Home builders are buying up more land in anticipation of a stronger housing market, leading them to take on more debt.
While the biggest builders are obtaining most of their financing from the public debt and equity markets, where enthusiasm about a housing market recovery is running high, they are also re-establishing revolving lines of credit with banks, in many cases for the first time in several years.
On Sept. 7, D.R. Horton said it had entered into a five-year, $125 million senior unsecured revolving credit facility with Royal Bank of Scotland. Initially, RBS is providing the entire commitment, but the facility has an uncommitted $375 million accordion feature that could increase it to $500 million, subject to the availability of additional bank commitments, among other conditions. The bank had terminated its previous facility in 2009.
D.R. Horton is rated BB- by Standard & Poor's, Ba2 by Moody's Investors Service and BB by Fitch Ratings.
"We are excited about the profitable growth opportunities we are seeing across our home building markets, and we believe this is an opportune time to add a revolving credit facility to our capital structure," Donald R. Horton, the company's chairman, said in a press release.
In July, Beazer Homes negotiated a commitment letter with four financial institutions for a $150 million secured revolving credit agreement, replacing a much smaller, $22 million facility. Beazer is rated B- by S&P, Caa2 by Moody's and B- by Fitch.
And Lennar entered a new, unsecured revolving credit facility, effective May 2, 2012. The $410 million facility, which matures May 2, 2015, has an accordion feature under which it can increase to a maximum of $525 million, subject to certain conditions and the availability of additional bank commitments. Lennar is rated B+ by S&P, B1 by Moody's and BB+ by Fitch.
Builders are going to need the financial flexibility, especially if they accelerate their spending on land and development. Fitch anticipates that such spending will rise moderately to sharply this year versus 2011, meaning most builders will burn more cash than they generate from home sales. As a result the ratings agency expects at least a few more public builders will re-establish revolvers.
A majority of the public builders that Fitch tracks negotiated amendments to revolving credit agreements late in 2007, 2008, and 2009, and many builders then terminated their facilities during the past two and a half years.
At the time, many builders didn't need revolvers because they were generating more cash than they were spending on new land and didn't want to pay the fees for facilities they weren't using. For example, D.R. Horton has used internally generated funds to repay more than $4 billion in debt since the downturn, according to Moody's. However, the ratings agency expects the home builder's cash flow to be negative this year as it replenishes and adds to its land position.
Another possible motivation for terminating revolvers, according to Robert Rulla, a director at Fitch, is that home builders wanted to avoid covenant restrictions associated with revolvers. Many ran afoul of these covenants during the downturn when they took writedowns on options to buy land.
In some cases, builders substituted much smaller lines that were solely in place to back letters of credit, which builders need in any kind of operating environment to issue performance bonds or satisfy option deposits. (Performance bonds are guarantees provided to a community that funds will be available for the roads, utilities and other infrastructure needed to support new homes.) Such letters of credit lines were generally collateralized with cash, while many large public builders are obtaining revolvers that are unsecured.
The biggest builders also have access to public debt and equity markets, where enthusiasm for a housing recovery is running high. On Sept. 11, D.R. Horton priced $350 million of 4.375% senior unsecured notes due in 2022, its second offering this year. On Sept. 5, Toll Brothers priced a private offering of $250 million aggregate principal amount of 0.50% exchangeable senior notes due 2032. Toll Brothers is rated BB+ by S&P, Ba1 by Moody's and BBB- by Fitch.
And in July, Beazer completed public offerings of its common stock, tangible equity units and a private placement of $300 million of 6.625% senior secured notes, netting $466 million, according to Fitch. (It also called for redemption of all of its $250 million 12% senior secured notes due 2017 and repaid $20 million under its outstanding cash-secured term loan.)
Both stock and bond markets have responded positively to upbeat readings on real estate. On Aug. 23 the Federal Housing Finance Agency reported the biggest quarterly jump in housing prices in more than six years, going back to the fourth quarter of 2005. It said U.S. house prices rose by 1.8% on a seasonally adjusted basis in the second quarter of 2012 compared with the first quarter and by 3.0% compared with the same quarter last year.
Confirming the trend, on Aug. 28 the S&P/Case-Shiller Home Price Index showed that the national composite was up 1.2% in the second quarter of 2012 over a year earlier and up 6.9% over the previous quarter. In a separate report on Aug. 23, the Department of Commerce said seasonally adjusted single-family new home sales for July were 372,000, a 3.6% increase over June and a 25.3% increase over July 2011.
Home builders are reaping the benefit; in a report published last week, Moody's said three market-implied ratings it tracks have progressed significantly for the average home builder compared with the same time last year. Compared with the B1 level of a year ago, the average CDS-implied rating for a peer group of U.S. home builders is now two notches higher at Ba2.
The five-year median CDS spread for this peer group plunged from around 598 bps in September 2011 to 339 bps at present, or 43%, and the CDS-spread for every company in the peer group fell. By contrast the average CDS-spreads for U.S. financials, U.S. industrials, and the median B1-rated companies remained mostly flat.
Standard Pacific performed the best in the CDS market last year, its CDS-implied rating improving by four notches, from B3 to Ba2. The other nine companies' CDS-implied ratings rose between one and three notches.
Smaller, typically private home builders don't have it so good. Fitch expects they will be restrained in their construction activity by their banks' subdued lending, as was the case in 2009 and 2010. "Much of what a private builder tends to build is what we call speculative homes, construction begun before an order is taken," said Bob Curran, a managing director at Fitch. "By its nature, it's somewhat risky.”