NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Lennar Corporation's (NYSE: LEN) Issuer Default Rating (IDR) and senior unsecured debt rating at 'BB+'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The ratings and Outlook for Lennar reflect the company's strong liquidity position and continuing recovery of the housing sector this year and in 2015. The ratings also reflect Lennar's successful execution of its business model over many cycles, geographic and product line diversity, and much lessened joint venture exposure than was the case just a few years ago.
The company did a good job in reducing its inventory exposure (especially early in the correction) and generating positive operating cash flow during the recent, severe industry downturn. Additionally, Lennar steadily, substantially reduced its number of JVs over the last few years and, as a consequence, has very sharply lowered its JV recourse debt exposure (from $1.76 billion to $29.3 million as of May 31, 2014).
In contrast to almost all the other public homebuilders Lennar was profitable in fiscal 2010 and 2011 and the company was solidly profitable in fiscal 2012 and 2013. The company's gross margins are consistently above its peers, and contributions from its Rialto Investment segment have added to corporate profits in 2010, 2011, 2012 and 2013.
There are still some challenges facing the housing market that are likely to moderate the early-to-intermediate stages of this recovery. Nevertheless, Lennar has the financial flexibility to navigate through the sometimes challenging market conditions and continue to broaden its franchise and invest in land and other opportunities.
Housing metrics should increase in 2014 due to faster economic growth (prompted by improved household net worth, industrial production and consumer spending), and consequently some acceleration in job growth (as unemployment rates decrease to 6.4% for 2014 from an average of 7.4% in 2013), despite somewhat higher interest rates, as well as more measured home price inflation. A combination of tax increases and spending cuts in 2013 shaved about 1.5pp off annual economic growth, according to the Congressional Budget Office. Many forecasters expect the fiscal drag in 2014 to be only 0.25%. Single-family starts in 2014 are projected to improve 9.5% to 677,000 as multifamily volume grows about 11.7% to 343,000. Thus, total starts this year should top 1 million. New home sales are forecast to advance about 8% to 465,000, while existing home volume is likely to decline to 4.835 million due to fewer distressed homes for sale and limited inventory.
New home price inflation should moderate in 2014, at least partially because of higher interest rates. Average and median new home prices should rise about 3.5% in 2014.
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 (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 25-35-year-olds should provide some incremental elevation to the rental and starter home markets. Single-family starts are forecast to rise 21% to 819,000 as multifamily volume expands about 6.5% to 366,000. Total starts would be approaching 1.2 million. New home sales are projected to increase 20.4% to 560,000. Existing home volume is expected to approximate 5.075 million, up 5%.
New home price inflation should further taper off with higher interest rates and the mix of sales shifting more to first time homebuyer product. Average and median home prices should increase 2.5-3%.
Challenges remain, including the potential for higher interest rates, and restrictive credit qualification standards.
IMPROVING FINANCIAL RESULTS AND CREDIT METRICS
Lennar's corporate revenues expanded 31.6% to $3,181.84 million during the first six months of 2014. Homebuilding revenues increased 34% to $2,866.17 million as home deliveries grew 12.5% to 8,573 and the average selling price increased 15.6% to $320,261. Deliveries improved in each region with the exception of Southeast Florida (-6.4%). The strongest comparisons were reported for the East and West regions, both up 18.6%. The housing gross profit margin also reflected healthy improvement, growing 202 bps during the first half 2014 - well above peer averages. SG&A expense as a percentage of total homebuilding revenues declined from 11.17% to 10.75% for the first six months of 2014. The company reported homebuilding income, before real estate charges, of $399.08 million for the first half 2014, up 69.4%
Financial services revenues decreased 12.6% to $187.97 million in the absence of refinance activity, while segment profits dropped almost 50% to $22.76 million as a result of competitive pressures. Rialto Investments revenues expanded 97.5% to $101.35 million and consisted primarily of securitization revenue and interest income from Rialto Mortgage Finance (RMF), interest income associated with the Rialto's segment's portfolio of real estate loans and fees for managing and servicing assets. Rialto had a slight operating loss ($173,000) for the first half of 2014 (including $16.1 million of net loss attributable to non-controlling interest) as compared to a year earlier profit of $9.88 million (including $5.4 million of net earnings attributable to non-controlling interest). Lennar Multifamily reported revenues of $26.35 million in 2014, up 109.9%. The segment operating loss widened from $4.89 million to $13.38 million.
The corporate pretax income (before real estate charges) advanced 50.3% to $331.86 million. With a much higher (normalized) tax rate in 2014, net earnings attributable to Lennar rose 10.7% to $215.84 million for the six months ended May 31, 2014. Debt-to-LTM EBITDA was 4.6x at the end of the second quarter 2014, while interest coverage was 3.7x. Fitch expects further improvement in credit metrics, with leverage approaching 4.0x and interest coverage nearing 4.0x by the end of 2014.
Net unit orders and the value of orders expanded 9.1% and 23.1% respectively, for the first six months of 2014. As of May 31, 2014, unit backlog increased 11.3% to 6,858 and the backlog average sales price improved 13.4% to $342,694. The value of backlog gained 26.1% to $2,350.2 million.
The company ended the second quarter of 2014 with $627.62 million in unrestricted cash and equivalents and $39.9 million in restricted cash.
At May 31, 2014, Lennar had a $950 million unsecured revolving credit facility with certain financial institutions that matures in June 2017, $200 million of letter of credit facilities with a financial institution and a $140 million letter of credit facility with a different financial institution. The proceeds available under the credit facility, which are subject to specified conditions for borrowing, may be used for working capital and general corporate purposes. The credit facility agreement also provides that up to $500 million in commitments may be used for letters of credit. As of May 31, 2014, there were no outstanding borrowings under the credit facility.
In June 2014, Lennar amended its credit facility increasing the aggregated principal amount from $950 million to $1.5 billion, which includes a $263 million accordion feature, subject to additional commitments. The credit facility's maturity date was extended to June 2018.
The company's debt maturities are well-laddered, with about 21% of its senior notes (as of May 31, 2014) maturing through 2016.
Lennar's performance letters of credit outstanding were $225.4 million as of May 31, 2014. The company's financial letters of credit outstanding were $212.6 million at the end of the second quarter. Performance letters of credit are generally posted with regulatory bodies to guarantee its performance of certain development and construction activities. Financial letters of credit are generally posted in lieu of cash deposits on option contracts, for insurance risks, credit enhancements and as other collateral.
The company was the second largest homebuilder in 2013 and primarily focuses on entry-level and first-time move-up homebuyers. In 2013 and so far in 2014 approximately one third of sales were to the first time buyer, half to first time move up customers and the balance is a mix of second time move up, luxury and active adult. The company builds in 17 states with particular focus on markets in Florida, Texas and California. Lennar's significant ranking (within the top five or top 10) in many of its markets, its largely presale operating strategy, and a return on capital focus provide the framework to soften the impact on margins from declining market conditions. Fitch notes that in the past, acquisitions (in particular, strategic acquisitions) have played a significant role in Lennar's operating strategy.
Compared to its peers, Lennar has had above-average exposure to joint ventures (JVs) during this past housing cycle. Longer-dated land positions are controlled off balance sheet. The company's equity interests in its partnerships generally ranged from 10% to 50%. These JVs have a substantial business purpose and are governed by Lennar's conservative operating principles. They allow Lennar to strategically acquire land while mitigating land risks and reduce the supply of land owned by the company. They help Lennar to match financing to asset life. JVs facilitate just-in-time inventory management.
Nonetheless, Lennar has substantially reduced its number of JVs over the last eight years (from 270 at the peak in 2006 to 35 as of May 31, 2014). As a consequence, the company has very sharply lowered its JV recourse debt exposure from $1.76 billion to $29.3 million ($25.1 million net of joint and several reimbursement agreements with its partners) as of May 31, 2014. In the future, management will still be involved with partnerships and JVs, but there will be fewer of them and they will be larger, on average, than in the past.
The company did a good job in reducing its inventory exposure (especially early in the correction) and generating positive operating cash flow. In 2010, the company started to rebuild its lot position and increased land and development spending. Lennar spent about $600 million on new land purchases during 2011 and expended about $225 million on land development during the year. This compares to roughly $475 million of combined land and development spending during 2009 and about $704 million in 2010. During 2012, Lennar purchased approximately $1 billion of new land and spent roughly $302 million on development expenditures. Land spend totaled almost $1.9 billion in 2013, and development expenditures reached about $600 million, double the level of 2012. Total real estate spending in 2014 could be flat to up moderately (perhaps $200 million) as Lennar incrementally focuses more on development activities than on land spend.
The company was considerably more cash flow negative in 2013 ($807.71 million) than in 2012 ($424.65 million). Lennar is likely to be much less cash flow negative in 2014, maybe half as much as in 2013.
Fitch is comfortable with this real estate strategy given the company's cash position, debt maturity schedule, proven access to the capital markets and willingness to quickly put the brake on spending as conditions warrant.
Lennar's financial services segment provides mortgage financing, title insurance and closing services for both buyers of its homes and others. Substantially all of the loans that the segment originates are sold within a short period in the secondary mortgage market on a servicing released, non-recourse basis. After the loans are sold, Lennar retains potential liability for possible claims by purchasers that the company breached certain limited industry standard representations and warranties in the loan sale agreements. The company participates in mortgage refinance activity, which periodically is consequential business.
During the first half of 2014, Lennar's financial services subsidiary provided loans to approximately 76% of its homebuyers who obtained mortgage financing in areas where Lennar offered services. During that same period, the company originated approximately 9,100 mortgage loans totaling $2.29 billion.
Lennar's Rialto segment was formed to focus on acquisitions of distressed debt and other real estate assets utilizing Rialto's abilities to source, underwrite, price, turnaround and ultimately monetize such assets in markets across the United States. Lennar had a similar operation in the 1980s, LNR Property Corporation, which was the vehicle used by the company to invest in and work out large portfolios of distressed real estate assets purchased from the government's Resolution Trust Corporation (RTC). This operation was subsequently spun-off as a separate publicly traded company and was later acquired by Cerberus Capital Management.
Lennar's Rialto reportable segment is a commercial real estate investment, investment management, and finance company focused on raising, investing and managing third party capital, originating and securitizing commercial mortgage loans, as well as investing its own capital in real estate related mortgage loans, properties and related securities. Rialto utilizes its vertically-integrated investment and operating platform to underwrite, diligence, acquire, manage, workout and add value to diverse portfolios of real estate loans, properties and securities, as well as providing strategic real estate capital. Rialto's primary focus is to manage third party capital and to originate and sell into securitizations commercial mortgage loans. Rialto has commenced the workout and/or oversight of billions of dollars of real estate assets across the United States, including commercial and residential real estate loans and properties, as well as mortgage backed securities. To date, many of the investment and management opportunities have arisen from the dislocation in the United States real estate markets and the restructuring and recapitalization of those markets. In July 2013, RMF was formed to originate and sell into securitization five, seven and 10-year commercial first mortgage loans, generally with principal amounts between $2 million and $75 million, which are secured by income producing properties. This business is expected to be a significant contributor to our Rialto revenues, at least in the near future.
Rialto is the sponsor of and an investor in private equity vehicles that invest in and manage real estate related assets. This includes:
--Rialto Real Estate Fund, LP that was formed in 2010 to which investors have committed and contributed a total of $700 million of equity (including $75 million by Lennar);
--Rialto Real Estate Fund II, LP that was formed in 2013 with the objective to invest in distressed real estate assets and other related investments and that as of May 31, 2014 had equity commitments of $1.3 billion (including $100 million by Lennar) and was closed to additional commitments and
--Rialto Mezzanine Partners Fund that was formed in 2013 with a target of raising $300 million in capital (including $27 million committed and invested by Lennar) to invest in performing mezzanine commercial loans that have expected durations of one to two years and are secured by equity interests in the borrowing entity owning the real estate assets.
Rialto also earns fees for its role as a manager of these vehicles and for providing asset management and other services to those vehicles and other third parties.
Since 2012, Lennar has become actively involved, primarily through unconsolidated entities, in the development of multifamily rental properties. This business segment focuses on developing a geographically diversified portfolio of institutional quality multifamily rental properties in select U.S. markets.
As of May 31, 2014 Lennar's balance sheet had $166.6 million of assets related to the Lennar Multifamily segment, which includes investments in unconsolidated entities of $77.5 million. Lennar's net investment in the Lennar Multifamily segment as of May 31, 2014 was $136.2 million. The Lennar Multifamily segment had 18 unconsolidated entities, as of May 31, 2014. As of May 31, 2014, the Lennar Multifamily segment had interests in 18 communities with development costs of approximately $1 billion, of which two communities were completed and operating, two communities were partially completed and leasing, 13 communities were under construction and one community was under development. The Lennar Multifamily segment also had a pipeline of future projects totaling $3.3 billion in assets across a number of states that will be developed primarily by unconsolidated entities.
FivePoint manages large, complex master planned communities in the Western U.S., typically in a joint venture structure. These include the former military installation El Toro, the former Newhall Land and Farming Company (just north of Los Angeles) and San Francisco's Hunters Point. These entities will not be generating meaningful home deliveries for another few years. At Great Park (El Toro), the first phase of 726 homes is over 75% sold out and the second phase of 1,000 home sites will begin to be sold to builders late this year or early next year. The grand opening will be late spring 2015. Lennar won two lawsuits which would have impeded the development at Newhall Land and also won an appeal of a lawsuit that challenged its environmental permit in the second quarter 2014. Lennar expects opponents' appeals to be concluded in late 2014 and then development should begin on the first 5,000 home sites. Lennar is pre-selling homes at the Shipyard, Candle Stick Park/Hunters Point, in San Francisco. The grand opening will take place in August. About 250 homes are under construction and another 100 are scheduled to break ground in 2014. Some homes will be delivered by the end of this year. Lastly, at Treasure Island, Lennar is designing homes and doing land development engineering with an expectation to break ground in early 2016.
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, free cash flow trends and uses, and the company's cash position.
Fitch would consider taking further positive rating actions if the recovery in housing accelerates and Lennar shows steady improvement in credit metrics (such as debt to EBITDA leverage consistently less than 3x), while maintaining a healthy liquidity position (in excess of $1 billion in a combination of cash and revolver availability).
Conversely, negative rating actions could occur if the recovery in housing dissipates and Lennar maintains an overly aggressive land and development spending program. This could lead to sharp declines in profitability, consistent and significant negative quarterly cash flow from operations, higher leverage and meaningfully diminished liquidity position (below $500 million).
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Liquidity Considerations for Corporate Issuers' (June 12, 2007.
Applicable Criteria and Related Research:
Liquidity Considerations for Corporate Issuers
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage