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How Hurricane-Resistant is U.S. Homebuilder Credit Quality?

S&P Global Ratings

COP24 Special Edition Shining A Light On Climate Finance

S&P Dow Jones Indices

Considering the Risk from Future Carbon Prices

S&P Global Ratings

Plugging the Climate Adaptation Gap with High Resilience Benefit Investments

Empowering Public Private Collaboration in Infrastructure


How Hurricane-Resistant is U.S. Homebuilder Credit Quality?

Homebuilders in the U.S. can be acutely exposed to natural disasters, such as with severe weather in key growth areas in the southern U.S. Hurricane Harvey flooded large portions of the Houston area, which is an important market for several companies, despite recent economic difficulties stemming from sharply lower oil prices. That said, S&P Global Ratings expects that homebuilders' geographic diversity will mute the worst effects of disruptions in Houston and potentially Florida in all but a few cases. Home closings have occurred since Harvey, but we expect the outlook for sales for the rest of 2017 will remain choppy because of a potential hit to consumer sentiment, as well as tight availability of materials and trades.

Homebuilders in the U.S. have increased their debt loads in tandem with improving market conditions in recent years, reducing their buffer for a potential downturn. Even so, it appears that damage is minimal to inventories in the Houston area and to overall profitability. In fact, the biggest risks to profitability might yet be ahead: Labor availability, higher materials costs, and potential constraints on land development could pressure margins in the region.

At the time of publishing, Hurricane Irma is bearing down on the U.S. east coast, potentially Florida. Some homebuilders have significant exposures to both Houston and Florida, most notably Lennar Corp. (BB+/Stable/--) and Weekley Homes LLC (B+/Watch Neg/--). Our recent upgrade of Lennar

is underscored by the company's good profitability and improving credit ratios, which position Lennar favorably to withstand most scenarios of localized business disruption. The company has national coverage and good geographic breadth, but Florida accounts for about one-quarter of its closings. We estimate that compared with other homebuilders, Lennar has double-digit market shares in the five largest Florida markets, where PulteGroup Inc. (BB+/Stable/--) and D.R. Horton Inc. (BBB-/Positive/--) combine for double-digit penetration of only one Florida market. Miami-based Lennar has considerable experience in these weather-related emergencies, however, which we expect will enable its expeditious return to full operations in the event of a storm.

S&P Global Ratings believes it will be useful to provide additional context about its views on U.S. homebuilders' credit quality and how it could be affected by this year's hurricane season.

Frequently Asked Questions

What's the immediate effect of the hurricanes on homebuilder ratings?

Our only rating action has been to place Weekley Homes on CreditWatch with negative implications. We had already assigned a negative outlook to the company because of elevated debt leverage, much of which came from previously weak market conditions in Houston. We estimate Weekley has about 20% of its inventory in Houston, although the preliminary damage assessment is modest, limited to only a few homes. Nevertheless, difficult conditions could impede the company's turnaround in Houston that would be necessary to improve debt leverage below our 5x threshold for a downgrade. Moreover, Weekley is about 20% exposed to Florida, which may yet emerge as another source of near-term profit pressure because of Hurricane Irma.

It appears that flood damage to homebuilder inventories in Houston might not be as substantial as initially expected. Homebuilders we rate suggest that damage to the communities has been limited to a few model homes, with street flooding in some communities. The largest homebuilders in Houston based on closings are D.R. Horton and Lennar. Their size and geographic diversification, however, insulate their credit ratios. Other exposed issuers, like Beazer Homes USA Inc. (B-/Stable/--) and Meritage Homes Corp. (BB/Stable/--), could only see a small effect on credit measures in the event of a few months of poor market conditions in Houston, and their financial performance should remain within our expectations for the ratings.

How exposed are homebuilders to the affected areas?

Weekley has 20%-25% of its 2016 closings from the Houston area, Hovnanian Enterprises Inc. (CCC+/Negative/--) about 20%, Beazer Homes and Taylor Morrison Home Corp. (BB-/Stable/--) each about 15%, and Meritage Homes about 10%. D.R. Horton and Lennar had the most closings in the Houston area in 2016, but this represented less than 10% of their total. Most of these companies have fairly low direct exposure to Florida, but Taylor Morrison, Meritage, and Beazer all have more than 25% of their revenue from southeast U.S. states, which could be affected by Irma.

Each homebuilder is still assessing damage, but we are not aware of any communities that have been especially affected. More to the point, we believe active selling communities that are mostly developed, entitled, and selling will recover quickly.

In our worst-case scenario, which appears unlikely, adjusted debt to EBITDA for Meritage could rise about one-quarter on weaker earnings, but would remain well within our rating thresholds. In this harsh scenario, Hovnanian and Beazer Homes could see their adjusted debt to EBITDA increase about 0.5x, although we do not expect any rating actions because of both issuers' already-high leverage. Our worst-case scenario is emerging as unlikely, because we reduced Houston revenues to zero for a month for the most affected issuers to simulate an uncertain path to weaker full-year results, rather than a specific one-month shutdown.

How have S&P Global Ratings' assumptions for homebuilders changed?

The most likely scenario appears to be some delay in closings and a gradual return of construction activity over the next few weeks, followed by an improved sales pace by late 2017. This is all predicated on resumed land development and a good pace of construction, which will be difficult given recovery construction activity and potential labor constraints.

If we assume a 5%-10% hit to Houston-area revenue in 2017 along with higher input costs and inflexible sales, general, and administration, we expect that credit ratios deteriorate only modestly in 2017 without breaching any of our rating thresholds.

Beazer Homes, with about 15% of its closings in Houston, had been performing well before the storm, but we estimate that the important EBITDA interest coverage could decline to about 1.4x, but still above our threshold of 1x for a downgrade.

Meritage Homes' adjusted debt leverage could increase modestly from 3.4x because of temporary earnings pressure, but will remain well below our threshold for a downgrade of 4x. Hovnanian Enterprises, with 20% of its closings in Houston, remains exposed to refinancing risk in the next 12-18 months, which is exacerbated by any such operating disruptions.

What will S&P Global Ratings be watching as the situation evolves?

According to the National Association of Homebuilders, we should not expect a massive surge in home building in affected areas, as replacing units destroyed by the storm will take place slowly over a number of years. That said, estimates vary, but tens of thousands of homes have been destroyed, which will boost demand from our previous expectations and provide a tailwind for exposed builders over the next 24 months.

We'll be watching profitability, as well. We believe that labor availability and land development substantially hinder normalizing Houston homebuilder operations and returning to steady volumes, while higher materials costs and lower overhead absorption will constrain margin improvements.

And we'll be watching Hurricane Irma.



COP24 Special Edition Shining A Light On Climate Finance

Highlights

− Green loans are evolving, with the Climate Bond Initiative forecasting nearly $1 trillion in green bond issuance by 2020.

− Despite the uptick in green bond and loan issuance, the market still remains relatively small, especially compared to the universe of assets comprising CLO 2.0 transactions.

− In our view, a green CLO market has large growth potential, boosted by regulatory initiatives and emerging interest from both issuers and investors in 2018.

− We built a hypothetical rating scenario for a green CLO to compare and contrast the underlying portfolio and structure with a typical European CLO 2.0 transaction.

− Our hypothetical green CLO analysis showed that green loans may have different fundamental characteristics to corporate loans, such as lower asset yields, higher credit quality, and higher recovery rates assumptions.

The global collateralized loan obligation (CLO) market has experienced a rebirth (2010 in the U.S. and 2013 in Europe). New issuance continues to increase due to investor familiarity with the product, as well as low historical default rates. While a market for green assets, such as green loans and bonds has been established for a while, although still of a relative size, a sustainable securitization market is still in its infancy. Considering the challenge in financing the amounts, S&P Global Ratings expects green CLOs to play a role in increasing the private sector presence in the sustainable finance market.

Following the Paris Agreement that came into force in November 2016, 184 parties have ratified the action plan to limit global warming. For this purpose, developed nations have pledged to provide $100 billion (about €87 billion) annually until 2025. As part of this deal the EU has committed to decrease carbon emissions by 40% by 2030. In March 2018 the European Commission (EC) proposed the creation of environmental, social, and corporate governance 'taxonomy', regulating sustainable finance product disclosures, as well as introducing the 'green supporting factor' in the EU prudential rules for banks and insurance companies.

Read the Full Report
Download


Considering the Risk from Future Carbon Prices

Along with the advent of the 2015 Paris Climate Agreement has come a growing understanding of the structural changes required across the global economy to shift to low- (or zero-) carbon, sustainable business practices.

The increasing regulation of carbon emissions through taxes, emissions trading schemes, and fossil fuel extraction fees is expected to feature prominently in global efforts to address climate change. Carbon prices are already implemented in 40 countries and 20 cities and regions. Average carbon prices could increase more than sevenfold to USD 120 per metric ton by 2030, as regulations aim to limit the average global temperature increase to 2 degrees Celsius, in accordance with the Paris Agreement.

S&P Dow Jones Indices launched the S&P Carbon Price Risk Adjusted Indices to embed future carbon price risk into today’s index constituents.

Read the Full Report
Download


Plugging the Climate Adaptation Gap with High Resilience Benefit Investments

Highlights

- Adaptation financing needs to substantially increase to address the higher impact of extreme weather to society due to climate change.

- Adaptation projects are typically cost effective and bring wide range of resilience benefits.

- To demonstrate the value of resilience benefits to various stakeholders we consider that it is important to quantify those benefits based on a robust modeling framework.

- We expect that due to the large size of the adaptation gap and constrained public finances,private investment would need to make a considerable contribution to adaptation financing.

Dec. 07 2018 — We believe the recent surge in economic damage from extreme climatic events may focus the attention of public authorities about the need for adaptation investments and accelerate investment in this area.The United Nations Environment Program (UNEP) forecasts adaptation costs in developing countries at between $140 billion and $300 billion by 2030, and $280 billion and $500 billion by 2050. That is approximately 6x-13x above the amount of international public-sector finance available today--just to meet 2030 costs.

Over the last two years,the world has seen a flurry of extreme weather, which has exposed the vulnerability of many countries to these events. Climate change may make matters worse, irrespective of whether we manage to keep global warming to 2 degrees Celsius or not. Attention to climate change adaptation is therefore increasing, especially about how to finance it, given the need to raise enough public and private investment to fortify exposed countries and communities against the potentially devastating effects of physical climate risk.

Read the Full Report
Download

Watch: Empowering Public Private Collaboration in Infrastructure

S&P Global CEO Doug Peterson speaks with Maha Eltobgy from the World Economic Forum, on their joint study that looks at how greater collaboration between the public and private sector can accelerate national infrastructure programmes.