Fitch Rates M/I Homes' Proposed $300MM Sr. Unsecured Notes Offering 'BB-/RR3'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'BB-/RR3' rating to M/I Homes Inc.'s (NYSE: MHO) proposed offering of $300 million aggregate amount of senior unsecured notes maturing in 2020. The new issue will be equal in right of payment with all other senior unsecured debt.

The company intends to use a portion of the net proceeds to repurchase or redeem all of its existing $230 million of 8.625% senior unsecured notes due 2018 and to pay related fees and expenses. MHO intends to use the remaining proceeds of the offering to reduce outstanding borrowings under the credit facility.

The Rating Outlook is Stable. A complete list of ratings follows at the end of this release.

KEY RATING DRIVERS

MHO's ratings and Outlook reflect the company's execution of its business model in the current housing environment, management's demonstrated ability to manage land and development spending, adequate liquidity position, improving credit metrics, and Fitch's expectation of further improvement in the housing market in 2015 and 2016.

IMPROVING CREDIT METRICS

MHO's credit metrics have improved over the past few years as the housing market continues to recover. Leverage as measured by debt-to-EBITDA declined from 6.6x at the end of 2012 to 4.9x at the end of 2013 and 4.2x at year-end 2014. Leverage was 4.8x for the latest 12 months (LTM) ending Sept. 30, 2015. Fitch expects this ratio will be approximately 4.0x at year-end 2015. Similarly, interest coverage increased from 1.7x at the close of 2012 to 2.6x at the end of 2013, 3.1x at year-end 2014 and 3.3x for the LTM Sept. 30, 2015. Fitch expects interest coverage will remain at or above 3x.

THE INDUSTRY

Housing metrics increased in 2014 due to more robust economic growth during the last three quarters of the year (prompted by improved household net worth, industrial production and consumer spending), and consequently, acceleration in job growth (as unemployment rates decreased to 6.2% for 2014 from an average of 7.4% in 2013), despite modestly higher interest rates, as well as more measured home price inflation. A combination of tax increases and spending cuts in 2013 shaved about 1.5 percentage points off annual economic growth, according to the Congressional Budget Office. Many forecasters estimate the fiscal drag in 2014 was only about 0.25%.

Single-family starts in 2014 improved 4.8% to 648,000 as multifamily volume grew 15.6% to 355,000. Thus, total starts in 2014 were 1.003 million. 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 rose 6.4% in 2014, while median home prices advanced approximately 5.4%.

Housing activity has ratcheted up more sharply in 2015 with the support of a steadily growing, relatively robust economy throughout the year. Considerably lower oil prices should restrain inflation and leave American consumers with more money to spend. The unemployment rate should continue to move lower (5.0% in 2015). Credit standards should steadily, moderately ease throughout 2015, while 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 now forecast to rise about 11.4% to 722,000 as multifamily volume expands about 11% to 394,000. Total starts would be just in excess of 1.1 million. New home sales are projected to increase 20% to 523,000, while existing home volume is expected to approximate 5.280 million, up 6.9%.

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 3.0%-3.5%.

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 approximate 1.24 million with single-family volume of 0.82 million and multifamily starts of 0.42 million. New home sales should reach 617,000, up 18.0%. Existing home volume growth should again be in the mid-single digits (+4.0%).

Average and median home prices should rise 2.0%-2.5%.

As Fitch noted in the past, the housing recovery will likely continue in fits and starts.

2015 Financial Results

Homebuilding revenues increased 11.9% for the first nine months of 2015 as home deliveries grew 0.5% and the average sales price advanced 9.6% compared with the same period last year. Homebuilding gross margins also improved during the 2015 YTD period, growing 40 basis points (bps) to 19.4% compared with 19.0% during the first nine months of 2014. Corporate pre-tax income expanded 28.2% to $64.1 million during the first nine months of 2015 (3Q15).

New home orders are up 10.6% so far this year and MHO ended the third quarter with 1,788 homes in backlog (up 15.1% year-over-year [YOY]) with a value of $656.9 million (up 26.8% YOY).

ADEQUATE LIQUIDITY POSITION

As of Sept. 30, 2015, the company had $25.1 million of unrestricted cash and $209.4 million of borrowing availability under its $400 million revolving credit facility. During 3Q15, MHO exercised the accordion feature under the revolver, increasing the credit facility from $300 million to $400 million. The company has no major debt maturities until 2017, when $57.5 million of convertible senior subordinated notes mature.

LAND STRATEGY

After significantly reducing its lot inventory in 2006 to 2009, MHO began to focus on growing its business in late 2009 by investing in new communities and entering new markets. In 2010, the company increased its total lot position by 9.2% and expanded into the Houston, TX market. During 2011, the company entered the San Antonio, TX market and grew its total lot position by 1.8%. MHO extended its geographic footprint by expanding further into TX, entering the Austin market in 2012 and the Dallas/Fort Worth market in 2013. On Oct. 28, 2015, MHO entered into a purchase agreement to acquire the residential homebuilding operations of Hans Hagen Homes, Inc., a privately held homebuilder, for an undisclosed purchase price to be paid in cash. The acquisition marks MHO's entry into the Minneapolis/St. Paul market, which will represent the company's 14th housing division. Total lots controlled increased 37.2% in 2012, 39.6% in 2013 and 4.5% in 2014. Total lots controlled as of Sept. 30, 2015 are 2.3% higher YOY.

MHO maintains an approximately 5.8-year supply of total lots controlled, based on trailing 12 months deliveries, and three years of owned land. Total lots controlled were 21,562 at Sept. 30, 2015. About 51.3% of the lots are owned and the balance is controlled through options.

LAND SPENDING AND CASH FLOW

MHO spent roughly $382 million on land and development during 2014 ($237.7 million for land and $144.3 million for development) compared with $323.6 million during 2013 ($216.8 million for land and $106.8 million for development) and $195.1 million in total spending during 2012. The company expects total land and development spending will be between $425 million and $450 million during 2015.

MHO has reported negative cash flow from operations (CFFO) for the past five years as the company rebuilds its land position. In 2014, MHO reported negative CFFO of $132.7 million; this compares to negative CFFO of $74 million in 2013, $47 million in 2012, $34 million in 2011 and $37.3 million in 2010. For the LTM Sept. 30, 2015, the company had negative CFFO of $121.2 million. Fitch expects MHO will be cash flow negative by about $25 million-$75 million during 2015.

Fitch is comfortable with the company's spending and cash flow strategy given its healthy liquidity position and management's demonstrated ability to manage spending.

KEY ASSUMPTIONS

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

--Total industry housing starts improve 11.3%, while new and existing home sales grow 20% and 4.3%, respectively, in 2015. Housing metrics continue to improve in 2016;

--MHO's revenues grow low double-digits and the operating profit margin remains stable in 2015;

--MHO's debt/EBITDA approximates 4.0x and interest coverage exceeds 3.0x during 2015;

--The company spends between $425 million and $450 million on land acquisitions and development activities during 2015;

--The company maintains a healthy liquidity position (above $150 million with a combination of unrestricted cash and revolver availability).

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 in particular, free cash flow trends and uses and the company's cash position.

Positive rating actions may be considered if the recovery in housing is maintained, MHO's credit metrics improve further (particularly debt-to-EBITDA sustaining at 3.5x and interest coverage exceeding 4x), and the company preserves a healthy liquidity position (above $150 million with a combination of unrestricted cash and revolver availability).

A negative rating action could be triggered if the industry recovery dissipates and MHO maintains an overly aggressive land strategy; EBITDA margins decline 200bps-300bps; leverage exceeds 6x, and MHO's liquidity position falls sharply, perhaps below $100 million.

FULL LIST OF RATING ACTIONS

Fitch currently rates MHO as follows:

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

--Senior unsecured notes 'BB-/RR3';

--Convertible senior subordinated notes 'B-/RR6';

--Series A non-cumulative perpetual preferred stock 'CCC+/RR6'.

The Rating Outlook is Stable.

The Recovery Rating (RR) of 'RR3' on MHO's senior unsecured notes indicates good recovery prospects for holders of this debt issue. MHO'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 debt holders. The 'RR6' on MHO's convertible senior subordinated notes and preferred stock indicates poor recovery prospects in a default scenario. Fitch applied a liquidation valuation analysis for these RRs.

Date of relevant committee: March 3, 2015.

Additional information is available on www.fitchratings.com.

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

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995161

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

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Contacts

Fitch Ratings
Primary Analyst
Monica Delarosa
Associate Director
+1-212-908-0525
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Robert Rulla, CPA
Director
+1-312-606-2311
or
Committee Chairperson
Robert Curran
Managing Director
+1-212-908-0515
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Monica Delarosa
Associate Director
+1-212-908-0525
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Robert Rulla, CPA
Director
+1-312-606-2311
or
Committee Chairperson
Robert Curran
Managing Director
+1-212-908-0515
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com