Monday, July 16, 2007

Homebuilder Debt to Capital Ratio - Be Careful Out There

Lennar Inc. (LNR) just released its quarterly earnings report and highlighted what it considers its low debt to total capitalization of 31.6%. Investors should note, however, that the numerator of this calculation only includes the on balance sheet debt and Equity of Lennar. Lennar has not filed its 10-Q for the May quarter as of the day I wrote this, but the company has the following debt according to its 10-Q from the previous quarter (ended 2/28/07).

$ 278,232 - 7 5/8% senior notes due 2009
$ 299,766 - 5.125% senior notes due 2010
$ 249,461 - 5.95% senior notes due 2011
$ 345,719 - 5.95% senior notes due 2013
$ 247,559 - 5.50% senior notes due 2014
$ 501,851 - 5.60% senior notes due 2015
$ 249,694 - 6.50% senior notes due 2016
$ 300,000 - senior floating-rate notes due 2009
$ 109,212 - Mortgage notes on land and other debt

$ 2,581,494

This total debt number is close to the number in Lennar's press release of $2,585,286,000 for the May quarter, which when divided by total debt and equity of $8,168,841,000 gives us the 31.6% number. However, if you dig into the 10-Q for February you will see that Lennar calculates the debt to total capital of its unconsolidated entities as follows:

Debt of Unconsolidated Entities $5,619,394,000
Total Equity of Unconsolidated Entities $3,299,991,000
Total Capital $8,919,385,000

Debt to total capital of Unconsolidated Entities 63%

To be fair to Lennar, there is a footnote that says the Equity is carried at book value and the market value is $1.3 billion higher than book.

If you do a weighted average of the on balance sheet debt to capital and then the unconsolidated entities, then you get

Debt $8,200,888,000
Equity $9,074,972,000

Total Capital $17,275,860,000

Debt to Capital 47.47%

I believe that Lennar has a reputation as one of the more open and transparent Homebuilders so it may not be possible to calculate this for the other publicly traded Homebuilders, but investors should look twice at the official number that come out in press releases.

Now when I contacted investor relations to get the company opinion on this matter they said that:

"it would not be accurate to add the equity and debt from our JVs. Most of this debt is non-recourse to Lennar or has recourse via maintenance guaranties."

Well, now I am even more confused and need to do a little more work on the entire concept of these structures. I will come back to this at a later time. If anyone has encountered these structures before and has a more complete understanding of them, please comment.

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