Hovnanian Escapes Abyss as JPMorgan Says Buy
Hovnanian Enterprises Inc. (HOV), the homebuilder that faced a 91 percent chance of default last October as seen in derivatives trades, is winning over bondholders by reducing debt as housing prices improve.
The average market value of the family-run company’s bonds surged 30 percent to $1.2 billion as of Sept. 5 from $910 million on Sept. 30, 2011, according to Bank of America Merrill Lynch index data. The builder’s probability of default in five years dropped to 43.5 percent yesterday.
Hovnanian’s tactic of buying land even as housing prices were falling is paying off as the market rebounds and the company has the raw materials to meet demand. A recovery in the home sector has bolstered the balance sheets of those builders that survived the worst financial crisis since the Great Depression as Red Bank, New Jersey-based Hovnanian reported a surprise profit yesterday with a 36 percent gain in revenue.
“If you weathered that storm and still come out whole, who’s to say you can’t continue doing so,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. “Provided that it doesn’t get as bad as things were in ’09 they should be fine. I think that’s the mentality about them.”
The company’s $121 million of 8.625 percent bonds due January 2017 traded at 85 cents on the dollar Sept. 5 to yield 13.2 percent, up from 33 cents Oct. 3, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Hovnanian had $1.55 billion in long-term debt as of July 31, down 44 percent from $2.74 billion in 2008, according to data compiled by Bloomberg.
“We’re pleased that the market recognized the improving fundamentals that we’ve been posting,” Larry Sorsby, chief financial officer, said in a telephone interview. “It’s clear to us that the industry is in a period of recovery. We’ve bounced off the bottom.”
JPMorgan Chase & Co., which had an “underweight” rating on the company’s bonds as recently as July, upgraded New Jersey’s largest homebuilder to “overweight” yesterday. Improvement in housing, the strength in the high-yield bond market and the potential for refinancing have improved the company’s outlook, analysts Susan Berliner and Richard DeGaetani wrote in a research note to clients. An “overweight” recommendation means the position is expected to outperform benchmarks during the next three months.
“We’ve been saying all year that they’ve showed a willingness to cut the costs when they need to,” Martha Ucko, an analyst at CreditSights Inc., said in a telephone interview. “It was a risky world for a while but the housing market is looking like it has stabilized with another big leg down in volumes unlikely and they’re getting pretty close to profitability.”
The company may refinance its $797 million of 10.625 percent first-lien notes due October 2016, which become callable for the first time on Oct. 15 at 108 cents on the dollar, said Michael Kim, a fixed-income analyst at CRT Capital Group LLC in Stamford, Connecticut. The securities traded at 107 cents on the dollar today, the highest since May 2011.
“Refinancing the first lien notes with lower coupon debt would benefit liquidity and provide further support to the rest of the capital structure, including the unsecured bonds,” Kim said in a telephone interview. “There’s certainly more optimism around their survival in having the liquidity on hand to get through the next couple of years.”
Credit-default swaps tied to Hovnanian debt have declined to 16.6 percent upfront, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That’s in addition to 5 percent a year, meaning it would cost $1.66 million initially and $500,000 annually to protect $10 million of Hovnanian’s debt.
Those prices imply that the market perceives a 43.5 percent chance the company will default within five years, based on an expectation that investors would recover 14.5 percent of face value of the company’s bonds if it failed to meet its obligations, the data show. That’s down from 60.5 percent at the end of 2011 when it implied 85 percent odds.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Investors are accepting the lowest relative yields for debt of the nation’s biggest homebuilders since 2007. So-called spreads at 4.74 percentage points on debt of borrowers from D.R. Horton Inc. (DHI), the largest U.S. homebuilder by volume, to Toll Brothers Inc. (TOL) have tightened six times faster than the overall high-yield market since February, Bank of America Merrill Lynch index show.
Blackstone Group LP (BX)’s GSO Capital Partners LP agreed to acquire a group of housing development sites from Hovnanian in July with plans to sell them back to the homebuilder under a $125 million deal, causing the company’s bonds to surge 4.3 cents on the day.
The GSO agreement is a “sizeable liquidity source” that will “enable Hovnanian to buy enough land to grow the company,” JPMorgan wrote in a July report.
Net income for the three months ended July 31 was $34.7 million, or 25 cents a share, compared with a net loss of $50.9 million, of 47 cents, a year earlier, Hovnanian said yesterday in a statement. The average estimate of 10 analysts in a Bloomberg survey was for a loss of 14 cents a share.
Ara Hovnanian is president and chief executive officer of the company his father founded in 1959. Hovnanian, New Jersey’s largest builder, has operations in 18 states including, Arizona, California, Delaware, Florida, Georgia, Illinois, Kentucky and Maryland.
Homebuilders, along with lenders, real-estate firms and investment banks that bundled mortgages made to the least creditworthy borrowers into securities, contributed to a run-up in housing prices that peaked in July 2006. Prices plummeted 35 percent from then until the market low in February, according to the Standard & Poor’s/Case-Shiller index.
Home prices in 20 U.S. cities climbed in June for the first time since a tax credit boosted sales in 2010. The S&P/Case- Shiller index increased 0.5 percent from June 2011 after falling 0.7 percent in the year to May, a report from the group showed last month in New York. The last 12-month increase took place in September 2010. Nationally, prices jumped last quarter by the most in more than six years.
Purchases of new homes rose more than projected in July to match a two-year high, Commerce Department data showed last month. Previously-owned house sales rebounded from an eight- month low, the National Association of Realtors reported.
A U.S. housing recovery will take longer than investors anticipate, said Vicki Bryan, an analyst at research firm Gimme Credit LLC in New York. Many investors are too optimistic and have pushed up prices on the bonds.
“I’m encouraged that the housing market is improving and gaining traction but they’ve already priced in years of improvement,” Bryan said in a telephone interview. “Not all the homebuilders are equipped to sustain themselves for years and years of slow sales, for the years it takes for the housing market to recover.”
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