What can public and private builders learn from NVR's recent announcement of a $325 million convertible note offering, and its subsequent withdrawal 48 hours later?
Keep in mind that NVR is no ordinary builder in today's market. At the end of June, NVR had $867 million in cash and owed only $319 million of debt. NVR was attempting to raise $325 million when its cash balance exceeded debt by $548 million, nearly twice the offering size. Of the $319 million in debt, the first maturity due is $200 million in June 2010.
One principle of financing is, "Always raise money when you don't need it." While this may sound illogical, it is based on the reality that lenders lend when you don't need it and don't lend when you do.
And everyone understands the capital markets are in terrible disarray. From Indy Mac and Bear Stearns to Fannie Mae and Freddie Mac to Lehman Brothers and AIG, the erosion of real estate values has placed tremendous stress on mortgage securities.
Why would NVR attempt to raise capital amidst such chaos? One reason might be that while the credit markets aren't great today, NVR's expectations for the future may be even dimmer.
If a very well capitalized builder with a strong cash position can't raise capital at terms that make sense, how can others in worse financial straits raise capital? Like it or not, it's a capital-intensive business.
JPMorgan analyst Michael Rehaut, in a note to his clients after NVR announced its offering withdrawal, wrote: "Despite having ample liquidity and a superior balance sheet, in our view, NVR's recent exploration of a potential $325 million convert issue underscores increasing concerns related to a tightening credit market for the home building sector, which is only expected to deteriorate."
Rehaut added to his concerns, writing, "Accordingly, we continue to view deteriorating credit conditions for home builders, particularly with regards to the private builders, as a key deflationary force for land values, as companies are forced to sell assets."
I recently spoke to Rehaut, and he said, "It's uglier and uglier for credit in our sector." The credit markets are in a "pretty big state of flux."
We are reaching a critical inflection point for some publics and the vast majority of private builders. Since capital is the life blood of builders, we can expect that a lack capital, especially bank debt for privates and publics and public debt for publics, will have devastating consequences.
The NVR experience shows that capital markets, even for well-capitalized builders, are very dicey. Public and private home builders need to heed the call and develop strategies to survive. Sell homes to pay off debt and improve leverage, reduce overhead to improve earnings–or reduce losses–and generate cash to create flexibility.
What's more, we are at a point where builders need to understand the condition of their lenders. Lenders in trouble won't be able to lend no matter how well builders are performing. Builders must cultivate relationships with lenders willing and able to lend. They can't allow themselves to be at the mercy of lenders unable to live up to their commitments.
Opportunities present themselves in difficult times. Unfortunately for private builders, Rehaut holds a dim view, because access to bank debt is getting tighter. As he points out, "A number of public builders have cash positions of over $1 billion. Out of this downturn, public builders are going to increase their market share like never before."
Private builders can survive and prosper, but they must capitalize on their strengths and mitigate their weaknesses. Right now, there's no weakness like diminished access to capital.
Jamie M. Pirrello is CFO of Michael Sivage Homes and Communities, an Albuquerque, N.M.-based home builder with operations in San Antonio, Albuquerque, and Santa Fe, and CEO of Fort Myers, Fla.-based Vision Homes USA. He may be reached via e-mail at firstname.lastname@example.org.