Fitch Rates NVR's $325MM Convertible Senior Notes 'BBB'

Fitch Ratings has assigned a 'BBB' rating to NVR, Inc.'s (NYSE:NVR) proposed $325 million convertible senior notes due Sept. 15, 2038. Fitch has also affirmed NVR's 'BBB' Issuer Default Rating (IDR) and senior unsecured rating. The Rating Outlook is Stable.

The ratings reflect the strong credit protection measures, solid free cash flow generation and balance sheet liquidity that results from its unique operating model, and NVR's capacity to withstand a meaningful housing downturn. While NVR's debt position will increase by $325 million, the transaction further enhances the company's liquidity position and provides the company the flexibility to meet upcoming debt maturities ($200 million in June 2010) and handle the possibility of a reduced revolver commitment to fund working capital needs. NVR has a $600 million revolving credit facility that matures in December 2010. During this housing downturn, the commitments under the revolving credit facilities for most homebuilders have been significantly reduced upon negotiations with their lenders. The cyclical nature of homebuilding is also reflected in the ratings as are NVR's relatively heavy exposure to Washington D.C. and Baltimore markets, its track record through the 1990-91 recession (albeit while burdened by certain earlier land development activities in the greater Washington and Baltimore markets), and its previous active share repurchase program.

The NVR ratings take into account Fitch's level of confidence with regard to the company's operating model under various economic conditions. NVR utilizes an operating model in which land is controlled exclusively through rolling options with fixed deposits sourced from independent land developers. Land is not purchased until construction is set to begin. As a consequence, NVR occasionally may be able to participate in land appreciation, while minimizing capital outlays and the company significantly reduces the risk of downside volatility. Over 90% of NVR's inventory is represented by relatively liquid pre-sold work in process that is less vulnerable to significant declines in value in periods of economic stress. In a downturn (such as the industry is in now), write-downs would primarily be limited to forfeiture of option deposits, a fraction of total land value (typically 5-10%). Alternatively, NVR seeks to renegotiate option contracts to realign the proposed land purchase price with prevailing market conditions, thereby averting severe margin compression.

NVR's short-dated inventory position turns over rapidly at about 4-5 times (x), enhancing operating cash flow. NVR's inventory turnover ratios are consistently and considerably higher than those of its peers. Even with a severe drop in deliveries, NVR continues to generate significant levels of cash relative to financial obligations and reinvestment prospects, allowing the company the capacity to manage its capital structure within management's stated parameters of debt to book capital at 30-40% or lower. As a consequence, NVR has often been an aggressive buyer of its stock, as evidenced by its annual purchases highlighted below:

--$507.5 million in 2007;

--$287.1 million in 2006;

--$962.6 million in 2005;

--$307.6 million in 2004;

--$460.4 million in 2003;

--$362.4 million in 2002;

--$223.8 million in 2001;

--$53.7 million in 2000.

However, NVR did not repurchase stock during fourth quarter-2007 and first half-2008. NVR ended the June 2008 quarter with $867 million of cash on the balance sheet.

Due to its operating model, NVR is reliant on third party land developers to prepare finished lots and sell them under option to NVR. This strategy may restrict growth only to markets where such a strategy is viable. However NVR has expanded its strategy to eight new markets over the past ten years. Fitch recognizes that NVR continued to replenish and expand its supply of lots amid the often competitive conditions prevailing in many of its markets during the first half of this decade. By building a significant presence in its markets, NVR positions itself as the preferred land purchaser and forges relationships with key local developers. Fitch believes that, if options were to become unattainable in NVR's markets, bondholders would be well protected due to the strong cash flow dynamics of the company's model. Without land reinvestment requirements, NVR produces significant cash with which to retire its debt.

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

Fitch will continue to closely monitor the trends of the broad housing market in its assessment of the appropriate credit ratings for all homebuilders.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.