TEXT-S&P rates Brookfield Residential Properties 'B+' CCR
Overview -- Brookfield Residential Properties Inc. (BRP) is a North American homebuilding and land development company with land holdings that ranks among the largest of the homebuilders that we rate. -- We are assigning a 'B+' corporate credit rating to the company and a stable outlook. -- We are also assigning a 'BB-' issue-level rating and a '2' recovery rating to the company's proposed $400 million senior unsecured notes. -- The stable outlook reflects our expectation that growth will largely come from U.S. homebuilding and land development as that market recovers and that the Canadian operations will remain stable. Rating Action On Dec. 4, 2012, Standard and Poor's Ratings Services assigned its 'B+' corporate credit rating to Brookfield Residential Properties Inc. (BRP). The outlook is stable. At the same time, we assigned a 'BB-' issue-level rating and a '2' recovery rating to the proposed offering of $400 million of senior unsecured notes due 2020, guaranteed by all the current and future restricted subsidiaries of the issuer other than U.S. project subsidiaries. The '2' recovery rating indicates prospects for a substantial recovery (70% to 90%) of principal in the event of payment default. The company plans to use proceeds from the notes to repay existing notes payable provided by Brookfield Office Properties Inc. ('BBB/Negative'), borrowings under an unsecured revolving facility provided by Brookfield Asset Management Inc. (A-/Negative/A-2), and other project and bank debt. Rationale The ratings on BRP reflects our assessment of an "aggressive" financial risk profile, reflecting weak EBITDA-based metrics (although book leverage is moderate), reliance on secured project level debt and potential near term refinancing risk due to on-demand secured credit facilities. We view the business risk profile as "weak". Brookfield's operations rely on the cyclical and capital intensive land development and homebuilding businesses. While we believe the nascent housing recovery in the U.S. will continue in 2013, we do acknowledge there are headwinds, and a significant proportion of BRP's future growth is reliant on growth derived from its U.S. operations, which is dependent on a continued recovery in the U.S. housing market and third party demand for lots. BRP's Canadian operations are heavily concentrated in Alberta but we expect BRP's operations in Alberta, as well as Ontario, will remain steady over the next one to two years. Toronto, Ontario-based BRP is a land developer and homebuilder operating in three Canadian markets and seven U.S. markets. Brookfield entitles and develops land and constructs homes on a portion of its lots and sells the bulk of its lots to third-party builders. BRP was formed on March 31, 2011, when Brookfield Homes Corp. merged with the former residential land and housing division of Brookfield Office Properties. Brookfield Asset Management Inc. (BAM), the ultimate parent company, retains ownership of approximately 72% of Brookfield Residential Properties Inc. While we do not ascribe support from 'A-'-rated Brookfield Asset Management's ownership of a large stake in BRP, we believe its significant stake may provide some incentive to support BRP in the event of temporary pressure. BRP delivered 1,295 homes and sold an additional 3,474 lots in 2011 and has sold 1,083 homes and 1,123 lots through the first three quarters of 2012. BRP's five largest markets were Calgary (45%), Edmonton (17%), Toronto (16%), Washington, D.C. (8%), and San Diego/Riverside (6%). Brookfield's operations are heavily concentrated in the Western Canadian markets, which has exhibited strong performance, but is heavily reliant on the health of the energy sector. We would expect this concentration to decline as the U.S. housing market recovers and becomes a larger proportion of revenues and profits. Lots controlled by market show a more balanced mix with 52% of lots in Canada and 48% in the U.S. It's likely that the revenue and profit mix over the next few years will skew more prominently toward the homebuilding operations, with greater growth out of the U.S. side of the business. We believe the company's mix of both homebuilding and land development, as well as its geographic footprint provides some additional diversity compared with many of its homebuilder peers. Notably, BRP's land development business remained profitable through the recent recession due primarily to the stability of the Canadian housing market. BRP is the fifth-largest landholder among the homebuilders that we rate, with about 107,000 lots under control, of which roughly 85% are raw and 55% are unentitled. We estimate that Brookfield has about a 12-18 month supply of lots that are either finished or under development that do not require significant capital to monetize through land sales or homebuilding. Brookfield typically builds on about 15%-20% of its developed lots in a given year while the rest is sold to other homebuilders or commercial developers. However, in certain land constrained markets, such as Toronto and the San Francisco area, BRP will typically utilize its lots exclusively for its own homebuilding operations. Many U.S. homebuilders have reduced their platforms and lot holdings in response to the deep and protracted downturn. As a result, U.S homebuilders have been investing in new inventory in healthier markets to grow volume and strengthen margins as they strive to return to consistent profitability. As the U.S. housing market continues to recover, we expect builders will remain focused on acquiring new lots in healthier U.S. housing markets, which has become more competitive. This could be a competitive advantage for BRP, given its ability to be a supplier of lots to builders. Normalized land revenues, excluding impact from accounting changes, represented about 35%-40% of total revenues over the past three years. Normalized gross profit was more concentrated toward the land business over the past three years accounting for 60-70% of gross profits, due to stronger land margins compared with the homebuilding margin. We expect profits from the homebuilding business will grow more rapidly and the mix will reverse in 2013 or 2014 with homebuilding accounting for the majority of BRP's profits. We think the company will also be able to generate cash in the near term as its land reinvestment needs are considerably lower than the peer group. However, the company will likely continue to be opportunistic, pursuing land acquisition and development, which requires significant capital. Brookfield's land development and homebuilding operations require significant capital to take raw land through the entitlement process and ultimately develop land into saleable/buildable developed inventory. Recent operating performance has shown marked improvement, consistent with the rest of the sector. Home closings were up 27% for the three months ended Sept. 30, 2012. The average sales price of a home edged up to $384,000, up from $366,000 a year earlier. Orders and sales backlog, which are fairly reliable indicators of future closings, were up 18% to 461 homes and 36% to 1,095 homes, respectively. Brookfield also benefits from very low cancellations in the Canadian market (less than 1%) compared with the U.S. market due to structural differences in these housing markets. Cancellations in the U.S. market have been similar to peers (14% in California and 20% in Central and Eastern U.S. markets for the nine months ended Sept. 30, 2012). Third quarter gross margin for the combined Canadian and U.S. homebuilding operations was 17%-18%, with Canada estimated to be closer to 20% and the U.S weaker in the 15% range. Land sales have been consistent with the prior year, with gross margins near 50%. Aggregate gross margins have been around 28%, which is strong relative to most homebuilders, given stronger margins within the land development business. The company's asset base is $2.8 billion, 83% of which is land and housing inventory. BRP's debt, prior to the note issuance, consisted of $488 million of debt owed to Brookfield Office Properties, $282 million outstanding under an unsecured credit facility due to BAM, $357 million of project specific financings, $325 of secured bank credit facilities, and $9 million of additional unsecured credit facility borrowings. The equity base was $1.03 billion at Sept. 30, 2012. Trailing-12-month debt-to-EBITDA was high at 6.6x as of Sept. 30, 2012, EBITDA interest coverage was 2.8x and debt-to-total-capitalization was 58%. Leverage metrics improved after the quarter ended when BRP issued $222 million of equity, with BAM taking half of the allotment in a private placement, using proceeds to repay debt. The company expects to use the proceeds of the notes issuance to extinguish most of the inter-company debt and a portion of the BAM borrowings and some project specific debt. Pro forma for the equity raise and proposed $400 million senior note offering, we expect BRP's debt to consist of $69 million of junior subordinated notes owed to Brookfield Office Properties, $117 million of credit facility borrowings due to BAM, $326 million of project specific financings, $325 million of secured bank debt, $9 million of unsecured credit facility borrowings, and the new $400 million of senior notes, totaling $1.25 billion of debt. We estimate debt/EBITDA and interest coverage will improve modestly by year-end to around 6x and 3x, respectively. Our base-case scenario analysis assumes that the homebuilding industry continues to recover in the U.S. and remains stable in Canada. Active selling communities gradually increase in both markets over the next two years and absorption of homes is flat in Canada and moderately increases in the U.S. Prices in Canada are unchanged over the forecast period and are up modestly in the U.S. (2%-3% per year). We anticipate that land constrained homebuilders will turn to BRP for land, which will also contribute to revenue growth from the land business (about 10% per annum). In contrast with previous years, we expect that the faster growing U.S. homebuilding business will affect gross profit mix such that homebuilding gross profit will eclipse 50% of total gross profits by year-end 2013. We also assume homebuilding gross margins remain flat in Canada and improve to 16.5% in 2013 and 17.5% in 2014, while land development margins are 35%-40%. SG&A/revenues are in the 9%-10% range. The inherent operating leverage in the business should contribute to growing profitability and we expect that based on our assumptions that leverage, as measured by debt/EBITDA and debt/book capital, will be about 5.7x and 54% at year-end 2013 and 4.6x and 50% at year-end 2014. We also estimate interest coverage will improve to 3.5x in 2013 and more thanb 4x in 2014. Liquidity We believe that Brookfield's liquidity position is adequate, with sources adequate to cover uses by at least 1.2x over the next 12 months. -- We expect Brookfield will be profitable in 2013, generating funds from operations (FFO) of about $150-$200 million; -- We estimate Brookfield will end 2012 with cash holding in the vicinity of about $125 million; -- Brookfield has a $300 million unsecured credit facility due in 2015 provided by BAM. We expect that the facility will have $233 million available after the note issuance; -- Debt maturities are significant in 2013 comprised primarily of $319 million of Canadian bank secured facilities with short debt durations that have historically rolled over every year and $200 million of project level financings. For purposes of this liquidity analysis, we assume the secured credit facilities are repaid with existing liquidity. We assume project debt is extended or repaid with cash flow from the related projects; -- We also assume roughly $400 million of land acquisition and development spend (net of any project level financing); and -- We believe that sources would cover the company's capital needs even if EBITDA were to drop by 30%. While we do not factor in availability under BRP's secured credit facilities as a source of liquidity due to the short tenor of those facilities, the company did have about $220 million of availability under these facilities. We also acknowledge that the company has historically renewed these facilities annually. Large land acquisitions would affect liquidity, which is possible considering the company's strategy as a large master planned land developer. However, we also expect the company to continue to finance land acquisitions with equity or seller financing and development with nonrecourse project-level debt. Liquidity could become constrained should demand for housing and land deteriorate. BRP was in compliance with all financial covenants as of Sept. 30, 2012. BRP doesn't currently pay a dividend. Recovery analysis Our rating on the company's senior unsecured notes is 'BB-' (one notch higher than BRP's corporate credit rating). The '2' recovery rating indicates our expectation for a substantial (70%-90%) recovery in the event of a payment default. For the complete recovery analysis, see our recovery report on BRP to be published after this report. Outlook The outlook is stable. We expect continued stability in BRP's Canadian markets and the steady recovery in the U.S. housing markets to support revenue and EBITDA growth leading to steadily improving credit metrics and continued adequate liquidity. The land development business, while cyclical, should support BRP's growth as many homebuilders continue to invest in new land to support future growth. We would consider raising the rating if housing demand recovers more quickly in the U.S. and remains stable in Canada, resulting in improved cash flow such that debt/EBITDA improves to the 3x-4x range. Alternatively, we could lower the ratings if the recovery in the U.S. falters or the Canadian housing market softens such that debt/EBITDA doesn't improve over the next two years and/or liquidity becomes constrained. Temporary telephone contact numbers: George Skoufis (201-470-2589); Susan Madison (201-259-1034). Related Criteria And Research -- Key Credit Factors: Global Criteria For Single-Family Homebuilders, Sept. 27, 2011 -- Industry Report Card: U.S. Homebuilders Pivot Toward Growth, Oct. 17, 2012 -- Issuer Ranking: U.S. Homebuilders, Strongest To Weakest, Oct. 12, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings On Global Industrial Issuers' Speculative Grade Debt, Aug. 10, 2009 Ratings List Ratings Assigned Brookfield Residential Properties Inc. Corporate credit B+/Stable/-- Senior unsec. notes BB- Recov. Rtg. 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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