Capital concerns are costing home builder executives sleep at night, as companies inch ever closer to tripping debt covenants–if they haven't already. Once in noncompliance, lenders have the right to demand immediate repayment of some or all of the debt. And for many builders, a repayment of any significant amount could take the business out at the knees.
To avoid a trip to bankruptcy court, builder executives are spending more time with their lenders, trying to renegotiate debt terms. Most have succeeded to date.
Steve Roberts, CEO of Atlanta-based McCar Homes, says his management team uses a soft-sell approach rather than tough guy tactics to secure more favorable debt terms. "In general, what we've done is be very, very focused on all of our relationships," he says. "There's a trust level that replaces the need to negotiate as much."
But a solid relationship may not cut it for long. Housing's woes have seeped into the financial sector, and banks are feeling the squeeze. As their executive teams come to grips with poor year-end results and regulators begin evaluating loan portfolios in early 2008, lenders will look for cold, hard cash rather than handshakes and promises.
The threat of full or partial loan repayments has builders scrambling for cheap, alternative sources of debt to keep from going belly up. Private equity funding is far too expensive; even the costs of maintaining existing credit revolvers appear steep in this market's light. In fact, some builders, including Standard Pacific Homes and TOUSA, are amending their revolvers.
But the one thing that is looking cheap these days is builder equity. And for builders facing a liquidity crisis, an equity deal may be the only solution–albeit one that comes with its own set of headaches.
For example, the executive team at Levitt Corp. recently generated $153 million from an equity offering that gave existing shareholders the chance to buy up to 5.04 new shares for each share owned. Management may use the funds to pay down debt or obtain new financing. The offering's opponents argued that the deal only benefited large shareholders such as BFC Financial, effectively diluting ownership for smaller players.
Dilution was also a big consideration for Standard Pacific when committing to an offering of $100 million in convertible senior subordinated notes. The deal allows the company to sell long-term debt to investors, similar to a bond transaction, but investors can then convert to cash or shares, in 2012. To offset any potential decline in the stock price due to the issuance of the convertibles, the management team is establishing a hedge position, in which it would lend a portion of company-owned shares to a financial group that would effectively short the borrowed shares on the open market.
Santosh Sreenivasan, an executive director for equity-linked capital markets with J.P. Morgan Securities, expects to see more convertible securities hit the home builder sphere, as builders look to refinance debt coming due; they carry lower interest rates than straight debt.
Layoffs at Levitt
The Florida builder's troubles portend another slew of job cuts.
Levitt Corp.'s decision to layoff as many as 200 employees bodes ill not only for the Florida-based company but also the industry as a whole. The announcement is likely to be a kick off to another round of job cuts as home builders limp closer to the close of their fiscal years.
Levitt's reduction in force represents an approximate 35 percent drop in payroll numbers. Most of the cuts, which took place in one fell swoop in mid-September, came out of the company's mainstay home building subsidiary, Levitt and Sons.
In a letter to employees dated Sept. 18, CEO and chairman Alan Levan says the company's inability to boost sales numbers despite "incentives, dramatic price reduction, and aggressive marketing" is to blame. Couple feeble sales figures with more than $10 billion in land and inventory impairments taken in the past 18 months, and the firm's balance sheet is showing distress.
To keep the company alive, Levitt's management team raised significant capital by putting together a controversial multi-million-dollar equity rights offering, which allows shareholders to purchase additional shares in the company based on percentage ownership. However, in the letter, Levan warns that "the funds raised in the offering will not necessarily be used to support Levitt and Sons or its home building activities."
But Levan isn't alone in being forced to cut sling load. Housing-related firms recently posted a record number of layoffs as troubles in the subprime mortgage market reached a boil, according to a recent job cut report by Challenger, Gray & Christmas, a global outplacement consultancy. By the close of August, nearly 32,000 jobs were cut from the housing industry, which includes construction, real estate, and related financial businesses. That figure represents roughly 10,000 more jobs lost in a single month than in all of 2006.
At a Glance: Fischer Homes
Curious to know who's got the biggest builders on the run in some of the most attractive markets? Check this one out.
- Founded by Henry Fischer in 1980, Fischer Homes projects $190 million in total revenue and 920 closings for 2007.
- The Kentucky Society for Human Resource Management (SHRM) state council and the Kentucky Chamber of Commerce recognized Fischer Homes as one of the "2007 Best Places to Work in Kentucky."
- Fischer Homes is currently selling more than 45 homes in the Indiana, Ohio, and Kentucky markets. It builds single-family homes, patio homes, and condos.
Fischer Homes has been around for more than 25 years. The company uses community partnerships to get its name out there in a challenging market. It's participating in the St. Jude Dream Home, where it will build a home for raffle. People can buy a $100 ticket to enter the drawing. All proceeds go to St. Jude Children's Research Hospital. In its community of Tree Tops in Hebron, Ky., Fischer Homes also hosted a "Dog Days of Summer" event on July 21. The event gave families the opportunity to adopt a pet and allowed The Kenton County K-9 Unit to show off its police dogs.
The Deal to Beat
Hovnanian Enterprises' national sales bonanza nets 2,100 sales in a weekend without giving away the kitchen sink.
Despite the hype, Hovnanian Enterprises' "Deal of the Century" really wasn't much of a deal for buyers. However, few realized that fact. The promotion generated more than 2,100 sales for the New Jersey-based builder, but it did so without lowering the average weighted cost per home, which is roughly $323,000, according to CEO Ara Hovnanian. The 31-state sale took place Sept. 14 to Sept.16.
Keeping in line with established sales strategies, discounts were market specific. In relatively solid markets such as Houston, for example, buyers had access to limited incentives. In other markets, the deals offered better value. But the difference this time around was the national promotional blitz.
To generate intense interest for its Deal of the Century, the company mounted an aggressive promotional campaign. Heavy use was made of radio, and the publicity effort landed the Hovnanian sale the lead slot on at least one television network news broadcast. CFO Larry Sorsby will not disclose how much the company spent in marketing for the weekend sales blitz, but one person who was involved in the promotion in the Southwest but would not speak for attribution says the effort included a 30 percent boost in the marketing budget.
As of press time, it was unclear how many of the 2,100 buyers actually qualified. But in Chicago, for instance, the company's Town and Country subsidiary took 72 reservations; 50 of those buyers signed purchased agreements the following week. Personal credit issues, contingency sales, and buyer's remorse kept the remaining 22 from signing on a new-home.
Hovnanian says when the sale was first envisioned, he hoped to sell between 700 and 800 homes. By surpassing that goal, he says his company now has one of the lowest inventory levels in the industry at a 2.7-month supply. "Clearly this sale will be beneficial to cash flow and inventory reduction," he says.
The news of the sale's success buoyed Standard Pacific Homes CEO Steve Scarborough's spirits. "We have a smaller campaign that is in progress in Southern California ? for a 10-day period," he states. It's too early to count it a success, but the preliminary numbers look good. The company had 70 sales over a weekend.
But other builders are hesitant to follow suit. "We continue to price to market conditions, but as we went through the third quarter, we saw so many competing [cost cutting] programs to dramatically reduce inventory that it kind of got to the point where pricing was unrealistic and even ridiculous," says Stuart Miller, CEO of Lennar Corp. "I think you have to be sensible as you work through market conditions like this. What we don't want to do is jump into the toughest competitive environments and sell things at below a reasonable price point."
Builders on the private side of the spectrum say they can't afford to offer such big discounts. "Public builders don't have to make sense," says Stephen Palmer, CFO of Atlanta-based Bowen Family Homes. "They can do what Wall Street wants them to do. They can give away houses below cost, whereas we really don't want to. That's not a recipe for success."