Fitch Downgrades Hovnanian's IDR to 'CCC'

CHICAGO--(BUSINESS WIRE)--

Fitch Ratings has downgraded the ratings of Hovnanian Enterprises, Inc. HOV, including the company's Issuer Default Rating (IDR), to 'CCC'. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The downgrade of the ratings reflects HOV's high debt load and leverage and Fitch's expectation that the company's liquidity position will weaken in the near- to intermediate-term due to upcoming debt maturities. Fitch had previously expected the company to refinance debt maturing in 2016, but HOV has been unable to access the capital markets. As of Oct. 31, 2015, the company had $245.4 million of unrestricted cash and $2.1 million of borrowing availability under its $75 million revolver that matures in 2018. HOV has $172.8 million of senior notes maturing in January 2016, $86.5 million coming due in May 2016, and $121 million maturing in January 2017.

The company currently has sufficient cash to repay the $172.8 million of senior notes maturing in January 2016. However, the company's overall liquidity will be meaningfully exhausted following this debt repayment (and before the May 2016 maturity) unless it is able to access the capital markets, generate meaningful free cash flow (FCF) during the first half of fiscal 2016, or is able to successfully tap alternative liquidity sources. Typically, homebuilders generate negative FCF during the first half of the year as they build their inventory and then turn cash flow positive during the second half (particularly during the fourth quarter) as homes are sold.

POTENTIAL SOURCES OF LIQUIDITY

Management has identified several levers it can pull to allow the company to repay its 2016 maturities while still investing in growth opportunities.

--Land banking - HOV could choose to take a higher percentage of new land deals through land banking arrangements instead of using the company's cash to purchase these lots. This reduces the upfront cash required to purchase and/or develop the land while still controlling the lots through option contracts. Fitch believes that this type of arrangement results in a lower operating margin compared to the margin derived from homes delivered on lots that are purchased and/or developed by the company.

Another land banking option is for HOV to take existing owned land and sell it to a land banker and then enter into an option agreement to purchase those lots back on a just-in-time basis. The company currently has $300 million of land banking arrangements - $125 million with Domain Real Estate Partners (affiliate of DW Partners) and $175 million with GSO Capital Partners (credit arm of Blackstone). As of Nov. 30, 2015, GSO had closed on one land parcel totaling 186 lots with total acquisition and future development costs of $24.2 million. GSO and HOV have also entered into a non-binding letter of intent to land-bank a portfolio of assets totaling about $95 million of land acquisition and future development costs with the expectation to close the transaction prior to Dec. 31, 2015. Fitch estimates that HOV's land banking arrangements with Domain Real Estate Partners and GSO Capital Partners could generate cash inflows of between $175 million to $200 million.

--Joint Ventures - HOV could monetize certain of its assets by contributing them to joint ventures (JV), wherein the company typically contributes about 10%-15% of the required capital and the JV partner(s) puts up the remainder. In November 2015, HOV completed a JV transaction for a 278-unit midrise building in New Jersey that generated $26 million of cash for the company.

--Non-recourse project-specific financing - the company currently has $143.9 million of non-recourse land mortgages, up from $104 million at the end of FY2014. The company can use project financing to fund its land and development spending.

--Model sale leasebacks - during FY2015, the company raised $43 million from model sale leaseback transactions.

Management indicated that the company has about $500 million of inventory that it can utilize for additional land banking arrangements, joint ventures and/or nonrecourse project financing.

HIGH DEBT LOAD AND LEVERAGE

The company had total debt of $2.1 billion as of Oct. 31, 2015. Leverage at the end of FY2015 (ending Oct. 31, 2015) was about 14.8x compared with 10.1x at the end of FY2014 and FY2013. EBITDA-to-interest coverage is low at 0.9x for FY2015 compared with 1.2x for FY2014 and FY2013. Fitch expects HOV's credit metrics will remain weak during the next 12 months, with leverage situating around 10.0x and interest coverage of roughly 1.0x at the end of FY2016.

STRONG 4Q15 ORDER ACTIVITY AND BACKLOG

HOV ended FY2015 strongly, reporting an 18% growth in consolidated net orders during 4Q15 compared with 4Q14. The company ended the year with 2,905 homes in backlog with a total value of $1.2 billion. The homes in backlog are 30% higher YOY while the total value is up 42.1% compared with the end of 2014. The strong backlog supports the robust revenue growth projected for the company during FY2016.

HOUSING INDUSTRY OUTLOOK

Housing metrics increased in 2014 due to more robust economic growth during the last three quarters of the year, and, consequently, there was an acceleration in job growth despite modestly higher interest rates as well as more measured home price inflation. Total starts in 2014 were 1.003 million, up 8.4%. New home sales were up a modest 1.6% to 436,000, while existing home volume was off 2.9% to 4.940 million largely due to fewer distressed homes for sale and limited inventory. New home price inflation moderated in 2014, at least partially because of higher interest rates and buyer resistance. Average new home prices, as measured by the Census Bureau, rose 6.4% in 2014, while median home prices advanced about 5.4%.

Housing activity ratcheted up more sharply in 2015 with the support of a steadily growing economy. Through the first 10 months of 2015, total housing starts grew 10.2% versus the same period last year, while existing home sales and new home sales are up 7.0% and 15.7%, respectively. Fitch projects total housing starts will expand 9.2% to 1.095 million this year. New home sales should grow 14.9%, while existing home sales should rise 6.6%.

Sparked by a slightly faster growing economy, the housing recovery is expected to continue in 2016. Although interest rates are likely to be higher, a more robust economy, healthy job creation and further moderation in lending standards should stimulate housing activity. Housing starts should be approximately 1.20 million (+9.8%) with single-family volume of 0.79 million and multifamily starts of 0.41 million. New home sales should reach 581,000, up 16.0%. Existing home volume growth should again be up by mid-single digits (+4.0%).

LAND POSITION

As of Oct. 31, 2015, the company controlled 37,659 lots, of which 49.4% were owned, 42.3% were optioned, and the remaining lots controlled through joint ventures. Based on LTM closings (excluding unconsolidated JVs), HOV controlled 6.3 years of land (excluding lots controlled through JVs) and owned roughly 3.4 years of owned land. Total lots controlled were flat YOY while owned lots increased 5%.

HOV spent $656.5 million on land and development during FY2015 compared with $585 million in FY2014, $502 million in FY2013, $364 million in FY2012 and $400 million in FY2011. Fitch estimates that HOV generated negative cash flow from operations (CFFO) between $250 million - $300 million during FY2015 (cash flow statement for FY2015 is not yet available). This compares to negative CFFO of $190.6 million during FY2014 and positive CFFO of $9.3 million during FY2013.

Fitch expects HOV will generate positive CFFO during FY2016 as it monetizes some of its land assets and utilizes land banking arrangements for new land transactions.

GEOGRAPHIC AND PRICE POINT DIVERSITY

HOV is geographically diversified, offering homes for sale in 206 communities in 34 markets across 16 states. According to Builder Magazine, during 2014, the company ranked among the top 10 builders in such metro markets as Houston and Dallas, TX, Phoenix, AZ, Washington DC / Arlington, VA / Alexandria, WV markets, New York / Northern New Jersey, Baltimore, MD, Philadelphia, PA / Camden, NJ / Wilmington, DE markets, Chicago, IL, Riverside / San Bernardino, CA, and Minneapolis / St. Paul, MN. Management estimates that about 29% of its 2014 product designs were to first-time homebuyers, 36% to the move-up segment, 22% to luxury homebuyers and 13% to the active adult segment.

EXPOSURE TO THE HOUSTON METRO MARKET

About 16% of HOV's LTM homebuilding revenues were generated from the Houston metro market. The company was the fifth largest homebuilder in Houston in 2014 with 1,312 home deliveries. The Houston/Sugarland/Baytown, TX market is one of the largest metro areas in the U.S., with about 49,329 housing permits issued through the first 10 months of 2015. The 2015 YTD housing permits are 6.2% below the 52,571 issued during the same period last year. About 63,741 housing permits were issued during 2014 and 51,333 were issued during 2013.

Fitch is concerned with the impact of continued low oil prices on the economy of this metro area. The unemployment rate for the Houston/Sugarland/Baytown metro market was 4.8% in October 2015, up from the 4.4% rate reported in October 2014 and the September 2015 rate of 4.6%. The monthly unemployment rate has ranged from 4% to 4.8% during the first 10 months of 2015.

HOV's average sales price in Houston is $302,000 and the company is focused on the entry-level and first move-up market. Based on general commentary from homebuilders, the weakness in the Houston market is currently most evident in the trade-up market ($300,000 and above price range). During 4Q15, HOV's net orders in Houston fell 9% YOY and the net contracts per community fell 12% compared with last year.

While the Houston market is HOV's largest market in terms of home deliveries, it is not the largest market in terms of land investment. HOV's strategy in Houston has been to purchase finished lots on a quarterly takedown basis, which somewhat limits the company's exposure and risk in a downside scenario. Owned lots in Houston were 1,631 or 8.8% of HOV's total owned lot position as of Oct. 31, 2015.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for HOV include:

--Housing starts expand 9.2% to 1.095 million during 2015, while new home sales grow 14.9% and existing home sales advance 6.6%;

--Housing starts advance 9.8% during 2016 and new and existing home sales expand 16% and 4%, respectively;

--HOV's revenues increase 25%-30% during 2016;

--EBITDA margins improve 25 bps-75 bps during 2016;

--HOV generates positive FCF;

--The company ends FY2016 with about $125 million - $175 million of liquidity (combination of unrestricted cash and revolver availability).

RATING SENSITIVITIES

HOV's ratings could be downgraded further if the company is unable to refinance $172.8 million of senior notes maturing in January 2016 and $86.5 million coming due in May 2016 and HOV's liquidity position falls below $150 million, and the company does not provide a credible plan to address $121 million of senior notes maturing in January 2017.

A rating upgrade is unlikely in the next 12 months as liquidity remains constrained, leverage is expected to remain elevated, and coverage will continue to be weak. However, Fitch may consider a positive rating action if the housing recovery is meaningfully better than Fitch's current outlook and is maintained over a multi-year period, allowing the company to significantly improve its liquidity position and credit metrics.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings:

Hovnanian Enterprises, Inc.

--Long-term IDR to 'CCC' from 'B-';

--Senior secured first lien notes due 2020 to 'B/RR1' from 'BB-/RR1';

--Senior secured second lien notes due 2020 to 'CCC-/RR5' from 'B-/RR4';

--Senior unsecured notes to 'CCC-/RR5' from 'CCC/RR6';

--Series A perpetual preferred stock to 'C/RR6' from 'CCC-/RR6'.

Fitch has also revised the Recovery Ratings for the following:

Hovnanian Enterprises, Inc.

--Senior secured notes (5% and 2%) due 2021 to 'CCC+/RR3' from 'CCC+/RR5'.

Recovery Ratings

HOV's Recovery Ratings reflects Fitch's expectation that the enterprise value of the company will be maximized in a restructuring scenario (going concern). Fitch employs a 6x distressed EBITDA enterprise value multiple and assumes going concern EBITDA of $180 million.

The 'B/RR1' rating for HOV's $550 million first lien senior secured notes reflect Fitch's estimate for a recovery range of 91%-100%. The company's first lien and second lien notes due 2020 are secured by $784.7 million of inventory and $197.1 million of cash. Fitch rates HOV's second lien senior secured notes 'CCC-/RR5', reflecting 11%-30% recovery for this debt issue.

The 'CCC+/RR3' rating for the company's 5% and 2% senior secured notes due 2021 reflect Fitch's estimate for a recovery range of 51%-70%. These notes are secured by $140.1 million of inventory, $50.9 million of cash, and HOV's interest in certain joint ventures.

Fitch's 'CCC-/RR5' rating on the company's senior unsecured notes reflects recovery of 11%-30% for these debtholders. Fitch assumed that assets that are not pledged and the excess value from property specifically pledged to certain lenders is distributed to unsecured claims on a pro rata basis, including the senior unsecured noteholders and the undersecured claim portion held by other secured lenders.

The 'C/RR6' rating on HOV's preferred stock assumes zero recovery.

Details of Fitch's Recovery Analysis for Hovnanian can be found in the following report:

Hovnanian Enterprises, Inc. Recovery Tool

Additional information is available on www.fitchratings.com

Related Research:

Hovnanian Enterprises, Inc. Recovery Tool

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 07 Dec 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=873504

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=996324

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=996324

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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