BZH Valens Credit Analysis – CDS 394bps, Base Case iCDS 644bps, Negative Case iCDS 857bps, 2025 6.750% Bond YTW of 7.763%, iYTW of 8.853%, B3 Rating from Moody’s, XO (equivalent to Baa3) Rating from Valens, High Refinancing Need

May 1, 2019

  • CDS markets are materially understating BZH’s credit risk with a CDS of 394bps relative to an Intrinsic CDS of 644bps, while cash bond markets are understating credit risk with a YTW of 7.763% relative to an Intrinsic YTW of 8.853%. However, Moody’s is materially overstating BZH’s fundamental credit risk, with their highly speculative B3 credit rating six notches lower than Valens’ XO (Baa3) rating
  • Incentives Dictate Behavior™ analysis highlights positive signals for creditors. Management’s compensation framework focuses them on all three value drivers, as well as debt reduction, which should lead to Uniform ROA expansion and increased cash flows available for servicing debt obligations. Furthermore, management members are material holders of BZH equity relative to their average annual compensation, indicating they are likely aligned with shareholders for long-term value creation. Additionally, management members have low change-in-control compensation, indicating they are not highly incentivized to seek a buyout or sale of the firm, decreasing potential event risk
  • Earnings Call Forensics™ of the firm’s Q1 2019 earnings call (2/4) highlights that management is confident in their pre-engineered structural plan options and balanced growth strategy execution. In addition, they are confident in late-January macro housing trends improvement. However, management may lack confidence in their ability to maintain margins and achieve community count expectations, and may be concerned about their ability to execute their capital allocation plan. Moreover, they may be exaggerating their transparent mortgage and energy efficiency competitive advantages, and may be downplaying concerns about the soft rate environment in fall, particularly among short-term ready to close homes
  • BZH currently trades near recent lows relative to UAFRS-based (Uniform) Earnings, with a 6.8x Uniform P/E. At these levels, the market is pricing in expectations for Uniform ROA to decline from 11% in 2018 to 9% in 2023, accompanied by immaterial Uniform Asset shrinkage going forward.

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