Standard & Poor's Ratings Services is releasing this final version of the Issuer Credit Rating Criteria for U.S. Public Housing Authorities (PHAs). A proposal was released on Sept. 14, 2007, and comments were solicited because the new criteria are applied to the industry. The comment period was scheduled to end on Oct. 15, 2007, but was extended until Nov. 9, 2007.
Issuer Credit Rating Summary
A Standard & Poor's issuer credit rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. Standard & Poor's offers issuer credit ratings for PHAs using a methodology that incorporates both qualitative and quantitative factors. We rely primarily on overall credit analysis applicable for the overall industry, taken in a context relevant to business types within the public housing sector. Other factors we take into account when assigning the rating include the sector history, government support for the industry, essentiality of the public service provided by the PHA industry, the earnings and financial strength of the PHA, experience and past performance of the PHA, and relevant peer comparisons based on size, market and business profile.
Framework For Creditworthiness
Standard & Poor's considers the following three factors in examining a framework for the PHA sector's creditworthiness:
Degree of business risk;
Essentiality of low-income housing; and
Longevity and predictability of government support.
Degree of business risk
Standard & Poor's generally perceives the degree of business risk in the PHA sector as low because of the public-policy role played by PHAs, and their strong essentiality. In addition, the strong regulatory framework, the history of appropriated subsidies and the high demand for and low availability of low-income housing in the U.S., further support the low level of business risk. Standard & Poor's expects that the low level of risk permits entities in the PHA industry to qualify for investment-grade ratings. However, key to determining a rating level for a PHA is its ability to balance growth with the appropriate level of financial risk, and its business and financial policies. This may vary by the business and strategic profile of the rated PHA based on its locality, market environment and overall goals and mission. A long-term history of government support, strong regulatory oversight by the federal government and a stable existence of PHAs, even in their most troubled state, make for little business risk in the most traditional PHA business operations. PHAs, even in the most difficult of circumstances, continue to operate and provide low-income housing for its tenants.
However, many PHAs also engage in other real estate and development activities that are designed to bring in additional income. The business risk associated with these activities, which are not under the same regulatory framework as the traditional PHA operations, often can be tied to market demand, strategic operations, and overall management performance. Financial and operational management practices that incorporate the business strategy type, the business risks associated with the strategy type, as well as historical management performance, are key elements in determining a PHA's level of creditworthiness.
Essentiality of low-income housing
The need for low-income housing outweighs the available public housing units in the U.S. A review of the demand for public housing, the general dearth of affordable rental housing, and the likely continuation of undersupply suggests that public housing authorities will continue to supply housing for those in greatest need. In fact, in many areas, PHAs are essentially the only supply of housing for the very lowest income residents.
The federal government recognizes the essentiality of low-income housing as evidenced by its continued support for public housing program during the last 70 years. However, the increasing pressures of the sector have led the federal government to adopt industry-changing regulations that help encourage alternatives to financing low-income housing programs. As a result, the federal government no longer deeply subsidizes publicly and privately owned housing. Rather, the government's regulatory approach to the PHA industry has shifted toward a model of mixed-finance; mixed-income housing that can sustain affordability by renting to higher-income tenants in properties with lower income tenants.
The number of existing deeply subsidized federally assisted units is expected to decrease due to the federal government's reduction in subsidy to fund new conventional public housing and the conversion of privately owned subsidized housing properties to market rate status upon expiration of subsidy contracts. Major production programs, such as the Low Income Housing Tax Credit program, although affordable, are targeted at tenants with incomes higher than the average PHA resident. In order to continue to serve their low-income constituencies, many PHAs engage in bond financing activities to add to their portfolio in order to meet the demand for low-income housing, and achieve their overall public purpose.
Longevity and predictability of government support
In evaluating the history of public housing, two elements are clear contributors to the creditworthiness of PHA funding: the long track record of funding for public housing by the federal government, and increasing predictability of funding levels for individual PHAs. Increased predictability in funding levels by the federal government allows PHAs to benefit from the mixed-finance model encouraged by changing federal regulations through leveraging of subsidies with other capital market investment vehicles.
Predictability of PHA appropriated funding levels
Evidence of federal support for the authorities can be found in the consistency of appropriated funding and its predictability. Despite cyclical changes in the amount of funding, public housing government subsidies have been annually appropriated for more than 70 years. While PHAs can obtain revenue from a number of sources, in general, the primary source of revenue for PHAs is annual appropriations. As part of analyzing appropriation risk, Standard & Poor's carefully considers the methodology for allocating federal funding to PHAs. Generally, funding comes from two primary subsidy programs for the public housing program: the Operating Fund and the Capital Fund. Both sources are distributed to individual housing authorities through a formula. The 1998 Quality Housing and Work Responsibility Act introduced some flexibility in the authorized uses of these funding sources. This Act permits PHAs to use subsidy funding to pay debt service to capital market investors for the development and/or rehabilitation of housing in their portfolios. As a result, PHAs are much more active in the affordable housing bond market—leveraging appropriated subsidy with capital market investment to raise the resources needed to meet their constituents' needs.
Regulatory sanctions that HUD is within its right to employ based upon PHA performance are a very significant factor that can affect PHA funding levels. As such, effective management and operations, as discussed below, are key factors in determining the creditworthiness of a public housing authority.
Rating Factors
Standard & Poor's considers the following three quantitative and qualitative measures in examining rating factors for each rated PHA:
Earnings and financial strength;
Management and operations; and
Portfolio quality.
Earnings and financial strength
Key to a PHA's creditworthiness is its ability to manage its finances through leveraging of its subsidy, identifying and pursuing additional income streams, establishing adequate reserve levels and maintaining sufficient liquidity to support its outstanding obligations. Although primary sources of revenue for PHAs generally include operating and modernization subsidies, as well as other federal grants, PHAs often generate additional income from other non-traditional sources. In order to gauge earnings quality and stability, Standard & Poor's reviews the PHA's financial performance with emphasis placed on any notable fluctuations. Consistency of performance is an additional credit strength. However, one bad year is not necessarily a negative factor, unless it signifies the beginning of a permanent shift.
Standard & Poor's uses income statement analysis to evaluate revenue sources, cost controls, and profitability in tandem with a balance sheet analysis of liquidity and cash coverage as discussed below. Both approaches involve evaluation of a PHA's subsidy levels, cash accumulation levels, types of investments, outstanding obligations, and fungability of unrestricted net assets. While the principal areas of analysis are leverage, profitability and cash coverage, sound financial policies and prudent financial management practices with adequate checks and balances also play a key role in evaluating PHAs' financial strength.
In addition to an analytical review of the key financial ratios, Standard & Poor's performs a Financial Management Assessment (FMA) as part of its issuer credit ratings for PHAs (See Public Finance Criteria: Financial Management Assessment). This assessment permits Standard & Poor's to determine the PHA's ability to implement timely and sound financial and operational decisions in response to its economic and fiscal demands. The seven key areas of review include revenue and expenditure assumptions, budget amendments and updates, long term financial planning, longer term capital planning, investment management policies, debt management policies and reserve and liquidity policies.
Table 1
Key Financial Ratios
The following are some ratios Standard & Poor?s uses in analyzing a PHA's earnings and financial strength:
- Profitability ratios: determine the credit quality of the earnings of the PHA, or how the net income is contributing to its growth in equity, total assets and net operating income.
- Leverage ratios: examine the PHA?s level of overall debt to its capital.
- Liquidity and Coverage ratios: determine the amount of available cash support for overall operations, as well as outstanding debt obligations.
Management and operations
As part of its issuer credit rating analysis, Standard & Poor's reviews the operating performance of PHAs, focusing on organization, strategic planning, and administrative procedures. Standard & Poor's assesses the continuity of management and the PHA's ability to manage through a variety of situations. Key factors in evaluating management include the PHA's administrative capabilities, such as portfolio oversight, asset management capability, strategic planning and procedures, and technological adequacy of systems. Adhering to regulatory requirements also play an important role, as the potential for government sanctions could affect the flow of subsidy revenue. Standard & Poor's reviews some assessments administered by HUD, such as Public Housing Assessment System (PHAS) scores to determine the PHA's ability to meet regulatory guidelines.
Standard & Poor's assesses the overall organizational structure of the PHA, which include a review of the experience and capabilities of the executive and senior staff, and its relationship with the board. Standard & Poor's also examines the experiences and credentials of the board. Key to understanding the operational effectiveness of the organization is an examination of internal oversight procedures, including checks and balances. Standard & Poor's also analyzes the PHA's decision-making and overall authority management structure. Further, Standard & Poor's also tries to determine if procedures and processes are institutionalized, and analyze the PHA's succession plan for senior staff.
While the federal government provides an overwhelming majority of the funding, much of the ancillary businesses of PHAs and related projects are supported by partnerships with municipalities and states. Effective partnerships in this area are essential to the overall success of a PHA's projects. Strong PHAs also anticipate the housing needs of the local community and continue to develop programs to address them.
Table 2
Key Factors In Examining A PHA?s Management And Operations Capacity
- Development opportunities: PHAs typically monitor housing needs and may expand the provision of low-income housing within their market. As part of its analysis of operations and planning, Standard & Poor?s will examine a PHA?s units or structures developed in recent years, pipeline for development, development partnerships in place, and alternative resources for development.
- Property/asset management: past performance, as well as policies designed to assure adherence to regulatory requirements while achieving long term strategic goals are important. Standard & Poor?s examines the PHA?s ability to maintain adequate property and asset management policies through review of efficiency ratio analysis (which examines the efficiency of operational costs v. revenues); policies and procedures; property management; and asset management.
Portfolio And Asset Quality
As an owner and operator of real estate, the key asset for any PHA is its housing portfolio; quality is a major determinant of the means and level by which the PHA maintains its assets. It is a strong indicator of the PHA's ability to meet its mission and goals. As part of the issuer credit rating analysis, Standard & Poor's conducts a site visit of a representative sampling of the PHA's portfolio to asses the following:
Overall curb appeal;
Unit mix and size;
Aesthetics;
Occupancy rates;
Marketability; and
Geographic diversity of developments.
PHA Business Profile
As the industry has evolved over the past 15 years, different business profiles for PHAs have emerged. The manner by which a PHA operates largely depends on its locality, its market environment, and the relative level of need for low-income housing in its community. Standard & Poor's recognizes these differences in the industry and, as such, considers these factors when completing an issuer credit rating analysis.
In general, Standard & Poor's sees four basic PHA business profiles/strategy types:
Traditional PHA: Relies almost exclusively on federal subsidy for operations—highly regulated with very few non-public housing units or other business activities.
Mixed-finance PHA: Has virtually no public housing units or is in the process of disposing of its public housing stock through sale, demolition or property transfers to its non-profit affiliate—has very little reliance on federal subsidy, and is virtually free from HUD regulatory oversight.
Tradition/mixed finance PHA: As a combination business strategy of traditional public housing management and mixed-finance units and/or business activities in its portfolio.
MTW PHA: Designated by HUD as a Moving to Work (MTW) authority under a special demonstration project to determine the long-term overall business effects of less onerous regulatory oversight. Some of these PHAs benefit from fungability of government subsidies and related administration fees paid to them by HUD (e.g. rental voucher program fees)—these funds can be combined for various purposes—including securing debt.
In conducting an issuer credit rating analysis, Standard & Poor's may give different weights, on a case-by-case basis, to rating factors as appropriate by PHA business profile type. For example, traditional PHAs may have higher equity, lower debt ratio due to the reliance on subsidy and general absence in the bond market. Profitability ratios may be lower. Mixed-financed PHAs may have lower equity ratios, but higher debt ratios—profitability and cash flow coverages may be lower—but the PHA will have less reliance on government subsidies and more business flexibility. MTWs will have more flexibility of funds to cover debt—although the business profile type of an MTW (more traditional units in its portfolio versus more mixed-financed units in its portfolio) will have an impact on equity ratios.
Irrespective of business profile, however, management capacity is weighted more heavily in all business profile types due to regulatory review and sanctioning power that could affect allocation of annually appropriated subsidy. In addition, portfolio quality is a key factor in determining the means and level by which the PHA maintains its primary assets.
While a PHA may have an issuer credit rating, debt issued by the PHA is rated separately based on the issue security. The issuer credit rating is an opinion of the organization's overall creditworthiness.
Table 4
U.S. Public Housing System
The U.S. Public Housing System was established under the Housing Act of 1937. Generally tax-exempt, PHAs are government entities established under state law, but are functions of their local municipality. PHAs are quasi-corporate entities, and, in most cases, would be considered "municipalities" under Chapter 9 of the U.S. bankruptcy code.
The vast majority of funding for public housing comes from annually appropriated subsidies from the federal government. Congress determines funding levels on an annual basis through appropriations. Federal funding has been steady since 1936. However, the current environment for public housing funding suggests declining appropriations since 2001. The PHA industry benefits from very strong regulatory oversight through the U.S. Department of Housing & Urban Development (HUD). HUD serves as industry regulator, and allocates and monitors appropriated funds. As such, HUD has sanctioning power over PHAs. Overall management capacity and performance is a key factor for PHAs to maintain subsidy allocations. In addition, a PHA can be subject to HUD receivership (HUD taking over the management of the PHA for a period of time) due to extremely poor performance.
PHAs can issue debt ?as of right? under their legal structure. The 1998 Quality Housing and Work Responsibility Act allows for PHAs to pledge annually appropriated subsidies to repay debt incurred for new development and/or modernization of units. PHAs generally have the authority to develop and/or own properties not subsidized under the Federal public housing units—and many have established non-profit entities to own and manage these affordable housing units.
PHA Guarantee Of GO Debt
If a PHA plans to issue debt backed by its general obligation (GO) pledge, Standard & Poor's accounts for that debt in evaluating the credit risk profile of the PHA. One tool that Standard & Poor's incorporates to determine a PHA's credit risk profile is capital adequacy analysis. This process involves adjusting a PHA's equity for any capital risks as assessed by Standard & Poor's. We evaluate the PHA's financial position to determine what assets would be available for the PHA to honor a debt payment backed by its GO pledge.
Standard & Poor's typically uses three principal ratios to measure a PHA's capital adequacy:
Adjusted unrestricted net assets to total debt outstanding (leverage ratio),
Adjusted unrestricted net assets to total GO debt outstanding (GO leverage ratio), and
GO debt exposure (GO debt to total debt outstanding).
Standard & Poor's adjusts a PHA's unrestricted net assets based on the level of reserves needed to support GO debt. The "adjusted" unrestricted net assets position is divided by total debt and GO debt (rating dependent) in order to gauge the level of assets available for the PHA to meet its debt obligations.
GO debt exposure is a good measure of the risk a PHA is willing to take with its unrestricted net assets in the event a PHA is required to pay debt service on GO debt. The ratio is derived by dividing GO debt (rating dependent) by total PHA debt outstanding. The more willing a PHA is to risk its unrestricted assets, the more credit concern may be posed.
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