Fitch Ratings has assigned a 'BB+' rating to Lennar Corporation's (NYSE: LEN) proposed offering of a new issue of senior notes due 2018 and an additional amount of its 4.750% senior notes due 2022. These issues will be ranked on a pari passu basis with all other senior unsecured debt. The notes will be guaranteed by some of Lennar's subsidiaries, but those guarantees may be suspended or released under certain circumstances. Net proceeds from the notes offering will be primarily used for working capital and general corporate purposes, which may include the repayment or repurchase of some of its outstanding senior notes.
The Rating Outlook is Stable. A full list of ratings is provided at the end of this release.
The ratings and Outlook for Lennar reflect the company's strong liquidity position and improved prospects for the housing sector this year and in 2014. The ratings also reflect Lennar's successful execution of its business model, geographic and product line diversity, and much lessened joint venture exposure.
There are still challenges facing the housing market that are likely to moderate the early stages of this recovery. Nevertheless, Lennar has the financial flexibility to navigate through the sometimes challenging market conditions and continue to invest in land opportunities.
Fitch's housing forecasts for 2012 were raised a number of times during the course of the year but still reflected a below-trend line cyclical rise off a very low bottom. In a slowly growing economy with somewhat diminished distressed home sales competition, less competitive rental cost alternatives, and new and existing home inventories at historically low levels, 2013 single-family housing starts should improve about 18%, while new home sales increase approximately 22% and existing home sales grow 7%. However, as Fitch has noted in the past, recovery will likely occur in fits and starts.
Challenges (although somewhat muted) remain, including continued relatively high levels of delinquencies, potential of short-term acceleration in foreclosures, and consequent meaningful distressed sales, and restrictive credit qualification standards.
Lennar has solid liquidity with unrestricted homebuilding cash of $1,147 million as of Nov. 30, 2012. The company also has an unsecured revolving credit facility of $500 million that expires May 2015. The credit facility may be increased to $525 million, subject to additional commitments. As of Nov. 30, 2012, the company had a $150 million letter of credit and reimbursement agreement with certain financial institutions, which may be increased to $200 million, and also another $50 million letter of credit and reimbursement agreement with certain financial institutions that had a $50 million accordion feature. There is also an additional $200 million letter of credit facility with another financial institution. The company's debt maturities are well-laddered, with about 23% of its senior notes (as of Nov. 30, 2012) maturing through 2015.
The company was the third largest homebuilder in 2011 and primarily focuses on entry-level and first-time move-up homebuyers. The company builds in 16 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 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 been substantially reducing its number of JVs over the last few years (from 270 at the peak in 2006 to 36 as of Nov. 30, 2012). As a consequence, the company has very sharply lowered its JV recourse debt exposure from $1.76 billion to $66.7 million ($49.9 million net of joint and several reimbursement agreements with its partners) as of Nov. 30, 2012. 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 $999 million of new land and spent roughly $302 million on development expenditures. Fitch expects land and development spending for 2013 to be sharply higher than in 2012. As a result, Fitch expects Lennar to be more than $500 million cash flow negative this year. Fitch is comfortable with this strategy given the company's cash position, debt maturity schedule and proven access to the capital markets.
During 2010, the company ramped up its investments in Rialto Investments. More recently it has been harvesting the by-products of its efforts. This segment provides advisory services, due-diligence, workout strategies, ongoing asset management services, and acquires and monetizes distressed loans and securities portfolios. (Management has considerable expertise in this highly specialized business.)
In February 2010, the company acquired indirectly 40% managing member equity interests in two limited liability companies in partnership with the FDIC, for approximately $243 million (net of transaction costs and a $22 million working capital reserve). Lennar had also invested $69 million in a fund formed under the Federal government's Public-Private Investment Program (PPIP), which was focused on acquiring securities backed by real estate loans. During the three months ended Aug. 31, 2012, the AB PPIP fund started unwinding its operations. During the fourth quarter, Lennar finalized its last sales of the underlying securities in the fund and made its final distributions to the partners, including Lennar. On average the company had $61 million of its equity invested in the fund and it has brought back all of that investment as well as profits and fees totaling $112 million.
On Sept. 30, 2010, Rialto completed the acquisitions of approximately $740 million of distressed real estate assets, in separate transactions, from three financial institutions. The company paid $310 million for these assets, of which $124 million was funded by a five-year senior unsecured note provided by one of the selling financial institutions. Rialto Investments had $594.8 million of debt, of which $111 million is recourse to Lennar. In December 2012, Lennar completed the first closing of its second real estate fund with initial equity commitments of approximately $260 million (including $100 million committed by Lennar).
Rialto provides Lennar with ancillary income as well as a source of land purchases (either directly or leveraging Rialto's relationship with owners of distressed assets). Fitch views this operation as strategically material to the company's operation, particularly as housing activity remains at relatively low levels.
RENTAL ACTIVITIES AND LARGE MPCs
In addition to the homebuilding, financial services and Rialto operating platforms, Lennar has been incubating a multi-family rental business strategy (beginning in early 2011) as well as FivePoint Land Company which manages large, complex master planned communities in the Western U.S. (including the former Newhall Land and Farming Company).
The multi-family JV activities have a pipeline that exceeds $1 billion, and over 6,500 apartments. At Nov. 30, 2012, Lennar had approximately $30 million invested in this business and expects that investment to rise to $100 million by the end of fiscal 2013. The company's long term goal is to build a portfolio of income producing apartment properties across the country.
GUIDELINES FOR FURTHER RATINGS ACTIONS
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.
Positive rating actions may be considered if the recovery in housing is maintained and is more robust than Fitch's current outlook, Lennar shows continuous improvement in credit metrics (with leverage less than 3 times (x) and interest coverage in excess of 5x), and maintains a healthy liquidity position.
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 consistent and significant negative quarterly cash flow from operations and meaningfully diminished liquidity position (below $700 million).
Fitch currently rates Lennar as follows:
--Issuer Default Rating 'BB+';
--Senior unsecured debt 'BB+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Liquidity Considerations for Corporate Issuers' (June 12, 2007.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Liquidity Considerations for Corporate Issuers
Robert Curran, +1-212-908-0515
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
Robert Rulla, CPA, +1-312-606-2311
Craig Fraser, +1-212-908-0310
Brian Bertsch, New York, +1 212-908-0549
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