Fitch Upgrades Hovnanian Enterprises, Inc.'s IDR to 'CCC' from Restricted Default

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NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has upgraded the Issuer Default Rating (IDR) of Hovnanian Enterprises, Inc. (NYSE: HOV) to 'CCC' from Restricted Default (RD). Fitch lowered Hovnanian's IDR to RD on Nov. 2, 2011 following the completion of the company's debt exchange offer, which Fitch viewed as a distressed debt exchange.

In addition, the following ratings are affirmed:

--Senior secured notes at 'B-/RR3';

--Senior unsecured notes at 'C/RR6';

--Series A perpetual preferred stock at 'C/RR6'.

Fitch has also assigned a 'CC/RR5' rating to the company's new $141.8 million 5% senior secured notes and $53.2 million 2% senior secured notes due 2021.

The rating for HOV is influenced by the company's execution of its business model, land policies, and geographic, price point and product line diversity. The rating additionally reflects the company's liquidity position, substantial debt and high leverage. The rating also incorporates the still challenging housing environment. With the soft economy and lowered economic growth expectations for 2011 and 2012, the environment may at best support a relatively modest recovery in housing metrics over the next year and a half.

The company ended the July 2011 quarter with $273.4 million of unrestricted cash on the balance sheet and no major debt maturities until calendar 2014, when approximately $42.9 million of senior notes become due. While the company currently has an adequate liquidity position, Fitch is somewhat concerned that the company is willing to lower its target level for unrestricted cash to between $110 million and $185 million to take advantage of land acquisition opportunities. Given that the company terminated its revolving credit facility during the fourth quarter of 2009, Fitch is concerned that this level of cash does not provide a large enough liquidity cushion in the event that the current low levels of housing activity persist longer than anticipated or gravitate lower. The absence of a bank credit facility also means a lack of bank oversight, which is a useful check on management's appetite for risk.

HOV spent roughly $305 million on land and development during the first nine months of fiscal 2011. This compares to $287.9 million of new land purchases during fiscal 2010. For the 12-month period ending July 31, 2011, the company had $238.7 million of negative cash flow from operations (CFO).

A weak operating environment over the next 12-18 months will likely result in continued losses and negative CFO for the company, thereby eroding its cash position. Fitch currently projects HOV's unrestricted cash position will be between $125 million and $150 million by year-end 2012. Should the depressed level of housing starts and weak new non-residential construction spending persist beyond 2012, HOV's liquidity could deteriorate further and lead to additional negative rating actions.

At July 31, 2011, the company controlled 32,185 lots (including unconsolidated joint ventures), of which 59.2% were owned and the remaining lots controlled through options and joint venture partnerships. Based on the latest 12-month (LTM) closings, HOV controlled 7.6 years of land and owned roughly 4.8 years of land.

As expected, the housing recovery has been irregular so far and to date quite anemic. Various housing and related statistics appear to have bottomed in early to mid-2009. Since then, the on, off, then on again federal housing credit at times spurred or at least pulled housing demand forward. With the U.S. economy moving from recession to expansion in the third quarter of 2009, plus very attractive housing affordability and government incentives, housing was jump-started. However, faltering consumer confidence, among other issues, has restrained the recovery so far.

Fitch currently projects new single-family housing starts will drop 13.1% in 2011 following 5.8% growth in 2010. After falling 14.1% in 2010, new home sales are forecast to decrease about 7% in 2011. Fitch expects existing home sales to slip 2% in 2011 after a 4.8% decline in 2010. In a moderately growing economy in 2012, housing metrics could modestly expand, off a very depressed base.

Future ratings and Outlooks will be influenced by broad housing-market trends as well as company specific activity, such as trends in land and development spending, general inventory levels, speculative inventory activity (including the impact of high cancellation rates on such activity), gross and net new order activity, debt levels and especially free cash flow trends and uses, and the company's cash position. Negative rating actions could occur if the anticipated recovery in housing does not materialize and the company prematurely steps up its land/development spending, leading to consistent and significant negative quarterly CFO. HOV's rating is constrained in the intermediate term due to weak credit metrics and high leverage.

Fitch's Recovery Rating (RR) of 'RR3' on HOV's senior secured notes indicates good recovery prospects for holders of these debt issues. The 'RR5' on the new senior secured notes indicates below-average recovery prospects in a default scenario. The 'RR6' on HOV's senior unsecured notes, senior subordinated notes and preferred stock indicates poor recovery prospects in a default scenario. HOV's exposure to claims made pursuant to performance bonds and the possibility that part of these contingent liabilities would have a claim against the company's assets were considered in determining the recovery for the unsecured debtholders. Fitch applied a liquidation value analysis for these RRs.

Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 12, 2011);

--'Distressed Debt Exchange' (Aug. 12, 2011);

--'Liquidity Considerations for Corporate Issuers' (June 12, 2007.

Applicable Criteria and Related Research:

Liquidity Considerations for Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

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