Fitch Ratings has affirmed the ratings for Hovnanian Enterprises, Inc. (NYSE: HOV), including the company's Issuer Default Rating (IDR), at 'CCC'. A complete list of rating actions follows this release.
The rating for HOV is influenced by the company's execution of its business model, land policies, and geographic, price point and product line diversity. The rating additionally reflects the company's liquidity position, substantial debt and high leverage.
Fitch's housing forecasts for 2012 have been raised a few times this year but still assume a below-trendline cyclical rise off a very low bottom. In a slow-growth economy with somewhat diminished distressed home sales competition, less competitive rental cost alternatives, and new and existing home inventories at historically low levels, total housing starts should improve 27.6%, while new home sales increase 19.9% and existing home sales grow 9%. For 2013, total housing starts should grow 16.7% while new home sales advance 22% and existing home sales improve 7%.
The company ended the July 2012 quarter with $219.3 million of unrestricted cash on the balance sheet and no major debt maturities until calendar 2014, when approximately $37 million of senior notes become due.
While the company currently has an adequate liquidity position, Fitch is somewhat concerned that the company is willing to operate with a cash target level of between $170 million and $245 million (including $48.1 million of restricted cash) to take advantage of land acquisition opportunities. Given that the company does not have a revolving credit facility, Fitch is concerned that this level of cash does not provide a large enough liquidity cushion in the event that the housing recovery dissipates. The absence of a bank credit facility also means a lack of bank oversight, which is a useful check on management's appetite for risk.
Management has shown its ability to manage land and development spending. HOV spent roughly $236 million on land and development during the first nine months of 2012. This compares to $305 million of land and development spending during the first nine months of fiscal 2011. The company entered into a $250 million land-banking arrangement with GSO Capital Partners LP (GSO), the credit arm of The Blackstone Group. Funds managed by GSO will acquire a portfolio of land parcels and option finished lots on a quarterly takedown basis back to HOV. This arrangement allows the company to effectively control some land on a just-in-time basis, turn its inventory faster, and reduce capital that could be tied-up in longer-term projects.
HOV had negative cash flow from operations ($90.2 million) for the latest 12 months (LTM) ended July 31, 2012. For all of fiscal 2012, Fitch expects the company will be cash flow negative by $50 million to $75 million. Fitch also anticipates the company will be cash flow negative in fiscal 2013 as it continues to rebuild its land position. Fitch currently projects HOV's unrestricted cash position will be between $150 million and $200 million by year-end 2013.
At July 31, 2012, the company controlled 29,261 lots (including unconsolidated joint ventures), of which 56.4% were owned and the remaining lots controlled through options and joint venture partnerships. Based on LTM closings, HOV controlled six years of land and owned roughly 3.4 years of land.
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, a positive rating action may be considered if the recovery in housing is significantly stronger than the agency's current outlook, if HOV's interest coverage is above 1x, and liquidity improves from current levels.
A negative rating action could be triggered if the industry recovery dissipates; HOV's 2013 revenues drop mid-teens while the pretax loss approaches 2011 levels; and HOV's liquidity position falls sharply, perhaps below $125 million.
Fitch affirms the following ratings for HOV:
--Long-term IDR at 'CCC';
--Senior secured first lien notes due 2020 at 'B-/RR2';
--Senior secured notes due 2021 at 'CCC-/RR5';
--Senior secured second lien notes due 2020 at 'CC/RR6';
--Senior unsecured notes at 'CC/RR6';
--Exchangeable note units due 2017 at 'CC/RR6';
--Series A perpetual preferred stock at 'C/RR6'.
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 liquidation value analysis for these RRs.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers