Fitch Rates Hovnanian's Proposed $200MM Sr. Notes Offering 'CCC/RR6'

CHICAGO--(BUSINESS WIRE)--

Fitch Ratings has assigned a 'CCC/RR6' rating to Hovnanian Enterprises, Inc.'s HOV proposed offering of $200 million principal amount of senior unsecured notes due 2019. The notes issue will be ranked on a pari passu basis with the company's existing senior unsecured notes. Net proceeds from the offering will be used for general corporate purposes, including land acquisition and land development.

The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

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. Risk factors include the cyclical nature of the homebuilding industry, the company's high debt load and high leverage.

The Stable Outlook reflects HOV's operating performance, adequate liquidity position, and moderately better prospects for the housing sector in 2014 and 2015.

THE INDUSTRY

Housing metrics all showed improvement in 2013. However, what began as an untypically moderate housing recovery has decelerated further since late 2013. For the first nine months of 2014, existing home sales fell 4.9%, while new home sales grew 1.7%. Single-family housing starts increased 3.8% during the January-September year-to-date (YTD) period.

To reflect the subpar spring selling season, as well as the more guarded expectation for the next few months, Fitch tapered its 2014 macro housing forecast. Single-family starts are projected to improve 3% to 636,000 and multifamily volume should grow about 17.5% to 361,000. Total 2014 starts should approximate 1 million. New home sales are forecast to advance about 1.5% to 436,000, while existing home sales volume is expected to decline 6% to 4.785 million, largely due to fewer distressed homes for sale.

Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the year. The unemployment rate should continue to move lower (averaging 5.8% in 2015). Credit standards should steadily, moderately ease throughout next year. Demographics should be more of a positive catalyst. More of those younger adults who have been living at home should find jobs and these 25- to 35- year olds should provide some incremental elevation to the rental and starter home markets. Total housing starts are projected to expand 14% to 1.14 million as single-family starts advance 18% and multifamily volumes gain 7%. New home sales should grow 18%, while existing home sales rise 5%.

CREDIT METRICS

Debt to EBITDA for the latest 12 months (LTM) ending July 31, 2014 was 10.3x compared with 10.1x at the end of fiscal 2013 and 16.5x at the end of fiscal 2012. EBITDA to interest coverage was 1.3x for the July 31, 2014 LTM period compared with 1.2x for fiscal 2013 and 0.7x in fiscal 2012. Fitch expects HOV's leverage will increase slightly as a result of the proposed offering. HOV's leverage is projected to be between 10.5x and 11.0x while interest coverage is expected to settle at around 1.25x - 1.50x at the end of fiscal 2014.

HOV's HOMEBUILDING OPERATIONS

HOV reported improved revenues so far this year. Homebuilding revenues increased 9.2% for the first nine months of fiscal 2014 as home deliveries grew 2.1% and the average sales price advanced 8.1% compared with the same period last year. The homebuilding gross margin (including interest and excluding impairment charges) also improved during the 2014 YTD period, growing 150 basis points (bps) to 17.5% compared with 16% during the first nine months of 2013.

On the other hand, new home orders have been weak so far this year. New home orders fell 1.8% for the first nine months of the year, and orders for the third quarter of 2014 were 6.3% lower year-over-year (YOY). HOV ended the third quarter with 2,569 homes in backlog (up 4.7% YOY) with a value of $1.026 billion (up 14.3% YOY).

LIQUIDITY

As of July 31, 2014, HOV had $176.6 million of unrestricted cash and $49.5 million of availability under its $75 million unsecured revolving credit facility maturing in 2018. Total liquidity at the end of the quarter was $226.1 million, which is close to the upper-end of HOV's liquidity target of $170 million - $245 million (cash plus revolver availability).

The proposed $200 million debt offering will further enhance the company's liquidity position. The company's debt maturities are well-laddered, with about $61 million maturing in 2015 and $259 million coming due in 2016.

LAND STRATEGY

At July 31, 2014, the company controlled 37,999 lots (including unconsolidated joint ventures), of which 47% were owned and the remaining lots controlled through options and joint venture partnerships. Based on total LTM closings (including unconsolidated JVs), HOV controlled 6.5 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 15.9% YOY. HOV spent roughly $424.5 million on land purchases and development activities for the first nine months of fiscal 2014. This compares to $502 million spent on land and development activities during fiscal 2013 and $364 million expended during fiscal 2012.

For the LTM period ending July 31, 2014, HOV reported cash flow from operations of negative $203 million. During fiscal 2013, HOV reported cash flow from operations of $9.3 million. Fitch expects HOV's fiscal 2014 cash flow from operations will approximate the negative cash flow reported for the LTM period. Nevertheless, Fitch expects the company will have liquidity that is above its stated target range, particularly if the company completes the proposed notes offering.

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, 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 2015 revenues drop high-teens while the pretax loss approaches 2012 levels; and HOV's liquidity position falls sharply, perhaps below $125 million.

Fitch currently rates HOV as follows with a Stable Outlook:

--Long-term Issuer Default Rating (IDR) 'B-';

--Senior secured first lien notes due 2020 'B+/RR2';

--Senior secured notes due 2021 'CCC+/RR5';

--Senior secured second lien notes due 2020 'CCC/RR6';

--Senior unsecured notes 'CCC/RR6';

--Exchangeable note units due 2017 'CCC/RR6';

--Series A perpetual preferred stock 'CCC-/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 going concern valuation analysis for these RRs.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=913436

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