July 27, 2012 / 4:05 PM / in 5 years

TEXT-S&P revises Hovnanian outlook to positive, affirms ratings

Overview
     -- Hovnanian Enterprises Inc. is among the largest homebuilders in the 
U.S. but the company has struggled under a heavy debt load.
     -- Through the first half of fiscal 2012 (ending Oct. 30), the company 
has reported improving trends that have exceeded our expectations. 
     -- We revised our outlook on Hovnanian to positive from negative and 
affirmed our ratings on the company.
     -- The positive outlook reflects an improved liquidity position that we 
believe will be sufficient to meet near-term capital needs. We would raise our 
ratings if recently improved operating trends appear sustainable and the 
company maintains adequate liquidity.  

Rating Action
On July 27, 2012, Standard & Poor's Ratings Services revised its outlook on 
Hovnanian Enterprises Inc. to positive from negative. At the same time, we 
affirmed our ratings on the company, including the 'CCC-' corporate credit 
rating (see list). 

Rationale
The outlook revision reflects the company's improved liquidity position. We 
also revised our liquidity assessment to "adequate" from "less than adequate." 
Hovnanian has taken steps to improve its near-term liquidity, which consists 
of cash that modestly exceeds our prior expectations. Importantly, the company 
faces negligible maturities over the next 18 months. However, we note that 
aggressive land spend or debt repurchases would reduce what is a moderate 
absolute level of cash. 

Our rating on Hovnanian reflects the company's "highly leveraged" financial 
risk profile and very weak credit metrics. We view the company's business risk 
profile as "vulnerable." The company has significant overhead and interest 
burden due to a heavy debt load. Although operating performance has been 
improving, we consider the company's potential to return to profitability 
unlikely until at least 2013. We further note that if the operating 
environment modestly recovers (as we expect) and Hovnanian cannot return to 
consistent profitability, the company will need to raise additional capital or 
pursue another round of debt exchanges/restructurings to contend with its 
future debt maturities. 

However, Hovnanian's pretax loss has narrowed in the first half of fiscal 2012 
to $60 million (excluding noncash gains/charges) from more than $100 million. 
The second-quarter loss was more moderate at $22 million on stronger 
deliveries (up 25%), average sales price (up 13%), and gross margins (up 260 
basis points). New orders were up 52.2% and the average price of new orders 
increased 7.8%. Higher unit orders and a lower cancellation rate (17%) helped 
drive unit backlog up 48.2% to 2,298 units, which will be delivered over the 
next two to three quarters. Overhead reductions have helped contain selling, 
general, and administrative (SG&A) expenses (including corporate overhead). 
Additionally, as the company's deliveries increase, SG&A as a percent of 
revenues will improve. SG&A-to-homebuilding revenues improved to 15% in the 
second quarter compared with 21% in the prior year period. Despite these 
stronger recent trends, we do not expect the company to attain profitability 
until 2013 at the earliest. 

Our base case assumes a 20%-25% improvement in 2012 deliveries, resulting in 
about 4,600-4,700 deliveries. We also assume a $300,000 average home price, an 
average margin around 14.5% (18.5% excluding interest in cost of sales), and 
SG&A-to-revenues around 14%-15% for the full year. Under these assumptions, 
Hovnanian's gross profits would still not be sufficient to cover overhead and 
interest. As a result, we expect key credit metrics to remain weak. Most 
notably, we expect debt-to-EBITDA to improve but remain very high in the 
17x-20x range. 

Liquidity
Hovnanian's liquidity position, in our view, has improved and is now adequate 
to meet the company's needs over the next 12 months. Relevant liquidity 
profile considerations include: 

     -- We expect Hovnanian's sources of liquidity over the next 12 months to 
be well above 1.2x, however we take our expectation that the company is likely 
to invest current cash holdings into new land investments and the large 
maturity the company faces in 2016 into consideration. 
     -- The company faces negligible debt maturities until 2014. 
     -- The company is unlikely to absorb a high-impact, low-probability event.
     -- The company, in our view, has poor standing in the credit markets 
based on trading levels of its debt and equity.
 
Hovnanian's liquidity consists of $195.2 million of unrestricted homebuilding 
cash ($243.5 million including restricted cash) as of April 30, 2012. We 
estimate that land sales, primarily through the sale of existing inventory to 
a land banking arrangement the company entered with GSO Capital Partners L.P. 
(GSO), added roughly $30 million to Hovnanian's cash in the second quarter. We 
estimate cash flow from operations will be relatively flat over the next 12 
months, including land acquisitions and development that we estimate at $350 
million over the next four quarters. However, land spend may be greater than 
what we have assumed based on the company's intent to maintain total cash 
between $170 million and $245 million (roughly $125 million-$200 million 
excluding restricted cash) and its publicly stated goal of potentially 
managing cash at the lower end of the range. 

We believe the company could pull back on its land expenditures if recent 
sales momentum recedes in order to preserve cash. In addition, the recent $125 
million land banking arrangement with GSO provides the company with the 
flexibility to retain cash by using third party capital to acquire land, grow 
and utilize rolling options, and acquire lots. The ability to grow or 
replicate this structure could help Hovnanian expand its platform and return 
to profitability while retaining its current liquidity. The company's next 
debt maturity is not until 2014 when $42 million matures, followed by $84 
million in 2015. However, the debt maturity burden is considerably higher in 
2016 when $1 billion matures (67% of total debt).

Recovery analysis
The rating on the company's 10.625% senior secured first-lien notes due 2016 
is 'CCC-' (the same as the corporate credit rating), with a recovery rating of 
'3', indicating our expectation for a meaningful (50%-70%) recovery in the 
event of a payment default. The rating on the 5% and 2% first-lien senior 
secured notes due 2021 is 'CC', with a recovery rating of '5', indicating our 
expectations for a modest (10%-30%) recovery in the event of a payment 
default. We assigned a 'CC' rating on the senior unsecured notes, with a 
recovery rating of '6', indicating our expectation for a negligible (0%-10%) 
recovery in the event of a payment default. For the latest recovery analysis, 
please see "Recovery Report: Hovnanian Enterprises Inc.'s Recovery Rating 
Profile," published Oct. 27, 2011, on RatingsDirect on the Global Credit 
Portal, at www.globalcreditportal.com.


Outlook
The positive outlook reflects an improved liquidity position that appears 
sufficient to meet near-term capital needs. We would raise our ratings if 
recently improved operating trends appear sustainable and adequate liquidity 
is maintained. Alternatively, we would lower our ratings if housing operations 
deteriorate and the company aggressively invests in land resulting in a cash 
position below the low end of the company's cash target or we believe another 
distressed debt exchange or debt restructuring is likely. 

Related Criteria And Research
     -- Issuer Ranking: U.S. Homebuilders, Strongest To Weakest, July 23, 2012
     -- Industry Economic And Ratings Outlook: U.S. Home Buyers Return, But 
Can Builders Deliver?, July 20, 2012
     -- The Credit Overhang: The Differing Recovery Trajectories Of U.S. Auto 
Companies And Homebuilders, May 21, 2012
     -- Capital Markets Update: Homebuilder Bond Spreads May Foretell U.S. 
Housing Price Trends, April 20, 2012
     -- Key Credit Factors: Global Criteria For Single-Family Homebuilders, 
Sept. 27, 2011

Ratings List

Ratings Affirmed; CreditWatch/Outlook Action

                             To                 From
Hovnanian Enterprises Inc.
Corporate credit rating     CCC-/Positive/--   CCC-/Negative/--

Ratings Affirmed

Hovnanian Enterprises Inc.
Senior unsecured                      CC 
     due 2021
  Recovery Rating                      6 
Preferred Stock                        C

K. Hovnanian Enterprises Inc.
Senior Secured                        CCC- 
     due 2016
 Recovery Rating                        3 
Senior Secured                         CC 
     due 2021
 Recovery Rating                        5 
Senior Unsecured                       CC
 Recovery Rating                        6 

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

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