Fitch Rates Lennar's Proposed Senior Notes Offering 'BB '
The Rating Outlook is Stable. A full list of ratings is provided at the end of this release.
KEY RATING DRIVERS
The ratings and Outlook for Lennar reflect the company's strong liquidity position and continuing recovery of the housing sector in 2015 and 2016. 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 in generating positive operating cash flow during the past severe industry downturn. In addition, Lennar steadily, substantially reduced its number of joint ventures (JVs) over the last few years and, as a consequence, has very sharply lowered its JV recourse debt exposure (from \$1.76 billion to \$24.5 million as of Nov. 30, 2014).
In contrast to almost all the other public homebuilders Lennar was profitable in fiscal 2010 and 2011 and was solidly profitable in fiscal 2012, 2013 and 2014. The company's gross margins are typically above its peers, and contributions from its Rialto Investment segment have added to corporate profits from 2010 through 2014.
There are still some challenges facing the housing market that are likely to moderate the intermediate stages of this recovery. Nevertheless, Fitch believes 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.
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 (pp) 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 647,900 and multifamily volume grew 15.6% to 355,400. Thus, total starts in 2014 were 1.003 million. New-home sales were up 1.9% to 437,000, 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 5.7% in 2014, while median home prices advanced approximately 5.5%.
Housing activity is likely to ratchet 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 (averaging 5.3% in 2015). Credit standards should steadily, moderately ease throughout 2015. 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 17.3% to 760,000 as multifamily volume expands 7.3% to 381,000. Total starts would be in excess of 1.1 million. New-home sales are projected to increase about 18% to 515,000. Existing home volume is expected to approximate 5.152 million, up 4.3%.
New-home price inflation should further taper off with higher interest rates and the mix of sales shifting more to first-time homebuyer product.
Challenges remain, including the potential for higher interest rates, and restrictive credit qualification standards.
LIQUIDITY/DEBT
The company's homebuilding operations ended the first quarter of 2015 with \$583.75 million in unrestricted cash and equivalents. Debt totaled \$5.13 billion as of Feb. 28, 2015, up from \$4.69 billion at fiscal year-end 2014.
At Nov. 30, 2014, Lennar had a \$1.5 billion unsecured revolving credit facility (RCF) with certain financial institutions which includes a \$248 million accordion feature that matures in June 2018, \$125 million of letter of credit (LOC) facilities with a financial institution and a \$140 million LOC 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 LOCs. As of Nov. 30, 2014, there were no borrowings under the credit facility.
On April 17, 2015, Lennar amended the RCF, to, among other things, increase the maximum borrowing from \$1.5 billion to \$1.6 billion, which includes a \$263 million accordion feature. The amendment also extended the maturity of \$1.18 billion of the credit facility from June 2018 to June 2019.
Lennar's debt maturities are well-laddered, with about 33.6% of its senior notes (as of Feb. 28, 2015) maturing through 2017.
Lennar's performance LOCs outstanding were \$234.1 million as of Nov. 30, 2014. The company's financial LOCs outstanding were \$190.4 million at the end of the fourth quarter. Performance LOCs are generally posted with regulatory bodies to guarantee its performance of certain development and construction activities. Financial LOCs are generally posted in lieu of cash deposits on option contracts, for insurance risks, credit enhancements and as other collateral.
Debt leverage (debt/EBITDA) decreased to 4.0x as of Nov. 30, 2014, down from 4.9x at the end of 2013. EBITDA-to-interest expense rose from 3.2x at Nov. 30 2013 to 4.3x at the conclusion of 2014.
HOMEBUILDING
The company was the second largest homebuilder in 2013 and primarily focuses on entry-level and first-time move-up homebuyers. In 2013 and 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 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 Nov. 30, 2014). As a consequence, the company has very sharply lowered its JV recourse debt exposure from \$1.76 billion to \$24.5 million as of Nov. 30, 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. Approximately, \$1.5 billion was expended on land and \$1.1 billion on development in 2014. Fitch expects that total real estate spending in 2015 could be up moderately (perhaps \$200 million-\$300 million) with more expended on land than development activities.
The company was slightly less cash flow negative in 2014 (\$788.49 million) than in 2013 (\$807.71 million). Lennar is likely to be much less cash flow negative in 2015, perhaps less than half as much as in 2014. The company could be cash flow positive in 2016.
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.
FINANCIAL SERVICES
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 2014, Lennar's financial services subsidiary provided loans to approximately 78% of its homebuyers who obtained mortgage financing in areas where Lennar offered services. During that same period, the company originated approximately 23,300 mortgage loans totaling \$6 billion. (By loan count refinanced loans accounted for 9% of originations in 2014.)
RIALTO
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 U.S. 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, do the due 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 U.S., 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 U.S. 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 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, 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, formed in 2012 with the objective to invest in distressed real estate assets and other related investments and that as of Nov. 30, 2014 had equity commitments of \$1.3 billion (including \$100 million by Lennar) and was closed to additional commitments;
--Rialto Mezzanine Partners Fund, formed in 2013 with a target of raising \$300 million in capital (including \$27 million committed 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.
LENNAR MULTIFAMILY
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 Nov. 30, 2014, Lennar's balance sheet had \$268 million of assets related to the Lennar Multifamily segment, which includes investments in unconsolidated entities of \$105.7 million. Lennar's net investment in the Lennar Multifamily segment, as of Nov. 30, 2014, was about \$200 million. As of Nov. 30, 2014, the Lennar Multifamily segment had 24 communities under construction with development costs of approximately \$1.6 billion. The Lennar Multifamily segment has a pipeline of future projects totaling \$5.5 billion in assets (including the \$1.6 billion in development) across a number of states that will be developed primarily by unconsolidated entities.
FIVEPOINT COMMUNITIES
FivePoint manages large, complex master planned communities in the Western U.S., typically in a JV 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.
KEY ASSUMPTIONS
Fitch's key assumptions within its rating case for the issuer include:
--Industry single-family housing starts improve almost 17.5%, while new and existing home sales grow 18% and 4.3%, respectively, in 2015;
--Lennar's deliveries increase 12% and homebuilding gross margins decline more than a single pp to 24% this year;
--The company's debt/EBITDA approximates 3.4x-3.5x and interest coverage exceeds 4.5x by year-end 2015;
--Lennar spends at least \$2.6 billion on land acquisitions and development activities this year;
--The company maintains a healthy liquidity position (well above \$1 billion 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, free cash flow trends and uses, and the company's cash position.
Fitch would consider taking positive rating action 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).
Fitch currently rates Lennar as follows:
--Issuer Default Rating 'BB+';
--Senior unsecured debt 'BB+'.
The Rating Outlook is Stable.
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