Fitch Affirms and Removes KB Home from Rating Watch Negative; Outlook Stable

Business Wire, Feb 16, 2007

NEW YORK -- Fitch Ratings has affirmed its ratings for KB Home (NYSE:KBH) and removed them from Rating Watch Negative, as follows:

--Issuer Default (IDR) at 'BB ';

--Senior unsecured debt (including revolving credit facility) at 'BB ';

--Senior subordinated debt at 'BB-' .

KB Home's Rating Outlook is Stable.

The Negative Rating Watch (originally placed on Oct. 25, 2006) was primarily implemented due to KB Home's inability to file its third-quarter 10Q (for the quarter ended Aug. 31, 2006) with the SEC. The delay was a by-product of an internal option back-dating investigation by independent board members, which was concluded in the late fall of 2006. Consent waivers had to be secured from bondholders and KB Home's banks due to the delayed filing. The third-quarter 10Q and fiscal 2006 10K were finally filed on Feb. 13, 2007.

The housing sector is in the midst of a meaningful, multi-year downturn. KB Home continues to focus on paring down its land position and slowing its current, relatively moderate speculative construction to levels commensurate with the current housing contraction. During this current downturn, most builders, including KB Home, have leveraged the financial flexibility of land options, walking away from overpriced and unneeded lots (forfeiting their deposits). There have also been meaningful charges associated with writedowns of land values for most public builders. Fitch anticipates that, in general, major builders will report a lesser amount of these non-cash real estate charges in 2007. KB Home took a more cautious stance on land purchases as calendar 2006 evolved, to the advantage of free cash flow in the fourth quarter of 2006. Fitch expects that free cash flow will be positive in fiscal 2007, benefiting from less land and development spending and, consequently, reduced inventories. Coverage ratios will be lower in 2007.

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

The ratings reflect KB Home's solid, consistent improving profit performance in recent years (until 2006) and the expectation that the company continues to execute its business model. The ratings also take into account the company's primary focus on entry-level and first-step trade-up housing (the deepest segments of the market), its conservative building practices, and effective utilization of return on invested capital criteria as a key element of its operating model. Over recent years the company has improved its capital structure and increased its geographic diversity and has better positioned itself to withstand a meaningful housing downturn. Fitch also has taken note of KB Home's role as an active consolidator within the industry. Risk factors also include the cyclical nature of the homebuilding industry and the company's exposure to the state of California. Fitch expects future leverage (excluding financial services) to be comfortably within KB Home's stated debt to capital target range of 45-55%.

The company has expanded EBITDA margins over the past several years (until 2006) on steady price increases, volume improvements, and reductions in SG&A expenses. Also, KB Home had produced record levels of home closings, orders and backlog as the housing cycle extended its upward momentum into 2005. KB Home realizes a significant portion of its revenue from California, a state that has proved volatile in past cycles. However, the company has reduced this exposure as it has implemented its growth strategy and, in fiscal 2006 sourced 18.5% of its deliveries from California, compared with 69% in fiscal 1995. Over the past decade KB Home shifted toward a presale strategy, producing a higher backlog/delivery ratio and reducing the risk of excess inventory and debt accumulation in the event of a slowdown in new orders (as is the case currently). The strategy also served to enhance margins. The company maintains a 3.4-year supply of lots (based on last 12 months deliveries), 56.9% of which are owned and the balance controlled through options. (The options share of total lots controlled is down sharply in recent quarters as the company has written off substantial numbers of options.) Inventory turnover has been consistently at or above 1.3 times (x) during the past twelve years, and was 1.4x at the conclusion of fiscal 2006.

Over time balance sheet liquidity has improved as a result of efforts to reduce long-dated inventories, quicken inventory turns and improve returns on capital. Progress in these areas allowed the company to accelerate deliveries without excessively burdening the balance sheet.

As the housing cycle continues to contract, creditors should benefit from KB Home's solid financial flexibility supported by cash and equivalents of $639.2 million and $1.04 billion available under its $1.5 billion domestic unsecured credit facility (net of $464 million of letters of credit) as of Nov. 30, 2006. In addition, liquid, primarily pre-sold work-in-process, and finished inventory totaling $4.3 billion provides comfortable coverage for construction debt. Debt is well laddered with the first of the company's fixed-rate debt maturing in 2008. The current $1.5 billion revolving credit facility matures in November 2010.