR's latest monthly existing home affordability index was 164.3, well below the all-time high of 213.6, but still meaningfully above the 20-year average. In the case of HOV, whose average home price is roughly $344,800, assuming a 20% down payment, a 100 bps rise in mortgage rates will increase principal and interest payment by about $208 each month or a 12.2% impact. There has been some short-term volatility in certain housing metrics following the increase in interest rates (and higher home prices) during the past six months. Existing home sales (on a seasonally adjusted basis) fell 3.2% on a month-over-month basis in October following a 1.8% decline in September. New home sales in October grew 25.4% on a seasonally-adjusted basis to 444,000, compared with 354,000 during the previous month. This follows a 6.6% month-over-month decline in September, a 1.6% improvement in August and a 17.1% decline in the month of July. 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. OPERATING ENVIRONMENT HOV's homebuilding revenues for the first nine months of its 2013 fiscal year (ending July 31, 2013) increased 25.9% to $1.22 billion as home deliveries grew 16.3% to 3,658 homes and the average selling price advanced 10.7% to $329,752. Homebuilding gross profit margins (excluding inventory impairments and lot option abandonments) also showed improvement, growing 220 bps to 16.0% during the first nine months of fiscal 2013 compared with 13.8% during the same period last year. SG&A as a percentage of sales declined to 12.5% during the nine-month period in fiscal 2013 from 14.2% last year. HOV reported a pre-tax loss of $11.7 million during the first nine months of fiscal 2013. (HOV reported pre-tax profit of $10.4 million during the third quarter 2013 (3Q'13).) Fitch currently expects HOV will be profitable for all of fiscal 2013. New home orders improved 12.7% during the nine-month period but only advanced 4.8% year-over-year (yoy) during the 3Q'13. The company reported net order declines during the months of July and August. Cancellation rates improved 300 bps to 17% during 3Q'13 compared with 20% during 3Q'12. HOV ended 3Q'13 with 2,569 homes (+20.5% yoy) in backlog with a value of $897.2 million (+33.1% 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. CREDIT METRICS Leverage at the end of the July quarter was 11.7x compared with 16.5x at the end of fiscal 2012. EBITDA to interest coverage is low at 1x for the LTM period ending July 31, 2013 compared with 0.7x in fiscal 2012. Fitch expects these credit metrics will improve 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 during fiscal 2014. LIQUIDITY The company ended the July 2013 quarter with $221.5 million of unrestricted cash on the balance sheet and $52.2 million of availability under its new $75 million unsecured revolving credit facility maturing in 2018. In September 2013, the company also completed a $41.6 million add-on offering to its 6.25% senior notes due 2016. Net proceeds from the notes issuance were used to redeem $39.7 million of senior notes maturing in 2014. The company has no major debt maturities until 2015, when $85 million of senior notes become due. The company has about $260 million of debt maturing in 2016. LAND STRATEGY At July 31, 2013, the company controlled 32,780 lots (including unconsolidated joint ventures), of which 49.8% were owned and the remaining lots controlled through options and joint venture partnerships. Based on total LTM closings (including unconsolidated JVs), HOV controlled 5.6 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 12.0% yoy and grew 8.3% compared with the previous quarter. HOV spent roughly $377 million on land purchases and development activities during the first nine months of fiscal 2013 compared with $236 million expended during the same period last year. For the LTM period ending July 31, 2013, HOV reported negative cash flow from operations of $52.1 million. Fitch expects HOV will be cash flow negative by approximately $50 million - $100 million during fiscal 2013, resulting in the company's liquidity position comfortably within its $170 million - $245 million liquidity target. 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 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 has upgraded the following ratings for HOV: --Long-term IDR to 'B-' from 'CCC'; --Senior secured first lien notes due 2020 to 'B+/RR2' from 'B-/RR2'; --Senior secured notes due 2021 to 'CCC+/RR5' from 'CCC-/RR5'; --Senior secured second lien notes due 2020 to 'CCC/RR6' from 'CC/RR6'; --Senior unsecured notes to 'CCC/RR6' from 'CC/RR6'; --Exchangeable note units due 2017 to 'CCC/RR6' from 'CC/RR6'; --Series A perpetual preferred stock to 'CCC-/RR6' from 'C/RR6'. The Rating Outlook is Stable. 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. Contact: Primary Analyst Robert Rulla, CPA Director +1-312-606-2311 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Robert Curran Managing Director +1-212-908-0515 Committee Chairperson David Peterson Senior Director +1-312-368-3177 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. 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). 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