Home builders likely to see further downgrades

By Karen Brettell

NEW YORK (Reuters) - The downgrade of three home builders into junk territory by Moody's Investors Service may only be the start of a rash of cuts of high grade builders into high yield, which may present funding challenges for some companies.

Moody's Investors Service on Thursday cut its ratings on home builders Centex Corp (CTX.N), Lennar Corp (LEN.N) and Pulte Homes (PHM.N) to junk status, saying it expects bleak housing industry conditions to linger at least until 2009.

Lennar and Centex were both cut by two notches, while Pulte was cut one notch, all to "Ba1," one level below investment grade. The outlook on all three companies is negative, indicating another cut is likely over the next 12 to 18 months.

"We do not believe Moody's will stop with the three ratings actions they took," Bank of America analyst Christopher Brown said in a report. "The criteria for the downgrades appear applicable to all the credits in the sector, and we think it is just a matter of time that the agency looks hard at the other investment grade credits, including Toll Brothers."

Brown has a "sell" recommendation on Toll Brothers Inc (TOL.N), arguing that its spreads are trading close to its historical tights when compared to peers such as Centex, Lennar, Pulte and KB Home (KBH.N).

While Lennar, Centex and Pulte retain investment grade ratings from Standard & Poor's and Fitch Ratings, the two agencies may be likely to follow Moody's example, according to analysts at New York-based CreditSights.

"The fact that Moody's would even consider -- let alone act upon -- a two-notch downgrade for an investment grade builder signals some serious worries that the current downturn has eroded debt protection measures to very uncomfortable levels," the analysts said in a report.

"We would not be surprised if S&P and Fitch came out with similar assessments in the upcoming months as there is now a two-notch disparity amongst the agencies," they said.

FUNDING CHALLENGES

For some home builders, a cut below investment grade threatens to create funding challenges.

"As credit quality for the home-building sector descends, the impact could have significant ramifications on builders' access to liquidity as negative ratings actions could trigger tighter bank line convenants and restrict the ability to tap the capital markets," CreditSights said.

Lennar, Pulte and DR Horton Inc (DHI.N) are particularly at risk of funding disruptions if their ratings fall below investment grade, the analysts said.

"We are concerned that Lennar's substantial off balance sheet joint ventures could expose the company to incremental risks, while Pulte's intense regional concentration across the overheated Las Vegas and Phoenix markets could prove to be similarly damaging," CreditSights said.

"The capacity of Lennar and Pulte's bank lines could be limited by borrowing base restrictions -- in the event of a downgrade from either S&P or Fitch as the borrowing base for both builders are both subjected to ratings triggers," CreditSights said.

DR Horton, which was not included in Moody's action on Thursday, also risks falling to junk, which would reduce the capacity of its bank revolver, they said.