Fitch Affirms Hovnanian's IDR at 'B-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has affirmed Hovnanian Enterprises, Inc.'s HOV Issuer Default Rating (IDR) at 'B-'. The Rating Outlook is Stable. A complete list of rating actions 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 2015.

THE INDUSTRY

Housing should benefit from a steadily expanding economy in 2015. As byproducts of a smoothly growing economy, employment should show moderate gains and consumer confidence is expected to improve. Mortgage rates are expected to increase, similar in size to the escalation in 2013. 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 - 35 year olds should provide some incremental elevation to the rental and starter home markets.

Single-family starts are forecast to rise about 18% to 757,000 and multifamily volume expands about 7% to 386,000. Total starts would be in excess of 1.1 million in 2015. New home sales are projected to increase 18% to 515,000. Existing home volume is expected to approximate 5.138 million, up 4.3%.

GEOGRAPHIC AND PRICE POINT DIVERSITY

HOV is geographically diversified, offering homes for sale in 201 communities in 34 markets across 16 states. According to Builder Magazine, during 2013, 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 31% of its 2013 product designs were to first-time homebuyers, 32% to the move-up segment, 24% to luxury homebuyers and 13% to the active adult segment.

The company has some concentration in the Houston market, with about 24% of its 2013 home closings coming from this metro area. The Houston/Sugarland/Baytown, TX market is one of the largest metro areas in the U.S., with about 51,500 housing permits issued during 2013 and roughly 52,500 housing permits issued through the first 10 months of 2014. Fitch is somewhat concerned with the potential impact of lower oil prices on the economy of this metro area. The unemployment rate for the Houston/Sugarland/Baytown metro market was 4.7% in October 2014. Management indicated that its net orders per community in the Houston market increased 11% during the month of November.

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. Management indicated that its strategy in Houston has been purchasing finished lots on a quarterly take down basis, which somewhat limits the company's exposure and risk in a downside scenario. Total deliveries in the company's southwest region (which includes Arizona and Texas) represented about 43.5% of total consolidated deliveries during fiscal year (FY) 2014. On the other hand, HOV's assets in the southwest region represented about 27.4% of total homebuilding assets. Owned lots in this region were 2,499 lots or 14.1% of HOV's total owned lot position as of Oct. 31, 2014.

HOV's HOMEBUILDING OPERATIONS

HOV's homebuilding revenues during FY 2014 (ending Oct. 31, 2014) increased 12.1% to $2.02 billion as home deliveries grew 4.4% to 5,497 homes and the average selling price advanced 8.1% to $366,202. Homebuilding gross profit margins (excluding inventory impairments and lot option abandonments) improved slightly to 17.3% during FY2014 compared with 17.2% during FY2013. SG&A as a percentage of homebuilding sales increased to 12.6% during FY2014 from 12.2% last year. The company reported pre-tax income of $20.2 million during FY2014 compared with $21.9 million during FY2013.

New home orders were relatively flat during FY2014, although net orders increased 7.9% during the fourth quarter as the company's community count grew 4.7% and the net contracts per community improved 3.2% during the period. HOV ended FY2014 with 2,229 homes in backlog (up 2.9% YOY) with a value of $855.8 million (up 12.3% YOY).

Fitch expects HOV's revenues will increase mid-teens next year from greater home deliveries and modestly higher average selling prices. Fitch expects margin pressure during FY2015 due to higher land, labor and materials costs. Nevertheless, Fitch expects HOV will remain profitable next year, although at a lower level compared with FY2014 due to the additional interest expense associated with its recently issued $250 million 8% senior unsecured notes.

CREDIT METRICS

Leverage at the end of FY2014 was 10.0x compared with 10.0x at the end of FY2013 and 16.5x at the end of FY2012. EBITDA to interest coverage is low at 1.2x for FY2014 compared with 1.2x in FY2013 and 0.7x in FY2012. Fitch expects HOV's credit metrics will remain weak during the next 12 months, with leverage situating around 10.0x - 11.0x and interest coverage of roughly 1.0x - 1.2x at the end of FY2015.

LIQUIDITY

The company ended FY2014 with $255.1 million of unrestricted cash and $48 million of borrowing availability under its $75 million unsecured revolving credit facility maturing in 2018. The company has been operating at or above the top of its target liquidity range of $170 million to $245 million since the end of FY2012. Subsequent to the end of FY2014, HOV issued $250 million of senior unsecured notes due 2019. This new issuance further enhances the company's liquidity position.

HOV has some upcoming debt maturities over the next three years, including $61 million of senior notes maturing in October 2015, $172 million of senior notes coming due in January 2016, $86.5 million of senior notes maturing in May 2016 and $121 million of senior notes coming due in January 2017. Fitch expects the company will refinance these debt maturities.

LAND STRATEGY

At Oct. 31, 2014, the company controlled 37,820 lots (including unconsolidated JVs), of which 46.9% were owned and the remaining lots controlled through options and JV partnerships. Based on latest twelve months closings, HOV controlled 6.4 years of land (including unconsolidated JVs) and owned 3.2 years of land. As is the case with other public homebuilders, the company is rebuilding its land position and opportunistically acquiring land. Total lots controlled increased 9% YOY while owned lots grew 8.5%.

HOV spent $585 million on land and development during FY2014 compared with $502 million spent on land and development activities during FY2013, $364 million expended during FY2012 and $400 million spent during FY2011. The company reported cash flow from operations of negative $190.6 million during FY2014 compared with positive CFFO of $9.3 million during FY2013.

Fitch expects HOV will be cash flow negative again in FY2015 as it continues to build its land position. Management indicated that land and development spending will be governed by its liquidity position. Fitch expects the company will continue to have liquidity above or at the upper end of its stated target range during the next 12 - 18 months.

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 and low coverage 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 has affirmed the following ratings:

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

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

--Senior unsecured notes at 'CCC/RR6';

--Senior unsecured exchangeable notes due 2017 at 'CCC/RR6';

--Series A perpetual preferred stock at 'CCC-/RR6'.

Fitch has also upgraded the following ratings:

--Senior secured first lien notes due 2020 to 'BB-/RR1' from 'B+/RR2';

--Senior secured second lien notes due 2020 to 'B-/RR4' from 'CCC/RR6';

The Rating Outlook is Stable.

The higher recoveries for the senior secured first lien and second lien notes are based on Fitch's estimate of a greater enterprise value for the company. Fitch applied a going concern valuation analysis for these RRs.

Fitch's Recovery Rating (RR) of 'RR1' on HOV's senior secured first-lien notes indicates excellent recovery prospects for holders of these debt issues. The 'RR2' on the second lien notes due 2020 indicates superior recovery prospects while the 'RR5' on the senior secured notes due 2021 indicates below-average recovery prospects in a default scenario. The 'RR6' on HOV's senior unsecured 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.

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=962915

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