Moody's Investors Service on October 31 slapped all of the ratings of D.R.Horton, Inc. the Ryland Group, Inc. with an "under review" designation, which could lead to a downgrade in the debt to junk status.
The review includes the Baa3 rating on both companies' senior unsecured notes and the Ba1 rating on Horton's senior subordinated notes.
A downgrade, should it occur, would primarily affect the value of existing debt to traders and investors. The traditional markets for new debt offerings have been largely closed to the home-building sector as it has been hamstrung by the persistent slump in the housing market and the overall credit markets have contracted in the wake of the subprime mortgage collapse.
Moody's said its review will focus on "the ability of the two companies to reduce actual inventory levels going forward." It noted that "the bulk of Horton's inventory reduction has been driven through accounting charges, such as impairments, option abandonments, and other write-downs." And it noted that Ryland's inventory reduction has come up short of "industry leaders" including NVR, MDC and KB Home.
Moody's said it will also focus on whether the companies will be able to maintain positive cash flow in the face of their "limited success" in reducing inventory, high cancellation rates and, in Horton's case, an "elevated level of spec inventory."
Also under review will be whether the companies can ever return to profitability when write-offs and impairments are included in results. In the announcement of the review, the ratings service stated, somewhat bluntly, that " Moody's expects investment grade companies, even in cyclical industries, eventually to return to profitability, even with charge-offs."
Moody's also said it will look at whether the companies are acting to clear high levels of debt off their balance sheets and whether they will be able to keep a "comfortable cushion in their bank covenant compliance tests." The service put a deadline of 2009 on both companies to "reverse their current underperformance on key credit metrics."