Fitch Affirms M.D.C. Holdings' IDR at 'BBB-'; Outlook Stable

Fitch Ratings has affirmed the ratings of M.D.C. Holdings, Inc. (NYSE: MDC), including the company's Long-Term Issuer Default Rating (IDR) at 'BBB-'. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

MDC's ratings are based on the company's execution of its business model in the current moderately recovering housing environment, cautious land policies and solid liquidity. During the past cycle the company noticeably improved its capital structure, pursued conservative capitalization policies and positioned itself to withstand the past, sharp, long-lasting housing correction.

The Stable Outlook takes into account further moderate growth in the housing market in 2016 and 2017 along with expected improvement in the company's operating and financial results.

STRONG LIQUIDITY POSITION

As of June 30, 2016, MDC's homebuilding operations had $132 million in unrestricted cash and equivalents along with $55.8 million in marketable securities. In addition, MDC had $508 million of borrowing availability under its $550 million revolving credit facility that matures in December 2020. The company has no significant debt maturities until February 2020 when its $250 million 5.625% bond comes due. The next significant debt maturity is not until 2024.

CONSERVATIVE LAND POLICIES

The company employs conservative land and development strategies. MDC's priority is to acquire finished lots using rolling options, finished lots in phases for cash or, if the potential returns justify the risk, land for development. The long-term goal is to maintain a three year supply of land, where possible increase land under option, and reduce land owned.

MDC chooses to be relatively short on land as many of its peer's control six to eight years of lots (much of that owned). That strategy can be a disadvantage when land prices are rapidly rising. On the other hand, being short on land is clearly advantageous following a market peak when excess land compromises the balance sheet and margins.

Land and development spending totalled $670 million in FY15, $605 million in FY14, and $770 million during FY13. Through the first six months of FY16, the company spent $276 million on land and development activities. Fitch expects the company will spend approximately $700 million on land and development activities this year. Despite the higher land expenditures, Fitch expects MDC will be modestly cash flow positive during FY16.

Fitch is comfortable with this real estate strategy given the company's strong liquidity position, well-laddered debt maturity schedule and management's demonstrated ability to manage its spending. Fitch expects management will pull back on spending if the current recovery in housing stalls or dissipates.

GEOGRAPHIC AND PRODUCT DIVERSIFICATION

MDC benefits from geographic diversification with operations across nine states located in the West Coast, East Coast and Mountain Region of the United States. Some concentrations do exist within MDC's portfolio as approximately 1/3rd of owned and optioned lots and 1/3rd of its backlog units by dollar value were located in Colorado as of June 30, 2016.

Management estimates that about 20% of its unit volume is currently directed to the entry-level/first time homebuyer, 50%-60% to first move-up, approximately 15% to the second move-up/luxury segment, and about 5% are directed to townhome/urban infill products.

HOUSING CONTINUES MODERATE RECOVERY

Housing activity ratcheted up more sharply in 2015 than in 2014 with the support of a steadily growing, relatively robust economy. Total housing starts grew 10.9% versus 2014, while existing and new home sales were up 6.3% and 14.6%, respectively. New home price inflation slimmed with higher interest rates and the mix of sales shifting more to first-time homebuyer product. Average home prices increased 3.7%, while median prices rose 4.7%.

After four years of a moderate recovery and with land and labor constraints, it is unlikely that housing will accelerate into a V-shaped recovery. But a continuation of a multi-year growth is in the offing, and is supported by demographics, pent-up demand and attractive affordability as well as steady, albeit modest, easing in credit standards.

Though far from spectacular, the 2016 spring selling season was solid, which argues well for the full year. Fitch is projecting single-family starts to expand 11.5% in 2016 and multifamily volume to gain about 4%. Total starts would be roughly 1.2 million (up 8.8%). New home sales should improve about 14.6%, while existing home sales rise 3%. Average and median home prices should rise 3.0% - 3.5%.

2017 could prove to be almost a mirror image of 2016. Real economic growth should be similar to this year, 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 qualification standards loosen further. Land and labor costs will inflate more rapidly than materials costs. Housing starts should total 1.311 million. Single-family volume should expand 10% to 877,000, while multi-family starts grow 5% to 434,000. New home sales should reach 640,000, up 11.5%. Existing home sales should gain 4% to 5.625 million. Average and median home prices should expand 2.0% - 2.5% in 2017. Demand will continue to be affected by some narrowing of affordability, diminished but persistent and widespread negative equity, relatively challenging mortgage-qualification standards and lot shortages. A tight labor supply will also constrain production.

SOME EROSION IN AFFORDABILITY

The most recent Freddie Mac 30-year average mortgage rate (Oct. 20, 2016) was 3.52%, up 5 bps sequentially from the previous week and 21 bps higher than the all-time record low of 3.31%. 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 163.5 in August 2016.

Erosion in affordability is likely to continue as interest rates likely head higher later in 2016 (as the economy strengthens). Home price inflation should moderate a bit this year reflecting the mix of sales shifting more to first-time homebuyer product. However, average and median home prices should still rise within a range of 3.0% - 3.5% this year, pressuring affordability.

Similar to other homebuilders, the company has taken steps to address the erosion in affordability. MDC is accelerating the rollout of its more affordable Seasons product. The affordable Seasons product is a simple product to build and consequently the construction cycle is shorter so inventory turns will be faster than for a standard MDC product.

KEY ASSUMPTIONS

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

--Industry single-family housing starts improve 11.5%, while new and existing home sales grow 14.6% and 3.0%, respectively, in 2016;

--MDC's homebuilding revenues advance 16%-18% and homebuilding EBITDA margin improves 30-50bps in 2016;

--The company's Net Debt/Capital ratio is below 35% while Debt/EBITDA approximates 4.7x and EBITDA/Interest reaches 3.8x by the end of FY16;

--MDC spends approximately $700 million on land acquisitions and development activities in 2016 and generates cash flow from operations in the $25 million to $75 million range;

--MDC maintains a strong liquidity position (above $700 million) with a combination of unrestricted cash and revolver availability.

RATING SENSITIVITIES

Positive rating actions are unlikely in the near to intermediate term absent a change in the company's operating model wherein land is primarily controlled through options. This type of operating model would result in more consistent cash flow generation through the cycle and significantly reduce the risk of downside volatility.

Negative rating actions may be considered if there is sustained erosion of profits due to both weak housing activity and land, labor and materials cost pressures (resulting in margin contraction and weakened credit metrics, including a net debt to capitalization ratio consistently above 40%) and MDC maintains an aggressive land and development spending program that leads to consistent negative cash flow from operations and a diminished liquidity position. Initiation of shareholder friendly activities including share repurchases and special dividends that deplete MDC's liquidity position may also pressure the ratings.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

M.D.C. Holdings, Inc.

--Long-Term IDR at 'BBB-';

--Senior Unsecured Debt at 'BBB-'

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 and land option abandonment costs.

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=1013502

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013502

Endorsement Policy

https://www.fitchratings.com/regulatory

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