The slow economic recovery is providing an environment that could bolster affordable housing that supports municipal bonds. However, fiscal, economic, and regulatory factors will bear watching as they affect the financial and operational capacity of municipal housing issuers. Today’s economic growth is not particularly robust, but even in the midst of the Great Recession and prolonged stagnation, municipal bond ratings have performed well, save for those that experienced downgrades linked to Standard & Poor’s downgrade of the U.S. in 2011. We expect the coming 12 months to continue the trends of 2012: stable ratings with similar numbers of upgrades and downgrades for most program types but more pressure on certain securities, such as unenhanced multifamily transactions, that have been more volatile historically.
The challenge for municipal issuers will be to balance the demand for their bonds with the loans that they can finance. Low mortgage rates have compressed the difference between the typically higher rates on loans and the rates on tax-exempt bonds to slim margins that often render bond-financed mortgage financing infeasible. An uptick in mortgage rates would be a welcome scenario for municipal issuers. Yet questions remain regarding the framework of municipal housing, including the tax treatment of bonds and loans, as well as how government sponsored entities, such as Fannie Mae and Freddie Mac, will participate in the market. At some point, Fannie Mae and Freddie Mac will likely transition to other types of entities or will give way to successors. And with legislators focused on the fiscal condition of the U.S., participants in the municipal housing sector must follow news regarding municipal bond tax exemption and mortgage interest deduction reforms. Organizations and programs that rely on federal funding of housing through the U.S. Department of Housing and Urban Development (HUD) also face uncertainties, particularly
in light of the automatic cuts from sequestration.
On the other hand, municipal housing’s proven track record of providing affordable housing has resulted in supportive regulatory treatment even while policymakers try to prevent a deterioration of lending standards, of the sort that contributed to the housing bubble. Municipal housing default and vacancy rates remain low enough to support high and medium investment-grade ratings (in the ‘A+’ through ‘AAA’ range). Indeed, the biggest contributor to municipal housing downgrades has been the fiscal status of the U.S. government, which has led to credit stress from the sovereign downgrade, as well as from shrinking appropriations.
To read the full report, click here.