Fitch Assesses U.S. Homebuilders' Termination of Revolving Credit Facilities.
In the absence of a revolving credit line, a consistently higher level of cash and equivalents than was typical should be maintained on a homebuilder's balance sheet, especially in these still uncertain times. Fitch expects managements will be allocating a certain percentage of cash to serve as standby liquidity, in an amount comparable to a standard revolving credit requirement over and above what is needed for working capital, debt maturities, etc.
In addition to the loss of standby liquidity, the termination of the bank facility eliminates the oversight of builder operations by bank groups, a useful check on management's appetite for risk. While certain bond indentures also have financial and other covenants (i.e. limitations on asset sales, limitations on secured indebtedness, etc.), the requirements under bank credit facilities are, in most cases, more onerous and would usually be violated in a deteriorating environment ahead of the covenants in place in bond indentures. Fitch suspects that this issue, in particular, will be an area of concern to bondholders and could result in tighter covenants on new bond offerings going forward.
Over the past few months three homebuilders have voluntarily terminated their revolving credit facilities in advance of the scheduled maturity dates. D.R. Horton, Inc. (DHI) terminated its revolving credit facility on May 11, 2009. Ryland Group, Inc. (RYL) terminated its revolving credit facility on June 26, 2009. On July 27, 2009 Meritage Homes Corp. (MTH) announced it would be terminating its revolving credit facility.
Their motivation includes the savings of a few million dollars from non-use fees on facilities that were scheduled to mature in 18-30 months and which they were not currently utilizing or planned to employ during the remaining lives of the facilities. Also, in at least one situation the existing facility constrained the ability of management to raise capital. This strategy may also reflect managements' views that a bottom has been reached or is near for new construction and an upturn is on the horizon. In any case, none of these companies were in violation of covenants at the time of the facility termination. And each of these companies has experienced a strong upsurge in cash on hand and cash from operations in recent quarters resulting in strong liquidity for the rating, thereby compensating for the reduction in standby liquidity.
Although the companies did not have debt outstanding under the credit lines, there were letters of credit backed by the facilities. Following the termination of the credit facility, the companies typically entered into secured letter of credit agreements which require the builder to deposit cash, in an amount approximating the balance of the letters of credit outstanding, as collateral with the issuing banks. As of March 31, 2009, DHI had $61.7 million letters of credit outstanding. RYL had $75.1 million letters of credit outstanding on March 31, 2009. MTH had approximately $22 million letters of credit outstanding as of June 30, 2009.
These companies and, perhaps, other builders that will terminate their facilities may be capable of functioning without their revolvers by utilizing cash and equivalents on hand, generation of cash flow from operations and capital markets activities. But this does result in a reduction in standby liquidity. In general, bank facilities are an important source of operating liquidity to finance working capital, seasonal requirements, one-off needs, short-term risks and other purposes, both in the normal course of business and due to unforeseen events. Fitch notes, as was witnessed last fall and winter, capital markets may not always be accessible. Barring changes in the tax law, tax refunds are largely over for the builders. And generation of cash flow from operations will be trending downward until the land pipeline is refilled with lower cost lots, which will support profitable home sales.
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|Date:||Jul 28, 2009|
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