NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of M/I Homes, Inc. (NYSE: MHO), including the company's 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 ratings for MHO reflect the company's execution of its business model in the current housing environment, management's demonstrated ability to manage land and development spending, healthy liquidity position and improving credit metrics. The Stable Outlook takes into account the favorable prospects for the housing sector in 2016 and 2017. Fitch believes that the housing recovery is firmly in place (although the rate of recovery remains well below historical levels and will likely continue to occur in fits and starts).
IMPROVING CREDIT METRICS
MHO's credit metrics have improved significantly over the past four years. Leverage as measured by debt-to-EBITDA declined from 12.1x at the end of 2011 to 4.2x at year-end 2014 and 4.1x at the conclusion of 2015. Similarly, interest coverage increased from 0.8x in 2011 to 3.5x in 2014 and 3.3x in 2015. Fitch expects further improvement in these credit metrics during 2016, with debt-to-EBITDA projected to be below 4x and interest coverage above 3x.
Housing activity ratcheted up more sharply in 2015 than in 2014 with the support of a generally robust economy throughout the year. Considerably lower oil prices restrained inflation and left American consumers with more money to spend. The unemployment rate moved lower (5.0% in 2015). Credit standards eased steadily moderately throughout 2015. Demographics were somewhat more of a positive catalyst. Single-family starts rose 10.3% to 715,000 as multifamily volume grew about 11.5% to 396,000. Total starts were just in excess of 1.1 million. New home sales increased 14.6% to 501,000. Existing home volume was approximately 5.260 million, up 6.5%.
New home price inflation slimmed with higher interest rates, and the mix of sales shifting more to first-time homebuyer product. Average home prices increased 2.8%, while median prices rose 3.8%.
Sparked by a similarly growing economy, the housing recovery is expected to continue in 2016. Although interest rates are likely to be higher, a robust economy, healthy job creation, demographics, pent-up demand, steep rent increases, and further moderation in lending standards should stimulate housing activity. 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. First-time buyers should be able to take advantage of less expensive mortgage insurance and lenders offering low down-payment programs. Housing starts should be approximately 1.22 million with single-family volume of 0.80 million and multifamily starts of 0.42 million. New home sales should reach 574,000, up 14.6%. Existing home volume growth should again see mid-single-digit growth (+4.0%). Average and median home prices should rise 2.0%-2.5%.
SOME EROSION IN HOUSING AFFORDABILITY
The most recent Freddie Mac 30-year average mortgage rate (March 24, 2016) was 3.71%, down 2 bps sequentially from the previous week and 2 bps higher than the same period a year ago. Current rates are still below historical averages and help moderate the effect of much higher home prices during the past few years. Income growth has been (and may continue to be) relatively modest. Nevertheless, there has been some lessening of affordability as the upcycle in housing has matured. The Realtor Association's composite affordability index peaked at 207.3 in the first quarter of 2012 (1Q12), averaged 176.9 in 2013, 165.8 in 2014, 163.9 in 2015, and 171 in January 2016.
Erosion in affordability is likely to continue, as interest rates are likely headed higher in 2016 (as the economic recovery continues). Fitch projects that mortgage rates will average 30-40 bps higher in 2016. Home price inflation should moderate this year, reflecting the higher interest rates and the mix of sales shifting more to first-time homebuyer product. However, average and median home prices should still rise within a range of 2.0%-2.5% this year, pressuring affordability.
HEALTHY LIQUIDITY POSITION
The company ended 2015 with $10.2 million of unrestricted cash and $316.4 million of borrowing availability under its $400 million revolving credit facility that matures in October 2018. During 3Q15, MHO exercised the accordion feature under the facility, increasing the commitment from $300 million to $400 million. The company's debt maturities are well-laddered, with no major debt maturities until September 2017, when $57.5 million of convertible senior subordinated notes becomes due.
Following the significant reduction of its land supply during 2006-2009, MHO began to focus on growing its business in late 2009 by investing in new communities and entering new markets. In March 2010, the company entered the Houston, TX market. MHO expanded into the San Antonio, TX market through the acquisition of a small homebuilder in 2011. The company expanded its geographic footprint by expanding further into Texas, entering the Austin market in 2012 and the Dallas/Fort Worth market in 2013. MHO entered the Minneapolis/St. Paul, MN market in 2015 with the acquisition of Hans Hagen Homes, Inc. The company has a strong presence in most of its markets. Total lots controlled increased 37.2% in 2012, 39.6% in 2013, 4.5% in 2014 and 8.2% in 2015.
MHO maintains an approximately 5.8-year supply of total lots controlled, based on trailing 12-month deliveries, and 2.9 years of owned land. As of Dec. 31, 2015, the company controlled 22,422 lots, of which 50.8% were owned and the rest controlled through options.
Historically, MHO developed about 80% of its communities from which it sells product, resulting in inventory turns that were moderately below average as compared to its public peers. During the recent downturn, MHO had been less focused on land development, as most land purchases were developed lots. In 2011, only 5% of land purchases were raw lots. During the past four years, MHO has been purchasing more raw land due to the decline in the availability of developed lots. Management estimates that raw land purchases accounted for about 60% of total land purchases during 2012 and 50% of total land purchases during 2013-2015. The percentage of lots internally developed by MHO decreased to 76% during 2015 from 79% in 2014 and 81% in 2013.
LAND AND DEVELOPMENT SPENDING AND CASH FLOW
The company spent roughly $438 million on land and development during 2015 ($233 million for land and $205 million for development) compared with $382 million in 2014 ($237.7 million for land and $144.3 million for development), $323.6 million spent during 2013 ($216.8 million for land and $106.8 million for development) and $195.1 million in total expenditures during 2012. The company expects total land and development spending will be between $425 million and $475 million during 2016.
MHO has reported negative cash flow from operations (CFFO) for the past six years, including during 2015, as the company adds to its land position. In 2015, MHO reported negative CFFO of $82.2 million. This compares to negative CFFO of $132.7 million in 2014, $74 million in 2013, $47 million in 2012, $34 million in 2011 and $37.3 million in 2010. Fitch expects MHO will be slightly cash flow negative-to-neutral during 2016 as the company expands inventory only slightly and the company reports modestly higher profits.
Fitch is comfortable with this strategy given the company's healthy liquidity position and management's demonstrated ability to manage its spending.
MHO ended 2015 with 872 speculative homes, of which 483 were completed. Total specs at the end of 2015 were 11% lower from year-end 2014. This translates into about 5 specs per community, a slight decrease from the 6.5 specs per community in 2014 and equal to 5 specs per community in 2013. The company has spec homes in order to facilitate delivery of homes on an immediate-need basis. Of the total number of homes closed in 2015 and 2014, 52% and 55%, respectively, were spec homes, which included both homes started as spec and homes that were started under a contract that were later cancelled and became spec inventory. In general, spec homes carry a lower margin compared with pre-sold homes, as was particularly the case during the sharp housing downturn. However, the margin differential during the past three years has narrowed and at times been comparable with pre-sold homes.
Fitch's key assumptions within its rating case for the issuer include:
--Industry single-family housing starts improve 11.5%, while new and existing home sales grow 14.6% and 4.0%, respectively, in 2016;
--MHO's revenues grow by low double-digits and the operating profit margin remains relatively stable in 2016;
--MHO's debt-to-EBITDA will be below 4.0x and interest coverage exceeds 3.0x during 2016;
--The company spends between $425 million and $475 million on land acquisitions and development activities during 2016;
--The company maintains a healthy liquidity position (above $150 million with a combination of unrestricted cash and revolver availability).
Future ratings and Outlooks will be influenced by broad housing-market trends as well as company-specific activities, 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 (cash and revolver availability to adequately cover debt maturities over the next two years and any cash flow shortfall in the next 12 months).
A negative rating action could be triggered if the industry recovery dissipates and MHO maintains an overly aggressive land strategy, EBITDA margins decline 200 bps-300 bps, and leverage exceeds 6x. If MHO's liquidity position (cash plus revolver availability) falls sharply and cannot cover maturities over the next two years and any cash flow shortfall in the next 12 months, this would also pressure the rating.
FULL LIST OF RATING ACTIONS
Fitch has affirmed M/I Homes Inc.'s ratings as follows:
--Long-term IDR at 'B+';
--Senior unsecured notes at 'BB-/RR3';
--Unsecured revolver at 'BB-/RR3';
--Convertible senior subordinated notes at 'B-/RR6';
--Series A non-cumulative perpetual preferred stock at '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.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)
Dodd-Frank Rating Information Disclosure Form