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Moody's Lowers Unsecured Rating of M.D.C. Holdings (MDC) to 'Ba1'; Outlook Stable

September 29, 2014 2:04 PM EDT

Moody's Investors Service lowered the Baa3 senior unsecured rating of M.D.C. Holdings (NYSE: MDC) and assigned the company a corporate family rating of Ba1 and a probability of default rating of Ba1-PD. The four issues of senior unsecured notes were lowered to Ba1 as well. In addition, Moody's assigned MDC a speculative grade liquidity rating of SGL-2. This action concludes the review for downgrade that commenced on September 11, 2014. The outlook is stable.

The following ratings were affected by this action:

Ba1 Corporate Family Rating assigned;

Ba1-PD Probability of Default Rating assigned;

Senior Unsecured Ratings downgraded to Ba1 (LGD4, 51%) from Baa3

SGL-2 Speculative Grade Liquidity Rating assigned;

RATINGS RATIONALE

The downgrades reflect that contrary to our previous expectations, MDC will be unable to restore any of its key credit metrics to investment grade levels, with the possible exception of adjusted debt leverage, for at least two more years, without having the formerly very strong mitigant of a sizable net cash position. After holding a net cash position for five years, which had been a distinguishing strength of the company, MDC now has a net debt position that is likely to widen, largely because of increasing land spend. While we still expect MDC to report progress in improving its key credit metrics, the gains will simply not be fast enough or strong enough to restore them to investment grade levels within the ratings horizon.

The Ba1 corporate family rating considers MDC's conservative financial policy, cautious land strategy, and clean and transparent balance sheet, notably its lack of off-balance sheet recourse obligations such as joint venture debt and specific performance lot option contracts. Additionally the rating incorporates positive net income generation and our view that positive industry conditions will result in further expansion of earnings in 2015.

At the same time, we recognize that while improving, many of the company's traditional credit metrics remain weak for a Ba1 credit, although they have improved nicely from the lows reached at the depth of the downturn. MDC's rating is also constrained by the accelerating land spend due to its strenuous efforts to grow its community count and the resulting negative cash flow generation.

MDC's good liquidity profile is reflected in its SGL-2 speculative-grade liquidity rating, which balances the company's unrestricted homebuilding cash and investments position of $592 million at June 30, 2014 and the availability under its $450 million senior unsecured revolving credit facility due December 2018 against our expectation for negative cash flow generation, the need for the company to maintain covenant compliance, and its somewhat limited opportunities to monetize excess assets quickly. The revolver has an accordion feature that would allow its total capacity to be increased to $1.0 billion. The financial covenants with which MDC will need to maintain compliance include a tangible net worth test, leverage ratio, and interest coverage ratio. In our view, the company's liquidity is likely to weaken somewhat from its increasing land spend and negative cash flow, which will result in a growing net debt position. Nevertheless, we still expect MDC to maintain its covenant compliance relatively easily over the next 12 to 18 months.

The outlook could be changed to positive if the company demonstrates significantly stronger than expected progress in restoring key credit metrics to investment grade levels while maintaining strong liquidity.

The ratings could come under pressure if the company's earnings growth slows, homebuilding debt leverage does not continue to decline and stay in the low 40% range, EBIT interest coverage remains below 5.0x, gross margins remain below 20%, and/or if liquidity weakens significantly. Further, the ratings could be lowered if the company made a sizable debt-financed acquisition or instituted a material share repurchase program.

The principal methodology used in this rating was Global Homebuilding Industry published in March 2009. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.



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