North American homebuilding companies have generally been issuing bonds with the weaker covenant packages more typical of investment-grade deals, says Moody’s Investor Service.
This is happening despite the bonds having almost exclusively non-investment grade ratings.
In its report “Valuable Inventory Key to HY-Lite Deals’ Dominance Among Homebuilders,” Moody’s says the homebuilding industry features bonds with the weakest average overall covenant quality score of any North American non-financial corporate sector.
HY-Lite deals are transactions that lack a restricted-payment covenant or a debt-incurrence covenant or both and are most common among investment-grade issuers.
Specifically, these HY-lite transactions constitute 65% of the bonds issued by North American homebuilders, compared with 20% of all North American bonds.
The average credit rating of homebuilders is B1 and only one company has an investment-grade rating.
“Homebuilders are also negotiating lower coupon rates for their bonds than the average speculative-grade issuers in North America,” says a Moody’s Assistant Vice President – Analyst, Tiina Siilaberg.
HY-lite homebuilding deals in 2014 have had an average coupon of 5%, while the average for all HY-lite transactions has been 5.4%.
In 2014, homebuilders, regardless of their covenant structure, average a 5.5% coupon, while North American non-financial companies overall average a 6.2% coupon.
Homebuilders can negotiate the weaker covenant packages and lower coupon rates because they have a strong, non-depreciating asset base, says Moody’s. That asset base is inventory, which includes land and work in process.
“Land will never become obsolete and having prime land on the balance sheet of the issuing entity is unmatched in the eyes of lenders,” Siilaberg says.
The new report is the latest in a series exploring the covenant quality of bonds issued by specific industries, based on Moody’s Covenant Quality Database.
The report and more information is available through Moody’s.