Fitch Affirms Lennar's IDR at 'BB '; Outlook to Positive
The Rating Outlook has been revised to Positive from Stable.
A complete list of rating actions is provided at the end of this release.
KEY RATING DRIVERS
The ratings for Lennar are based on the company's strong track record over the past 40+ years, geographic diversity, customer and product focus, generally conservative building practices and effective utilization of return on invested capital criteria as a key element of its operating model. Additionally, there has been continuity in Lennar's management during this housing cycle and Fitch considers this management team to be the deepest among the public builders within in its coverage.
The revision of the Outlook to Positive reflects Lennar's operating performance in 2014 and year-to-date (YTD) in 2015, current and year-end projected 2015 and 2016 financial ratios (especially leverage and coverage), solid liquidity position and favorable prospects for the housing sector during the balance of 2015 and 2016 and probably 2017. Fitch believes that the housing recovery is firmly in place (although the rate of recovery remains well below historical levels and the recovery will likely continue to occur in fits and starts).
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 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 \\$22.7 million as of May 31, 2015).
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 consistently above its peers and contributions from its Rialto segment have added to profits in 2010, 2011, 2012, 2013 and 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.
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 1.5pp 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 (as measured by the Census Bureau) rose 6.4% in 2014, while median home prices advanced approximately 5.4%.
Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing, relatively robust economy throughout the balance of 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 (average 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 about 12.5% to 729,000 as multifamily volume expands about 7.3% to 381,000. Total starts would be in excess of 1.1 million. New home sales are projected to increase 20% to 523,000. 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. Average and median home prices should increase 3.0%-3.5%.
Challenges remain, including the potential for higher interest rates, and continued restrictive credit qualification standards.
The company's homebuilding operations ended the second quarter of 2015 with \\$638.99 million in unrestricted cash and equivalents. Debt totaled \\$5.29 billion as of May 31, 2015, up from \\$4.69 billion at fiscal year-end 2014.
At May 31, 2015, Lennar had a \\$1.6 billion unsecured revolving credit facility with certain financial institutions that matures in June 2019. 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 (LOCs). As of May 31, 2015, there were \\$450 million of outstanding borrowings under the credit facility. Lennar believes that it was in compliance with its debt covenants at May 31, 2015. Also, the company had \\$315 million of LOC facilities with different financial institutions.
In April 2015, Lennar amended its credit facility, increasing the aggregate principal amount from \\$1.5 billion to \\$1.6 billion, which includes a \\$263 million accordion feature, subject to additional commitments. The credit facility's maturity date was extended to June 2019 from June 2018.
Lennar's debt maturities are well-laddered, with 22.8% of its senior notes (as of May 31, 2015) maturing through 2017.
Lennar's performance LOCs outstanding were \\$246.5 million at May 31, 2015, and financial LOCs outstanding were \\$179.5 million. Performance LOCs are generally posted with regulatory bodies to guarantee the company's 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) increased to 4.2x for the latest-12-months (LTM) May 31, 2015 from 4x at the conclusion of 2014, but is 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 and 4.4x for the May 31, 2015 LTM period.
The company was the second largest homebuilder in 2014 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. So far in 2015 approximately 25% of sales are 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.
As the cycle matures, Lennar is pivoting to a lighter land position and plans to reduce the number of years of land owned, and will shorten the tail of new land buys to 3-4 years. The company will endeavor to use rolling options and deferred takedowns with sellers and land developers. Lennar will also sell non-core holdings of land.
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 34 as of May 31, 2015). As a consequence, the company has very sharply lowered its JV recourse debt exposure from \\$1.76 billion to \\$22.7 million as of May 31, 2015. 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 totalled 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 slightly (perhaps by \\$100 million) with about 55% expended on land and 45% on 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 two-thirds as much as in 2014, and could be meaningfully 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.
Homebuilding realized \\$3.56 billion in revenues and \\$500.43 million in operating profits YTD in FY 2015.
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 time 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.
In the first half of 2015 (1H15), Lennar's financial services subsidiary provided loans to approximately 81% of its homebuyers who obtained mortgage financing in areas where Lennar offered services. During 1H15, Lennar originated approximately 15,000 mortgage loans totaling \\$4.03 billion. Lennar arranges title insurance for, and provides closing services to, its homebuyers and others. During 1H15, financial services generated \\$294.71 million in revenues and \\$54.58 million in operating profits.
Refinance (refi) activity accounted for about 20% of Lennar's unit originations YTD in fiscal 2015. A year ago refi represented less than 10% of originations.
Lennar is the sixth largest national mortgage originator (non- bank) and ranks among the top 10 national title insurers.
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.
Rialto employs an asset-light model with limited investment by Lennar which receives management fees. Rialto has returned more than \\$400 million to Lennar since November 2013.
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 uses its vertically-integrated investment and operating platform to underwrite, do the due diligence, acquire, manage, work out 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 May 31, 2015 had equity commitments of \\$1.3 billion (including \\$100 million by Lennar) and was closed to additional commitments;
--Rialto Mezzanine Partners Fund, LP, formed in 2013 with a target of raising \\$300 million in capital (including \\$33.8 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.
Rialto generated \\$109.13 million in revenues and \\$9.69 million of operating profits (prior to non-controlling interests) YTD in FY 2015.
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, 2015, Lennar's balance sheet had \\$362.3 million of assets related to the Lennar Multifamily segment, which includes investments in unconsolidated entities of \\$129.8 million. Lennar's net investment in the Lennar Multifamily segment, as of May 31, 2015, was about \\$310.5 million.
Multifamily contributed \\$75.43 million to corporate revenues YTD in fiscal 2015 and realized an operating loss of \\$14.39 million.
As of May 31, 2015, the Lennar Multifamily segment had 26 communities of which 24 are under construction and 2 are completed, with development costs of approximately \\$1.7 billion. The Lennar Multifamily segment has a pipeline of future projects totalling \\$4.5 billion in assets (including the \\$1.7 billion in development) across a number of states that will be developed primarily by unconsolidated entities.
Over the past four years Lennar built this business into the nation's fifth largest apartment developer. To date the company has been building its apartment communities in individual ventures, which were structured to sell the assets once they were leased and stabilized.
On July 15, 2015, Lennar announced the formation of Lennar Multifamily Venture (LMV), an equity fund between Lennar Multifamily Communities (LMC) and global sovereign and institutional investors targeting investments in class-A multifamily development assets in 25 top metropolitan markets in the U.S.
The new venture will aim to provide superior risk-adjusted returns through a "develop-to-core" strategy - developing multifamily communities and then holding those communities in a portfolio long term for cash flow. LMV will focus on the top growth and gateway markets in the U.S., which are characterized by strong long-term demand fundamentals and constrained supply.
With this first close, LMV will have approximately \\$1.1 billion in equity commitments, including a \\$504 million co-investment commitment by Lennar. The venture is targeting 50% leverage and will have a three-year investment period and an eight-year term. It will be seeded with 19 undeveloped multifamily assets that were previously purchased or under contract by LMC, totaling 6,120 apartments with a total projected development cost of approximately \\$2.1 billion. The venture represents the next stage of LMC's strategy, having previously structured 28 single-asset JVs with 18 different institutional partners utilizing a merchant-build approach. The assets from these existing ventures are not part of the new fund and will be sold over the next three years as the communities are leased and stabilized.
FIVE POINT COMMUNITIES
Five Point manages large, complex master planned communities, typically in a JV structure. Five Point is developing six projects in California spanning 40,000 potential home sites and 20 million square feet of commercial space. 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.
In early July 2015, Lennar announced an agreement to contribute its non-controlling ownership stakes (20%) in several sizeable California JVs (El Toro, Newhall Ranch, Hunters Point) and 60% interest in Five Point Communities (the management arm for these JVs) to form a new public entity along with its current partners. The Five Point IPO could happen by year-end FY 2015. Pro forma, including its current stake in Five Point, Lennar will have in excess of 30% ownership in the new public entity. Analysts estimate that Lennar's investment in Five Point (and including Treasure Island) is worth \\$1.2 billion-\\$1.3 billion. Lennar's current book investment in these JVs is \\$350 million.
Fitch's key assumptions within its rating case for the issuer include:
--Industry single-family housing starts improve 12.5%, while new and existing home sales grow 20% and 4.3%, respectively, in 2015;
--Lennar's homebuilding revenues increase at about a 21% pace. Although homebuilding EBITDA margins erode 160 bps this year due to higher expenses (especially land costs) and lesser home price inflation, homebuilding EBITDA increases 9.0%;
--The company's Debt/EBITDA approximates 3.8x and interest coverage reaches about 5.4x by year-end 2015;
--Lennar spends approximately \\$2.5 billion-\\$2.7 billion on land acquisition and development activities this year;
--The company maintains an adequate liquidity position (well above \\$500 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 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 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) and begins generating positive cash flow from operations starting in 2016 as it moderates its land and development spending.
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).
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings and assigned the following Recovery Rating for Lennar Corp. (NYSE: LEN):
--Long-term IDR at'BB+';
--Senior unsecured debt at 'BB+/RR4'.
The Rating Outlook is Positive.
In accordance with Fitch's updated Recovery Rating (RR) methodology, Fitch is now providing RRs to issuers with IDRs in the 'BB' category. The Recovery Rating of '4' for Lennar's unsecured debt supports a rating of 'BB+', and reflects average recovery prospects in a distressed scenario.