Although the U.S. economic recovery remains tepid and 2012 job growth was lackluster at best, activity in one area—new home sales—was markedly hotter, jumping 20% in 2012 compared with 2011. Contributing to this growth were record home affordability, rising apartment rents, an increase in household formations, and a limited supply of existing homes for sale. The trend continues in 2013, with new home sales in January and February improving 29% and 12%, respectively, over the same periods a year earlier.
Standard & Poor’s Ratings Services expects the U.S. housing sector recovery that began last year—after several false starts—will continue through 2014, providing support for the current ratings and outlooks on the homebuilders we rate. We expect to take few, if any, negative rating actions over the next 12 to 18 months, as improving profitability enables homebuilders (particularly those at the low end of our rating scale) to strengthen their balance sheets and fund an increasing percentage of their growth through operating profits. As the number of home sales increases, we believe homebuilders will draw on the sizable cash balances that have been a key liquidity and ratings support throughout the housing downturn in order to fund investment in land and inventory. However, as these cash balances decline, we expect increased profits and the addition of unsecured revolving credit facilities will supplement liquidity.
Despite the improving operating environment for homebuilders, positive rating momentum will likely be measured, particularly in cases where debt is the main source of funding for the significant land and inventory investment needed to support strong sales gains. Many homebuilders have taken advantage of receptive debt markets and historically low interest rates over the past few months and have issued debt to fund growth. In some instances, it is possible that rising debt balances could outpace our expectations for recovery in operating profitability and EBITDA, delaying recovery in key credit metrics and weighing on ratings, particularly for higher-rated builders. Although we expect most homebuilders will achieve strong revenue and EBITDA growth over the next 24 months, improvement in key EBITDA-based credit measures (which had lagged similarly rated industrial peers throughout the housing downturn) will likely be more restrained given the likelihood that more debt will be added to balance sheets. As a result, although we expect to raise some ratings, the extent of the upgrades for most issuers will likely be one or two notches.
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