Fitch Affirms Woodside's IDR at 'B'; Outlook Stable

Fitch Ratings has affirmed the ratings of Woodside Homes Company, LLC (Woodside), including the company's Issuer Default Rating (IDR) at 'B'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The ratings and Outlook for Woodside reflect the company's execution of its business model in the current housing environment, improving financial and operating results, customer and price point diversity, adequate liquidity position, and the cyclically improving industry outlook for 2014 and 2015. While the company has an established presence in Arizona, Nevada, Texas and Utah, the company's operations remain heavily weighted to California, albeit spread out through a variety of submarkets.

INITIAL PUBLIC OFFERING

On June 25, 2014, Woodside submitted its filing with the SEC to raise up to $200 million in an initial public offering (IPO). The company intends to use the proceeds from the IPO for growth, including the acquisition and development of land, and for general corporate purposes. The company also intends to use a portion of the net proceeds to make an offer to all of its existing owners to purchase a portion of the LLC Units held by these owners.

THE INDUSTRY

What began as an untypically moderate housing recovery has decelerated since late 2013. But demographics, attractive housing valuations, and a slow, steady easing in credit standards should sustain and ultimately accelerate the upturn. The latest macro statistics are encouraging.

To reflect the subpar spring selling season, as well as the more guarded expectation for the next few months, Fitch has tapered its macro housing forecast. Single-family starts are now projected to improve 9.5% to 677,000 (down from Fitch's previous forecast of a 15% improvement) and multifamily volume grows almost 12% to 343,000. Total starts this year should still slightly exceed 1 million. New home sales are forecast to advance about 8% to 465,000 (down from Fitch's prior forecast of 500,000), while existing home sales volume is expected to decline 5% to 4.835 million (down from Fitch's earlier estimate of 5.1 million), largely due to fewer distressed homes for sale.

Growing strength in the economy, employment and demographics should positively influence housing next year. Total housing starts are projected to expand 16% to 1.185 million as single-family starts advance 21% and multifamily volume gain 6.7%. New home sales should improve more than 20%, while existing home sales rise 5%.

SOME EROSION IN HOME AFFORDABILITY

The most recent Freddie Mac 30 year average mortgage rate was 4.13%, down 2 bps sequentially from the previous week and about 70 bps higher than the average rate during the month of January 2013, a recent low point for mortgage rates. While the current rates are still well below historical averages, the sharp increase in rates and considerably higher home prices in 2013/2014 have moderated affordability. Fitch projects mortgage rates will average 35-50 bps higher in 2014 (relative to 2013) as the Fed continues to taper and the economy strengthens.

New home price inflation should moderate in 2014, at least partially because of higher interest rates. Average and median new home prices should increase about 3.5% in 2014. However, Fitch's expectations of a more dynamic economic expansion this year with stronger job growth will more than offset this lessening in affordability. This will be particularly the case for the move-up and active adult markets.

WEAKNESS IN NET ORDERS

There has been some short-term volatility in certain housing metrics following the increase in interest rates and higher home prices during the past year as well as harsh winter weather conditions in some parts of the country earlier in 2014.

For the public homebuilders in Fitch's coverage, net order gains substantially slowed or turned negative during the second half of 2013 (2H'13) and into the first quarter 2014 (1Q'14) following strong gains in 2012 and 1H'13. On average, net orders for these builders fell 0.1% during 1Q'14 after declining 2.1% during 4Q'13. Net orders grew 1.5% in 3Q'13, 16.8% during 2Q'13 and 28.2% during 1Q'13. Fitch expects somewhat better year-over-year (yoy) net order comparisons during 2H'14.

Woodside's new home orders fell 21.4% during 1Q'14 and 5.3% during 2H'13 following a 14.3% increase during 1H'13. Cancellation rates increased 470 bps to 13.9% during 1Q'14 from 9.2% during 1Q'13. The company's monthly net sales per average active selling community declined 45.2% to 2.3 home sales during 1Q'14 compared with 4.2 homes during 1Q'13. Woodside has underperformed the public builders' average change in yoy net orders since 2H'12.

While there has been some weakness in housing activity so far in 2014, Fitch expects the housing recovery will continue over the course of the full year 2014. As Fitch noted in the past, the housing recovery will likely occur in fits and starts.

LIQUIDITY

Woodside currently has adequate liquidity, with $39.7 million of unrestricted cash as of March 31, 2014 and no borrowings under its $40 million unsecured revolving credit facility. The company's revolver has an accordion feature that allows the borrowing capacity to be increased up to $100 million, subject to obtaining additional commitments. The company expects to obtain additional commitments to increase the facility to $100 million.

Subsequent to the end of the March 2014 quarter, Woodside completed the issuance of an additional $50 million of its 6.75% senior unsecured notes due 2021. This debt issuance, together with the planned IPO, will further enhance Woodside's liquidity profile, allowing the company to fund increased land and development spending.

MANAGEMENT STRATEGY

Woodside emerged from bankruptcy at the end of 2009 with a new senior management team and successfully recapitalized its balance sheet during the third quarter of 2012, raising $127.7 million of debt and $75 million of equity. During the third quarter of 2013, the company issued $220 million of senior unsecured notes due 2021 and repaid $127.7 million of 9.75% senior secured notes due 2017.

Following its emergence from bankruptcy, management focused on the company's core homebuilding operations and transitioned from a national builder to a western regional homebuilder, with operations in California, Nevada, Arizona, Utah and Texas. As part of this process, the company sold projects and land holdings in five Eastern Divisions in the states of Florida and Minnesota and in metropolitan Washington DC.

Woodside has relatively heavy exposure to California, albeit spread out through a variety of submarkets. The state of California represented about 55% of 2013 closings. Fitch expects the reliance on California will remain material in the near to intermediate term as lots in this state still account for about 40% of total lots controlled as of March 31, 2014.

LAND STRATEGY

The company seeks to maintain at least a three-year supply of owned lots and control an additional one to two years of lots. As of March 31, 2014, the company owned 6,156 lots and controlled an additional 3,478 lots through options and purchase agreements, representing approximately 4 years of owned lots and 6.3 years of controlled lots based on latest-twelve-months (LTM) closings.

As is the case with other large homebuilders, the company is rebuilding and enhancing its land position and trying to opportunistically acquire land at attractive prices. Total lots controlled as of March 31, 2014 increased 40.3% yoy, driven by a 163.5% growth in optioned lots and an 11% rise in owned lots.

Woodside expects to spend roughly $214 million on land acquisition and an additional $102 million on land development during 2014. Fitch is relatively comfortable with this strategy given the company's liquidity position (including the planned IPO). Fitch expects management will pull back on spending if the expected recovery in housing stalls or dissipates.

IMPROVING FINANCIAL RESULTS

The company's financial results and credit metrics improved in 2013 relative to 2012 levels. Woodside reported a 17.9% increase in home deliveries during 2013 and homebuilding revenues grew 39.4% compared to 2012. Fitch-calculated EBITDA margins gained 480 bps to 12.8% during 2013 compared with 2012. This improving trend continued during 1Q'14, with homebuilding revenues increasing 24.8% and EBITDA margins expanding almost 500 bps.

Leverage as measured by debt to Fitch-calculated EBITDA improved to 3.6x for the LTM period ending March 31, 2014 from 3.9x at the end of 2013 and 4.8x at the conclusion of 2012. Fitch expects leverage will settle around 3.5x at year-end 2014. Interest coverage also improved to 3.9x for the LTM period ending March 31, 2014 from 3.2x during 2013 and 1.3x during 2012. Interest coverage is forecast to approach 4.5x at the conclusion of 2014.

RATING SENSITIVITIES

Future ratings and Outlooks will be influenced by broad housing market trends as well as company specific activity, such as trends in land and development spending, general inventory levels, speculative inventory activity (including the impact of cancellation rates on such activity), gross and net new order activity, debt levels, free cash flow trends and uses, and the company's cash position.

The Outlook or rating for Woodside could be raised in the next 6-12 months if the company performs in line with Fitch's expectations (including leverage consistently below 4.5x and interest coverage sustaining above 3x), the various housing metrics are trending towards Fitch's macro forecast and the company has liquidity (combination of cash and revolver availability) of at least $75 million.

Negative rating actions could occur if the recovery in housing dissipates; revenues decline 15% - 20%; EBITDA margins fall below 10% and Woodside maintains an overly aggressive land and development spending program. This could lead to consistent and significant negative quarterly cash flow from operations and meaningfully diminished liquidity position (below $40 million.)

Fitch has affirmed the following ratings for Woodside with a Stable Outlook:

--Long-term IDR 'B';

--Senior unsecured notes 'B/RR4'.

The 'RR4' Recovery Rating (RR) on the company's unsecured debt indicates average recovery prospects for holders of these debt issues. The recovery analysis assumes that the company increases its revolver commitment to $100 million from $40 million. Additionally, Woodside's exposure to claims made pursuant to performance bonds and the possibility that part of these contingent liabilities would have a claim against the company's assets were considered in determining the recovery for the unsecured debt holders. Fitch applied a going concern valuation analysis for this RR.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=840929

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