The fiscal cliff — a combination of an 8.2% spending cut and various tax increases that the U.S. could enact if Congress doesn’t address the federal government’s growing debt — could have far-reaching effects on U.S. municipal housing given the sector’s many links to the federal government.
The federal government’s activity in the housing market includes operational subsidies, rent subsidies, mortgage insurance, loan purchases, and loan securitization. Nearly all municipal housing transactions have at least one form of this support, so the impact of budget sequestration and tax increases on municipal housing would be multifaceted. For example, federal pullback in housing support would affect transaction volume and cause a reduction in municipal housing issuance even amid growing demand for affordable housing.
The Congressional Budget Office estimates that higher taxes and reduced spending would result in a nearly 4% reduction in GDP, making way for another recession. We believe that homeowners and renters alike may experience the effects, but we cannot speculate on the level of the impact.
DEBT SECURED BY CAPITAL FUND GRANTS WOULD EXPERIENCE THE MOST IMMEDIATE RATINGS IMPACT
In one of its most direct methods of support, the federal government provides subsidies to renters and local housing authorities. From this perspective, the effects are clearer. The proposed budget sequestration would represent a $154 million reduction in capital fund grants that the Department of Housing and Urban Development provides to public housing authorities (PHAs) for modernization of residential units. Several PHAs issue bonds and pledge the annually appropriated capital grants to the payment of the debt. We assign ratings based on debt service coverage (DSC) by the anticipated inflow of capital funds. Of the 37 issues that we rate, 21 are rated ‘AA-’, 14 are rated either ‘A+’ or ‘A’, and two are rated ‘BBB’. Seventeen of these ratings have negative outlooks, irrespective of the effects of possible sequestration. Should sequestration take effect, we would review all capital fund ratings to determine the impact of an 8.2% reduction in capital grant receipts, in addition to the other capital grant reductions that we assume.
LONGER-TERM IMPACT ON RENTAL SUBSIDIES
Other housing securities that could experience a rating impact from federal sequestration would be those relying on subsidies to generate revenue for debt service — in particular project-based rental assistance programs (commonly known as Section 8). We have 24 such ratings based on anticipated federal subsidies through a Housing Assistance Payments (HAP) contract, which is used to ultimately bolster affordable housing with guaranteed revenue derived from housing demand among tenants eligible for the subsidy. This revenue, in the form of a subsidy, is used for debt service and project operational expenses.
Sequestration would represent a reduction of $830 million in federal subsidies available for project-based rental assistance. Of the 24 ratings that we maintain, more than half are in the ‘A’ category with stable outlooks. Should sequestration take effect, we would review the ratings for the program on an annual basis or on an as-needed basis to determine how the overall reduction in rental revenue has affected the project cash flow available for debt service on the bonds.
Although the demand for the program is high, reductions in the program subsidies can begin to outweigh project expenses and create a shortfall in DSC at the assigned rating levels. We will monitor the rating trends and determine the overall impact on a current and forward-looking basis.
HOUSING FINANCE AGENCIES ARE MOSTLY IMMUNE
We rate 42 large housing finance agency (HFA) single-family indentures, 24 HFAs, and 20 HFA multifamily pools. The ratings are primarily in the ‘AA’ category, with 12 ‘AAA’ single-family program ratings, one ‘AAA’ issuer credit rating, and two multifamily pool ratings of ‘AAA’. We also rate one single-family resolution ‘BBB’ and one ‘BB+’. HFAs have experienced higher loan delinquency during the past six years, but loan performance has remained steady for two years, and delinquency has not affected any ratings. We anticipate no impact on any of these ratings regardless of the outcome of the fiscal cliff.
LONGER-TERM FISCAL ISSUES LOOM
Municipal housing is uniquely situated as a sector with strong links to the federal government, both in terms of programs and policy. Other programs not previously mentioned and not affected by the fiscal cliff are mortgage insurance through the Federal Housing Administration, Veteran’s Administration, and the Department of Agriculture; securitization of loans through Fannie Mae, Freddie Mac, and Ginnie Mae; loan purchases by the government-sponsored entities and Ginnie Mae; and liquidity support from Treasury through Fannie Mae and Freddie Mac. The various forms of support from the government are key rating factors for most municipal housing bonds. Furthermore, federal actions to spur housing activity or reduce foreclosures play significant roles as well. Tax policy influences housing of all types, including that in the municipal sector. A reduction in the mortgage interest deduction could reduce demand for single-family housing while a cut in the low-income housing tax credit would cause the supply of affordable rental housing to decline. In comparison, the net impact of the fiscal cliff on municipal housing is much smaller, but specific credits within the sector would experience an impact should sequestration take effect.
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