Investing in housing or securities related to housing seems to be all the rage. If you want to add exposure to housing but prefer to avoid the buy-to-rent craze sweeping the nation and want to stay away from housing-related common stocks, you might consider moving up the capital structure. Both the preferred stocks of several equity REITs and the senior unsecured debt of a few homebuilders are offering enticing risk-rewards.
Last week, D.R. Horton, one of the largest home builders in the United States, issued $400 million of new 5.75% coupon, 2023 maturing senior notes. According to the Prospectus Supplement dated July 31, 2013, D.R. Horton builds and sells homes in 27 states and 78 markets. Its homes generally range in size from 1,000 to 4,000 square feet and are generally priced between $100,000 and $800,000. Additionally, D.R. Horton has financial services operations through which it provides mortgage financing and title agency services. DHI Mortgage, a wholly owned subsidiary of D.R. Horton, provides mortgage financing and sells the mortgages and servicing rights to investors. D.R. Horton’s various subsidiary title companies provide title insurance policies and examination and closing services. For the nine months ending June 30, 2013, homebuilding operations generated approximately 97% of the company’s consolidated revenues, and the sale of detached single-family homes drove approximately 91% of home sales revenues.
Concerning the details of the notes (CUSIP 23331ABH1), they are senior unsecured, mature on August 15, 2023, have a coupon of 5.75%, and pay interest semiannually. There is a make whole call at the applicable Treasury rate plus 50 basis points, and there is a conditional put for a “Change of Control Triggering Event” at 101 cents-on-the-dollar. Furthermore, the notes are guaranteed by “substantially” all of D.R. Horton’s homebuilding subsidiaries on a senior unsecured basis and will be structurally subordinated to the debt of D.R. Horton’s non-guarantor subsidiaries. The notes were issued at a spread of 310 basis points over its benchmark, the 1.75% coupon, May 15, 2023 maturing Treasury notes.
There are a series of business risks mentioned in the Prospectus Supplement of which you should be aware. Below is a summary of a selection of those risks:
1. “Both national new home sales and our Company’s home sales remain below historical levels due to the current weak U.S. economic conditions, the restrictive mortgage lending environment and variations in local housing market conditions. The U.S. economy could be negatively impacted in the short-term by potential changes in fiscal, tax and monetary policies currently under consideration by the federal government. Therefore, it remains uncertain whether homebuilding industry conditions will continue to improve, remain stable or deteriorate from current levels. A subsequent deterioration in industry conditions could adversely affect our business or financial results.”
2. Tight credit markets could limit D.R. Horton’s ability to access capital and increase its cost of capital.
3. “Reductions in the availability of mortgage financing and the liquidity provided by government-sponsored enterprises, the effects of government programs, a decrease in our ability to sell mortgage loans on attractive terms or an increase in mortgage interest rates could adversely affect our business or financial results.”
4. Inventory risks associated with owning and developing land, and supply shortages related to acquiring land, building materials, and labor.
5. D.R. Horton is required to provide surety bonds to secure its obligations under construction contracts, development agreements, and “other arrangements.” The company’s ability to obtain surety bonds depends upon its “credit rating, financial condition, past performance, and other factors.”
6. Increasing costs associated with owning a home could prevent some people from buying homes.
7. Extensive and complex regulations.
8. “Homebuilders compete not only for homebuyers, but also for desirable properties, financial, raw materials and skilled labor.” Strong competition could adversely affect D.R. Horton’s business.
9. Certain amounts of inflation or deflation could cause significant changes to the company’s financial health.
Highlights From Rating Agencies’ Press Releases
On July 31, Moody’s, S&P, and Fitch each issued a press release regarding D.R. Horton’s new notes and the company itself. Here are the highlights:
Moody’s
- Rating: Ba2, Outlook: Positive
- “The Ba2 rating reflects the company’s conservative capital structure, as reflected in one of the lowest homebuilding debt leverage ratios in the industry; its relatively clean and transparent balance sheet; its strong earnings metrics, including healthy gross margins and positive net income generation; and its position as one of the largest and most geographically diversified homebuilders in the U.S.”
- “The ratings could improve if the company continues to expand its net income generation and maintains its homebuilding debt leverage close to 40% while sustaining strong liquidity.”
- “The ratings could be lowered if the company’s adjusted gross homebuilding debt leverage increased above 50% on a sustained basis, or if cash flow generation was significantly negative for a prolonged period of time without an offsetting sufficient increase in earnings.”
S&P
- Rating: BB, Outlook: Stable
- The stable outlook “reflects our expectation that D.R. Horton’s EBITDA-based credit metrics will continue to strengthen over the next 12 to 18 months as the homebuilder grows community count while maintaining or improving current absorption levels.”
- “We could lower our rating if home sales slow significantly, and debt to EBITDA exceeds 5x on a sustained basis.” S&P’s current expectation for debt to EBITDA is that it ends 2013 in the mid-4x region.
Fitch
- Rating: BB, Outlook: Positive
- “The ratings for DHI reflect the company’s strong liquidity position, the successful execution of its business model, geographic and product line diversity and steady capital structure.”
- “DHI had been aggressively reducing its debt during much of the past six years. Homebuilding debt declined from roughly $5.5 billion at June 30, 2006 to $1.58 billion as of Dec. 31, 2011, a 71% reduction. More recently, DHI has been responding to the stronger housing market, expanding inventories and increasing leverage. Homebuilding debt at the end of the fiscal 2013 third quarter was $2.86 billion.”
- “DHI maintains an 8.3-year supply of lots (based on last 12 months deliveries), 65.1% of which are owned and the balance controlled through options.”
- “The ratings also reflect DHI’s relatively heavy speculative building activity (at times averaging 50 – 60% of total inventory and 47.4% at June 30, 2013). DHI has historically built a significant number of its homes on a speculative basis (i.e. begun construction before an order was in hand).”
Please keep in mind that this article is for informational purposes only and not a recommendation to buy or sell any securities. Only you can decide if taking the counterparty risk of investing in individual bonds is right for you.
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