S&P Viewpoint

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 will permit entities in the PHA industry to qualify for investment-grade ratings. However, key to determining a rating level for a PHA will be 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, will be key elements in determining a PHA's level of creditworthiness.

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.

In evaluating the history of public housing, two elements will be 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.

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, will be key factors in determining the creditworthiness of a public housing authority.

Key to the creditworthiness of a PHA will be 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 will review the PHA's financial performance with emphasis placed on any notable fluctuations. Consistency of performance will be an additional credit strength. However, one bad year will not necessarily be a negative factor, unless it signifies the beginning of a permanent shift.

Standard & Poor's will use 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 will be leverage, profitability and cash coverage, sound financial policies and prudent financial management practices with adequate checks and balances will also play a key role in evaluating the financial strength of PHAs.

In addition to an analytical review of the key financial ratios, Standard & Poor's will perform a Financial Management Assessment (FMA) as part of its issuer credit ratings for PHAs (See Public Finance Criteria: Financial Management Assessment). This assessment will permit 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.

As part of its issuer credit rating analysis, Standard & Poor's will review the operating performance of PHAs, focusing on organization, strategic planning, and administrative procedures. Standard & Poor's will assess the continuity of management and the PHA's ability to manage through a variety of situations. Key factors in evaluating management will include the PHA's administrative capabilities, such as portfolio oversight, asset management capability, strategic planning and procedures, and technological adequacy of systems. Adherence to regulatory requirements will also play an important role, as the potential for government sanctions could affect the flow of subsidy revenue. Standard & Poor's may review 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 will assess the overall organizational structure of the PHA, which will include a review of the experience and capabilities of the executive and senior staff, and its relationship with the board. Standard & Poor's also will examine the experiences and credentials of the board. Key to understanding the operational effectiveness of the organization will be an examination of internal oversight procedures, including checks and balances. Standard & Poor's also will analyze the PHA's decision-making and overall authority management structure. Further, Standard & Poor's will also look 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.