U.S. states have proven to be a very strong municipal sector. Standard & Poor’s Ratings Services’ median state rating is ‘AA+’ and ratings have trended higher during the past 40 years. The ability of states to increase revenue through taxation and fees, the economic diversification they have in comparison with localities, and the proactive response many states have made to adverse financial conditions — including those in the current sluggish economy– contribute to the strength of state ratings.
However, another sector compares well with states: housing finance agencies (HFAs) that operate within a state or a city. HFAs are rated nearly as high as states — ‘AA’ is the median rating — and rating trends have been even more positive for HFAs than for states since we assigned our first HFA issuer credit rating (ICR) in 1983. This trend has continued in the recent recession and the current slow recovery despite the housing market’s role in the economic downturn.
State And HFA Ratings Climb
The rating trajectory for states and HFAs is similar over a long horizon, but it diverges in more recent years. In fact, the number of positive rating actions has accelerated for HFAs since 2008. Taking a long view, 20 states have experienced generally positive or recently positive rating actions, with eight having negative rating trends. Thirteen HFA ICRs have trended up, while three have trended down over a shorter period of 30 years. But since the economic crisis, which we define as having started with the fall 2008 Lehman Brothers bankruptcy, state ratings have seen 11 upgrades and six downgrades while HFAs have seen nine ICR upgrades and four downgrades.. We have raised about one in five state ratings since 2008, while a third of HFA ICRs experienced the same in that period.
Factors In HFA Strength
How is it possible that HFA ratings have fared better than those on states during the past few years even though the housing bubble was a main contributor to the economic downturn? For the most part, HFAs and their bond programs hold high-quality collateral in the form of single- and multifamily loans. To achieve high investment-grade ratings, the loans need strong guarantees, or the amount of collateral must exceed the debt by a significant margin. HFA loans typically have mortgage insurance from the U.S. (‘AA+’) in the form of Federal Housing Administration, Veterans Administration, or U.S. Department of Agriculture guarantees. Some bond programs have even stronger coverage from mortgage-backed securities (MBS) that Fannie Mae, Freddie Mac, and Ginnie Mae support. Because these programs derive their ratings from the U.S. sovereign, MBS parity programs were rated ‘AAA’ until the downgrade of the U.S.
This survey focuses on single-family housing, which is by far the predominant product that HFAs provide. The one exception is New York City Housing Development Corp. (NYCHDC), which finances only multifamily housing. NYCHDC has been instrumental in achieving New York City’s goals of preserving or creating 165,000 units of affordable housing pursuant to the city’s New Housing Marketplace Plan. Under the largest municipal housing initiative in the country, NYCHDC has financed roughly 58,000 of the nearly 125,000 units to date.
Federal government backing is what allows HFAs to operate within depressed housing markets and achieve very high ratings. The Florida Housing Finance Corp. has a ‘AA+’ rated bond program despite the state’s foreclosure rate, which is the highest in the country at 13%. Standard & Poor’s raised the ICR on the Nevada Housing Division (NHD) in March 2011 even though 14% of loans in the state were either 60 days delinquent or in foreclosure. NHD’s loan portfolio had significant protection through MBS, resulting in a delinquency and foreclosure rate of just 0.07%, 200 times lower than that of the state. MBS provide this protection because they contain loans, the payment of which the MBS provider guarantees. As municipal MBS are from Fannie Mae, Freddie Mac, and Ginnie Mae, payments are ‘AA+’ eligible. This contrasts with Nevada, the rating on which was lowered to ‘AA’ in the same month as the NHD upgrade, based in large part on the state’s economic downturn.
A Look Ahead
Much about state fiscal health and, therefore, credit quality rides on the performance of the economy. Throughout 2012, the U.S. recovered at a gradual if uneven pace. The recovery solidified in the latter part of the year and, by several measures, is gaining traction in early 2013. This being said, state finances are still relatively depleted when we compare “rainy day” fund balances and other measures of fiscal flexibility with their pre-recession levels. Any material economic retrenchment from here — which could be hastened by the effect of the federal sequestration cuts — would likely translate to escalating demand for state social services, such as Medicaid. Coupled with the revenue shortfalls that would likely accompany an economic downturn, numerous states would once again face budget gaps. In short, although the credit environment for states is improving, fiscal conditions remain precarious and linked to whether the economic recovery proves sustainable. With these caveats in mind, our forecast calls for 2.7% real U.S. GDP growth in 2013. Given that our forecast falls within the range of most states’ projections, we anticipate relatively stable rating trends for states in 2013.
We believe that HFA credit quality will mirror that of states during the coming year. In fact, HFAs may be less tied to the real estate cycle if their portfolios contain high levels of federal guarantees. That leads to a lower correlation between HFAs and the economies in which they operate, as well as potentially fewer positive rating actions should the economy improve. The bigger question for HFAs is loan production. Standard & Poor’s projects that housing starts will climb to 780,000 in 2013 from 610,000 in 2012 and that the 30-year mortgage rate will remain near historical lows at 3.5%. An increase in housing starts could provide more opportunities for HFAs, but low interest rates will suppress HFA issuance as they have since 2009. Furthermore, a decline in federal support or higher federal mortgage premiums could also negatively affect HFA production but not lead to a deterioration of credit. We believe that HFA production will be more variable than credit quality, which should remain strong in a variety of economic scenarios.
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