Investors search for signs of potential to survive amidst downturn in homebuilding industry

By Jennifer Lanning Drey

Portland, Ore., Sept. 5 - As inventory levels continue to mount for residential homebuilders who face a market downturn that shows little, if any, sign of a near-term recovery, high-yield issuers in the sector are scrambling to reduce the debt on their balance sheets, conserve cash, amend bank covenants and get out of land positions that are no longer valuable.

However, with earnings down almost entirely across the board and lenders tightening their credit standards, investor confidence may be sinking, giving rise to concerns over which companies will actually weather the storm - and which will not make it through to the other side.

One trader said Wednesday that it won't be long until some of the homebuilders are forced into bankruptcy as the downturn in the mortgage sector and the housing slump continue to weigh on the industry.

"We don't see how they can be successful unless market conditions change," the trader said.

The ratings agencies have indicated the sector will remain a difficult space to do business through next year and possibly beyond.

Homebuilders' full-year revenues for 2007 could drop by an average of 30% to 35%, while pre-tax profits before real estate charges could plummet by 75% to 80%, Bob Curran, managing director of Fitch Ratings, said during a conference call held last week to discuss Fitch's latest round of downgrades among homebuilders.

Price competition will persist, if not intensify, while margins remain under pressure and additional land write-offs are a distinct possibility, he added.

Standard & Poor's believes the market is about 1½ years into a two- to three-year downturn, and Moody's Investors Service does not expect a sector recovery to begin before 2009.

At the same time, however, some analysts and traders said the majority of residential construction high-yield issuers are likely to survive the industry downturn - an idea they view as backed by strong balance sheets and the fact that many of the companies have been through industry low points in the past.

"Fortunately for them [the homebuilders], they've built up a fair amount of cash reserves over the past few years and didn't necessarily spend it all on buying land options or the raw land itself - so I think the big ones have the staying power to weather the storm," Bill Featherston, managing director for J. Giordano Securities in Stamford, Conn., said Wednesday.

"I think that at the present time they're well enough capitalized.

"If this thing goes on for an extremely long period of time, they have a fair amount of debt on their balance sheets. That could create some negative cash flows."

When asked if anyone is on the verge of bankruptcy, he said: "I'd never say 'never.'"

Ashton Woods seen as yield play

Ashton Woods USA LLC is one of the two most attractive yield plays in the high-yield residential construction sector, according to a quarterly report sent to Prospect News on Friday by Wachovia analysts Lee Brading and John van Brederode.

They attributed their positive outlook on the company to adequate liquidity, a presence in more stabilized markets and a strong management team.

Ashton Woods had cash and cash equivalents of $38,000 at May 31, while total debt stood at $188.04 million on the same date, according to a 10-K filing with the Securities and Exchange Commission.

Additionally, Ashton Woods amended its revolving credit facility on June 15, permanently reducing the interest coverage ratio to 2.00 to 1.00 from 2.50 to 1.00.

Ashton Woods' net income decreased 71.5%, or by $61.8 million, in the fiscal year ended May 31, 2007, as compared to the previous fiscal year. Revenues decreased 17.4% for the year ended May 31.

Ashton Woods is a Roswell, Ga.-based homebuilder.

Beazer Homes' 10-Q troubles

Beazer Homes USA, Inc. has been plagued by bankruptcy rumors in recent weeks, exacerbated by the company's Aug. 10 announcement that it would postpone filing its 10-Q with the SEC for the quarter ended June 30 due to the discovery by an independent audit committee related to possible inappropriate accounting for over-accruing of reserves and liabilities.

However, Beazer said it does not currently believe the amounts at issue will affect its cash position - a statement the Wachovia analysts said was critical, in that the issue at hand did not affect the company's cash or debt balances.

Still, traders mentioned Beazer as one of the homebuilders likely to feel the most pain, due to its size and scope.

Beazer did not respond for a request for comment made Wednesday.

The company released unaudited financial results for the period in an 8-K filed Aug. 15, which listed the company's cash and cash equivalents at $123.28 million and total liabilities at $2.555 billion at June 30.

Citigroup equity analyst Stephen Kim, along with two other Citigroup analysts, said in a report sent to Prospect News on Tuesday that Beazer's significant exposure to Midwest markets could hamper sales, as the company remains committed to markets suffering from weaker-than-anticipated local economics and severe price competition.

But Beazer's biggest problem may be its potential for liquidity troubles if the trustee of its $1.3 billion of 8 3/8% senior notes due 2012 were to declare a default and demand repayment on the notes.

As previously reported, Beazer filed a lawsuit with the U.S. District Court in Atlanta on Aug. 21 against indenture trustee U.S. Bank NA that asks the court to confirm that the delayed 10-Q filing does not constitute an event of default on the notes and to keep the trustee and noteholders from accelerating payment on the notes.

The Wachovia report said case law is mixed on the issue of delayed SEC filings and whether a failure to file triggers a default under the company's bond indenture.

Beazer is an Atlanta-based homebuilder.

D.R. Horton debt called high

D.R. Horton, Inc.'s active participation in consolidation of the homebuilding industry has kept its debt levels a bit higher than those of its industry peers, according to Fitch, which last week revised D.R. Horton's rating outlook to negative from stable.

D.R. Horton had total liabilities of $6.731 billion, while total cash and cash equivalents stood at $60.8 million at June 30, according to a 10-Q filing with the SEC.

D.R. Horton has not made any acquisitions since 2002 and instead appears to be focusing on harvesting opportunities within its current and adjacent markets, Fitch said.

The company amended its revolving credit facility on July 6 to allow for the payment of dividends or distributions to shareholders.

Prior to the amendment, there was a restriction that limited the company's ability to pay dividends/distributions to shareholders to an amount equal to 50% of the consolidated net income for the most recent full fiscal year ended prior to the date of the distribution.

D.R. Horton is a Fort Worth, Texas-based homebuilding company.

Hovnanian faces pressure

Hovnanian Enterprises Inc.'s cash was called "below average" and its leverage "higher than average" by the Citigroup analysts and one trader said Wednesday, "even names like Hovnanian are under pressure." Another trader seconded the theory.

Hovnanian is completing a review of its finances and plans to announce results by Sept. 6, according to a spokesperson, who added that Hovnanian would not be able to make comments before its quarterly earnings call about its efforts to survive an industry downturn.

One positive factor for the company, noted by Fitch, is that Hovnanian faces less risk of problems with its bank debt than most of its peers because the interest coverage covenant in its $1.5 billion unsecured credit facility does not trigger a default if leverage falls below a certain threshold.

Additionally, the Wachovia analysts said in a late August report that Hovnanian's higher-than-average inventory levels should begin to taper off during the second half of 2007.

In its most recent quarterly earnings call, Hovnanian reported having $412 million outstanding on the credit facility at June 30.

The company expects to be in compliance with all of its debt covenants at July 31, according to its 8-K.

Hovnanian Enterprises is a Red Bank, N.J.-based homebuilder.

KB Home deleverages

KB Home's recent cash generation and deleveraging actions impressed Citigroup's analysts.

Additionally, the analysts said investors may have thus far overlooked the beneficial impact of the company's recent divestiture of its French subsidiary, which brings $550 million in cash to the balance sheet.

KB Home has improved its capital structure in recent years, increased its geographic diversity and better positioning itself to withstand a meaningful housing downturn, Fitch said in an August statement.

The agency also said the company has solid financial flexibility supported by cash and cash equivalents of $272 million plus $1.19 billion available under its $1.5 billion domestic unsecured credit facility, according to May 31 figures.

KB Home repaid its $400 million term loan in late July and on Aug. 7 completed the redemption of all $250 million of its 9½% senior subordinated notes due 2011.

The company amended its revolving credit facility on Aug. 17, allowing for the reduction of the consolidated earnings to consolidated interest expense ratio for a period of up to nine consecutive quarters.

KB Home is a Los Angeles-based homebuilder.

Kimball Hill looks to add liquidity

Kimball Hill Inc. reported cash and cash equivalents of $15.83 million and total liabilities of $695.60 million at June 30 and, like others in the industry, the company has said publicly that it is considering ways to increase its liquidity.

Kimball Hill amended its $500 million senior credit facility in early August in order to "protect its liquidity," chief executive officer David Hill said at the time.

The company has further said it is looking at asset restructuring as a source of progress toward positive cash flow.

As previously reported, the amendments made to Kimball Hill's credit facility allow the company to ignore, for purposes of financial covenant calculations, up to $40 million of tangible net worth reductions due to impairment and abandonment charges. In addition, the amendments suspend the interest coverage ratio covenant until March 31, 2009 and add a minimum requirement of adjusted EBITDA of $25 million on a trailing four-quarter basis and a minimum $50 million liquidity requirement, according to the company's form 10-Q filed with the SEC.

Kimball Hill is a Rolling Meadows, Ill.-based homebuilder.

MDC praised for low leverage

MDC Holdings Inc. was named by three Goldman Sachs analysts in an Aug. 29 report as their favorite "buy" rated stock for investors looking for a long-term position, "given its very low leverage."

Fitch also highlighted in an August statement that MDC has notably improved its capital structure, pursued conservative capitalization policies and positioned itself to withstand a meaningful downturn.

The agency went on to say that as the housing cycle continues to contract, creditors will benefit from MDC's solid financial flexibility supported by $668.4 million in cash and cash equivalents and $1.21 billion of availability under its $1.25billion unsecured revolving credit facility, as of June 30.

MDC reported a $106.07 million second-quarter net loss on revenue of $687.81 million, according to its most recently filed 10-Q with the SEC.

Denver-based MDC Holdings builds homes under the name Richmond American Homes.

Meritage's 'ample' liquidity

Meritage Homes Corp. had what the Wachovia analysts called "ample" liquidity at June 30, with $516 million of availability on its revolver and $51.7 million of cash on hand.

Another positive note, according to Fitch: Meritage's use of non-specific performance rolling options gives the company the ability to renegotiate prices and terms or void an option, which limits downside risk in the market downturns.

At June 30, 75% of Meritage's lots were controlled through options, a higher percentage than almost all other public builders, according to the agency, which last week revised Meritage's outlook to negative from stable.

Meritage's total liabilities stood at $1.261 billion at June 30, and the company reported a $56.58 million net loss for the second quarter on revenues of $568.67 million.

Meritage is a Scottsdale, Ariz.-based designer and builder of single-family attached and detached homes.

M/I trims borrowings

Gimme Credit analyst Vicki Bryan specifically named M/I Homes Inc. as a homebuilder that has improved its odds by improving its balance sheet, in a Wednesday report.

Bryan highlighted that the company has repaid $226 million in debt since the third quarter of 2006, with another $160 million to be repaid by year-end with cash flow from operations.

Gimme Credit currently estimates M/I to report free cash flow of $15 million for 2007 and leverage and interest coverage of 4.4x and 1.8x on total homebuilding debt of $310 million.

"By comparison, most high-yield homebuilders are tracking negative free cash flow and year-end leverage of 8x to 9x or more," Bryan said in the report.

M/I reported a $40.18 million net loss on revenues of $235.65 million for the quarter ended June 30, according to its 10-Q filing with the SEC for the quarter.

The company had $2.35 million in cash and total liabilities of $683.91 million at June 30, according to the filing.

M/I Homes' inventory turns are moderately below average as compared to its public peers but have slimmed in recent years as the company made a conscious effort to scale up the share of its communities in which it develops - to the advantage of margins, according to Fitch.

However, Fitch downgraded M/I last week and said the outlook remains negative, which the agency said was due to factors including negative trends in M/I's operating margins and meaningful deterioration in credit metrics, especially interest coverage and debt/EBITDA ratios.

Standard & Poor's also recently lowered M/I's ratings, saying the credit tightening in the mortgage market, higher-than-expected pricing concessions and continued inventory overhang are weighing heavily on both M/I's operations and key credit metrics.

M/I amended its credit facility on Aug. 28, reducing the size to $500 million from $650 million and revising covenants, according to an 8-K filing with the SEC.

As previously reported, under the amendment, the interest coverage ratio incrementally reduces beginning with the quarter ending Dec. 31 and continuing through the quarter ended March 31, 2009, and then slightly increases to 1.5 to 1.0 thereafter.

M/I Homes is a Columbus, Ohio-based builder of single-family homes.

Ryland seen well positioned

Ryland Group Inc. is positioned to withstand a meaningful industry downturn, Fitch recently stated. Specifically, Fitch said Ryland's significant ranking in most of its markets, its presale operating strategy and its focus on return on capital provide the framework to soften the impact on margins from declining market conditions.

Additionally, the agency said Ryland's inventory turns remain strong in comparison to the industry, demonstrating its ability to generate liquidity from its inventory base.

Ryland had cash and cash equivalents of $84.5 million and $871.4 million available under its $1.1 billion unsecured credit facility, at June 30.

The company reported a second-quarter net loss of $52.43 million on revenues of $739.69 million, according to its most recently filed 10-Q with the SEC.

Ryland is a Calabasas, Calif., homebuilder and mortgage-finance company.

Standard Pacific betters balance sheet

Standard Pacific Corp. is another sector participant to have helped its odds through recent balance sheet improvements, which include $370 million in debt repayment from peak levels in the third quarter of 2006, Gimme Credit analyst Vicki Bryan said the Wednesday report.

Additionally, she said Standard Pacific has enough cash and available borrowings to cover interest for nearly five years.

Gimme Credit estimates Standard Pacific will demonstrate free cash flow of $135 million, excluding tax benefits, for the year.

However, Fitch said in a late August statement that the outlook for Standard Pacific remains negative - although the agency did call the company's execution of its business model "successful."

The agency said 16% of Standard Pacific's lots are currently controlled through options and 22.8% through joint ventures, which the agency considers "material to the company's operations."

On a positive note, the company's manageable leverage levels and supply of land in attractive markets held in the partnerships mitigate that risk to some extent, the agency said in an August statement.

Standard Pacific reported total cash and cash equivalents of $22.34 million and total liabilities of $2.400 billion at June 30, according to its most recently filed 10-Q with the SEC.

The company reported a $165.92 million second-quarter net loss on homebuilding revenues of $694.83 million.

As previously reported, Standard Pacific is looking to amend its credit facility, reducing the overall size, increasing pricing and modifying covenants, according to an 8-K filed with the SEC on Aug. 24.

Under the amendment proposal, the company's $1.1 billion revolver would be downsized to $900 million and its $250 million term loan B would be downsized to $225 million, while its $100 million term loan A size would remain unchanged.

Standard Pacific is an Irvine, Calif.-based builder and seller of single-family attached and detached homes.

Stanley-Martin favored by Wachovia

Stanley-Martin Communities LLC was the second company named in a Wachovia report as a most attractive yield play, due to its adequate liquidity, presence in more stabilized markets and strong management team.

In a separate August report, the analysts also said that, assuming pricing does not take another leg down, Stanley-Martin should be profitable for fiscal year 2007.

The company said it believes its available financing is adequate to support operations and planned land acquisitions through 2009, according to its most recent 10-Q filed with the SEC.

Stanley-Martin had cash and cash equivalents of $4.62 million at June 30 and total liabilities of $242.28 million, which included $218.25 million of debt, according to the 10-Q.

The company's borrowing capacity under its senior secured credit facility is dependent on borrowing base calculations stipulated in the facility agreement. At June 30, those calculations allowed for additional borrowings of up to $71.2 million over the $68.3 million already on the line of credit at that date.

Unlike many of its competitors, which have slowed down new-community openings, Stanley Martin plans to open six new communities and close out one this year. The company has delayed a few of the openings to the fall from June, due to permitting delays and additional development needs, but the Wachovia analysts said they do not expect any further delays in community openings.

As previously reported, Stanley-Martin amended its credit facility, changing the aggregate number of Spec Units and Model Units in the borrowing base to 30% from 20% from June 29 to Sept. 30, 2008.

Stanley-Martin is a Reston-Va.-based builder of new homes in the Washington, D.C. area.

Tousa called weak

Multiple traders named Tousa Inc. (formerly Technical Olympic USA Inc.), as the weakest of the struggling residential construction high-yield issuers.

A spokesperson for Tousa did not respond to a request for comment, but the company said in its form 10-Q filed with the SEC for the second quarter that it is responding to the continued market deterioration through initiatives including analyzing sales positions and products in each of its markets, renegotiating takedowns under homesite and land option contracts, curtailing land acquisitions, working with suppliers to reduce costs and reducing expenses within the company.

Tousa had cash and cash equivalents of $27.9 million and total liabilities of $2.064 billion at June 30.

The company reported a second-quarter net loss of $132.0 million on revenues of $576.7 million, but Tousa's biggest news of the recent quarter was the settlement of the dispute over its Transeastern joint venture.

Company executives believe the settlement increased debt but decreased uncertainties about the company.

As previously reported, Tousa believes it will generate enough cash through planned asset management initiatives to pay off most, if not all, of its $200 million first-lien term loan by the end of 2008. The loan is part of a $500 million facility used to finance the settlement of the Transeastern joint venture.

The company's net debt-to-capital ratio was 65.4% on that date, but executives said during Tousa's most recent earnings call that the company has a strategy in place to bring the ratio closer to the historical range of 45% to 55%.

Tousa is a Hollywood, Fla., designer, builder and marketer of single-family residences, town homes and condominiums.

Toll's strengths

Toll Brothers Inc. has a number of factors that may help it weather an industry downturn, according to Fitch. In an August statement, the agency said Toll Brothers has a well-entrenched market position as the pre-eminent builder of luxury homes, a seasoned operating model that has produced the best margins within the industry, relatively stable debt-protection measures and a consistently profitable track record through past homebuilding cycles.

Risk factors mentioned by the agency included the cyclical nature of the homebuilding industry, the possible volatility in value of Toll's extensive land holdings, the shift to somewhat larger land purchases and developments in some markets and the company's primarily focus on the luxury housing segment of the market, which is not as broad as first-time and first-step trade-up segments.

The company had cash and cash equivalents of $771.72 million and total liabilities of $3.83 billion at July 31, according to its third-quarter earnings release.

Toll Brothers reported third-quarter net income of $26.5 million on revenues of $1.21 billion.

Toll Brothers is a Horsham, Pa.-based builder of luxury single-family home communities, residential golf communities and urban low-, mid-, and high-rise communities.

WCI shedding land

WCI Communities Inc. is actively marketing land parcels that are estimated to have an aggregate value of approximately $200 million to $300 million and are expected to generate significant profits in addition to cash flow, according to the company.

For the six months ended June 30, cash flow from operating activities and investing activities totaled $119.8 million compared with cash used of $382.0 million in the same period a year ago.

WCI reported total liquidity of $315 million at Aug. 17.

On the same date, WCI amended its credit facility to provide for, among other things, greater flexibility in the current market environment, according to an 8-K filed with the SEC in late August.

Specifically, the amendments permit certain changes in the composition of WCI's board of directors without triggering a change of control, adjust the pricing of the loans under the facilities, provide for certain commitment reductions, provide collateral for the loans and adjust certain financial coverage ratios. At the end of August, shareholders voted Carl C. Icahn, Keith Meister and David Schechter of the Icahn Group on to the board along with Craig W. Thomas, a portfolio manager at S.A.C. Capital Advisors, LLC, Nick Graziano, a managing director of Sandell Asset Management Corp., and Yale Law professor Jonathan R. Macey.

The amendments also reduce the company's borrowing capacity under its revolving credit facility to $700 million from $850 million with subsequent reductions to $600 million on July 1, 2008 and $550 million on July 1, 2009.

WCI experienced a second-quarter net loss of $33.22 million on revenues of $241.76 million, according to the 8-K.

WCI is a Bonita Springs, Fla., builder of master-planned lifestyle communities.

William Lyon

Privately held William Lyon Homes had cash and cash equivalents of $15.91 million and total liabilities of $1.098 billion at June 30, according to its second-quarter earnings news release.

On June 13, Moody's Investors Service downgraded the company's senior notes and changed its outlook to negative from stable. At the time, Moody's said it expected William Lyon to generate negative cash flow from operations for 2007, report earnings for 2007 that may be breakeven to slightly negative, see its interest coverage decline below 1x in 2007 and keep its debt leverage above 60% throughout 2007.

A company spokesperson did not respond to a request for comment nor did the company detail in its earnings release any plans for surviving the downturn.

William Lyon amended its revolving credit facility in mid-August, extending the maturity to July 10, 2008, according to an 8-K filed with the SEC.

The amendment also revised the minimum liquidity covenant to $20 million, of which no less than $10 million can consist of aggregate unpledged, unreserved and unrestricted cash and cash equivalent investments.

Based in Newport Beach, Calif., William Lyon is primarily engaged in the design, construction and sale of single-family homes.

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