Fitch Upgrades CalAtlantic Group's IDR to 'BB'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has upgraded the ratings of CalAtlantic Group, Inc. (NYSE: CAA), including the company's Issuer Default Rating (IDR), to 'BB' from 'BB-'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The upgrade of the company's IDR to 'BB' reflects the company's execution of its business model in the current moderately recovering housing environment, its land policies, and geographic diversity. The upgrade is also supported by the company's improving financial results and credit metrics following the merger with The Ryland Group (Ryland) in October 2015.

Risk factors include the cyclical nature of the homebuilding industry. The ratings also take into account CAA's recently implemented share repurchase program. In July 2016, CAA's board authorized a $500 million share repurchase program, replacing the previous $200 million authorization put in place in February 2016. Through the first ten months of 2016, CAA repurchased about $187 million of its stock, funded primarily with free cash flow.

IMPROVING FINANCIAL RESULTS AND CREDIT METRICS

The company completed its merger with The Ryland Group on Oct. 1, 2015 and the integration of the two companies has proceeded well and management has achieved its targeted annual synergy run rate of $80 million. CAA's homebuilding revenues during the first nine months of 2016 increased 22% on a proforma basis to $4.4 billion as home deliveries grew 13% and the average selling price advanced 8%. The company reported homebuilding pretax income of $505.6 million or 11.5% of homebuilding revenues during the first nine months of 2016, up from $383.7 million or 10.6% during the same period last year.

CAA's net debt (homebuilding debt less unrestricted homebuilding cash) to capitalization declined from 53.7% at the end of 2014 to 46.4% at the conclusion of 2015 and 45.1% as of Sept. 30, 2016. Debt to EBITDA improved from 4.5x at the end of 2014 to 4.0x for the latest-12-months (LTM) ending Sept. 30, 2016. Interest coverage rose from 3.1x during 2014 to 3.4x in 2015 and 4.0x for the Sept. 30, 2016 LTM period. Fitch expects further improvement in these credit metrics, including debt to EBITDA at or below 3.5x and interest coverage approaching 5x by the end of 2017, which are consistent with the positive rating triggers identified by Fitch last year. Additionally, net debt to capitalization is projected to be below 45% by the end of 2017.

LAND POSITION AND SPENDING

As of Sept. 30, 2016, the company controlled roughly 67,964 lots, of which 75.6% were owned and the remaining lots controlled through options and joint ventures. Total lots controlled increased 91% YOY as a result of the combination with Ryland, which closed on Oct. 1, 2015. On a pro forma basis, total lots controlled declined 10.3% YOY as the pro forma owned land position fell 4.9% and its lots under option fell 23%.

Based on LTM closings, CAA's total lots controlled declined from about seven years as of Sept. 30, 2015 to five years currently while owned lots fell from 5.8 years to 3.8 years currently. The company's current lot position is roughly in line with the average lot positions of issuers in Fitch's homebuilding coverage. The company ultimately wants to reduce its total controlled lots to about four years based on a trailing-12-months basis.

CAA's land and development spending totalled $1.6 billion on a proforma basis during 2015. Through the first nine months of 2016, CAA expended $1.15 billion on land and development activities. For all of 2016, the company is targeting approximately $1.7 billion of land and development spending. At this level of spending, Fitch expects CAA will be modestly cash flow positive for the year.

Fitch is comfortable with this real estate strategy given the company's strong liquidity position and management's demonstrated ability to manage its spending. Management reiterated that land and development spending will remain a priority, but the company will adhere to its strict underwriting guidelines. Additionally, Fitch expects management will pull back on spending if the current recovery in housing stalls or dissipates.

LIQUIDITY AND CASH FLOW

As of Sept. 30, 2016, CAA had unrestricted cash of $184 million and $491.1 million of availability under its $750 million revolving credit facility that matures in October 2019.

The company generated positive cash flow from operations (CFFO) of $112 million for the LTM period ending Sept. 30, 2016 after reporting negative CFFO of $362.4 million during 2014 and negative $271.5 million during 2015. Fitch expects CAA will generate positive CFFO of $150 million - $350 million during 2016 and perhaps a modestly higher amount in 2017.

CAA has meaningful debt coming due in the next 18 months, including $230 million of senior notes maturing in May 2017, $575 million of senior notes coming due in May 2018 and $225 million of convertible senior notes maturing in May 2018. Additionally, holders of the company's $253 million 1.25% convertible senior notes due 2032 may require the company to purchase all or any portion of their notes for cash on August 1, 2017. CAA has shown the ability to access the capital markets, issuing $300 million of 5.25% 10-year senior unsecured notes in May 2016. Fitch expects the company will access the capital markets to refinance its upcoming debt maturities.

GEOGRAPHIC DIVERSITY

CAA was the 5th largest U.S. homebuilder in 2015 (on a proforma basis) based on home closings. More importantly, according to management, CAA has a top 10 market share in 22 metropolitan statistical areas (MSAs), including a top five market share in 11 of the 25 largest MSAs. It is one of the most geographically diverse builders with operations in 41 markets across 17 states. Management estimates that about 22% of its third quarter 2016 deliveries were from entry-level buyers, 68% from move-up buyers, 8% from luxury buyers and 2% from the active adult sector.

HOUSING CONTINUES MODERATE RECOVERY

Though far from spectacular, the 2016 spring selling season was solid. Fitch is projecting single-family starts to expand 10% in 2016 while multifamily volume falls about 1%. Total starts would be roughly 1.18 million (up 6%). New home sales should improve about 14%, while existing home sales rise 3%.

The year 2017 could prove to be almost a mirror image of 2016. Economic growth should be somewhat stronger in 2017, although overall inflation should be more pronounced. Interest rates will rise further but demographics and employment growth should be at least as positive in 2017. First-time buyers will continue to gradually represent a higher portion of housing purchases as millennials are making an entry in the home-buying market and credit qualification standards loosen further. Land and labor costs will inflate more rapidly than materials costs. New home prices will continue to benefit from still-restrained levels of new home inventory, although a greater mix toward first-time/entry-level products will likely confine new home price appreciation to the low single digits.

Fitch projects single-family starts will expand 10% while multi-family volume grows about 1%. Total starts would be approximately 1.26 million, up 7% from 2016. New and existing home sales should advance 10% and 1.7%, respectively.

Longer term, there are regulatory risks, including uncertainty over the incoming administration's housing policies.

SOME EROSION IN AFFORDABILITY

The most recent Freddie Mac 30 year average mortgage rate increased more than 50 bps from 3.54% before the elections to 4.08% based in the most current survey. Of course, current rates are still well below historical averages and help moderate the effect of much higher home prices during the past few years. Income growth has been (and may continue to be) relatively modest. Nevertheless, there has been some lessening of affordability as the upcycle in housing has matured. The Realtor Association's composite affordability index peaked at 207.3 in the first quarter of 2012, averaged 176.9 in 2013, 165.8 in 2014, 165.7 in 2015 and was 167.5 in September 2016.

Affordability in the U.S. remains very good by historical standards, despite the increase in home prices. The home price/income ratio is at the lowest level in over 25 years and mortgage rates remain near historical lows. However, the abrupt increase in interest rates following the November 2016 elections could meaningfully erode affordability and trigger a temporary slowdown in demand. Such was the case in 2013 when interest rates increased from an average of 3.45% in April to 4.49% in September 2013. During the last two months of 2013 existing home sales (on a seasonally-adjusted basis) fell almost 10% compared with the level reported in July 2013. Fitch expects mortgage rates will be 40 bps-50 bps higher, on average, during 2017 compared with 2016.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for CAA include:

--Industry single-family housing starts improve 10%, while new and existing home sales grow 14% and 3.0%, respectively, in 2016. Fitch expects the housing upcycle to continue in 2017, with single-family housing starts advancing 10% while new and existing home sales improve 10% and 1.7%, respectively;

--CAA's homebuilding revenues increase about 7% - 10% in 2017;

--The company's net debt to capitalization ratio settles at about 46% at the end of 2016 and below 45% at year-end 2017;

--CAA generates cash flow from operations of $150 million to $350 million during 2016 and perhaps a modestly higher amount in 2017;

--The company makes moderate share repurchases, funded primarily with FCF;

--CAA maintains an adequate liquidity position (above $500 million) with a combination of unrestricted cash and revolver availability.

RATING SENSITIVITIES

Additional positive rating actions may be considered if CAA shows further steady improvement in credit metrics (such as net debt to capitalization ratio consistently approaching 40%), while maintaining a healthy liquidity position (in excess of $700 million in a combination of cash and revolver availability) and continues generating consistent positive cash flow from operations as it manages its land and development spending.

Negative rating actions may be considered if there is sustained erosion of profits due to either weak housing activity, meaningful and continued loss of market share, and/or ongoing land, materials and labor cost pressures (resulting in margin contraction and weakened credit metrics, including net debt to capitalization sustained at or above 50%) and CAA maintains an overly aggressive land and development spending program that leads to consistent negative cash flow from operations, higher debt levels and diminished liquidity position. In particular, Fitch will be focused on assessing the company's ability to repay debt maturities with available liquidity and internally generated cash flow.

Negative rating actions may also be considered if the company executes on a meaningful share repurchase program that is funded primarily by debt, leading to weaker credit metrics and diminished liquidity position

FULL LIST OF RATING ACTIONS

Fitch has upgraded the following ratings for CalAtlantic Group, Inc.:

--Long-Term IDR to 'BB' from 'BB-';

--Senior unsecured debt to 'BB/RR4' from 'BB-/RR4';

--Unsecured revolving credit facility to 'BB/RR4' from 'BB-/RR4'.

The Recovery Rating of '4' for CAA's unsecured debt and revolving credit facility support a rating of 'BB', and reflects average recovery prospects in a distressed scenario.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and interest expense included in cost of sales and also excludes impairment charges, land option abandonment costs and merger-related costs and charges.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1015981

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015981

Endorsement Policy

https://www.fitchratings.com/regulatory

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