l Strong and extensive history of the federal government's support for public housing programs;

Transcription

1 Pubication date: 19-Ju-2001 Reprinted from RatingsDirect Commentary Pubic Housing Authority Capita Securitization Criteria Anayst: Wendy Dober, New York (1) ; Jeffrey Previdi, Chicago (1) ; Ameie W. Cage, Washington D.C. (1) ; James Penrose, Esq., New York (1) Pubic Housing Reform Essentiaity, Longevity, and Predictabiity Assessing the PHA Redeveopment Pan Debt Service Coverage The Importance of HUD Approvas The Roe of Reserves Key Lega Features Surveiance Legisative changes put into effect in 1998 aid the groundwork for pubic housing authorities (PHAs) to acceerate the modernization and repair of their housing stock with U.S. Department of Housing and Urban Deveopment (HUD) funding. Since that time, HUD has been working with PHAs to determine the best financing structure for securitizations of HUD funds, which are directy appied to pay debt service on PHA modernization financings. Standard & Poor s has determined that PHA debt backed soey by the annuay appropriated HUD Capita Fund program can be rated in the investment grade category based on the foowing critica factors: Strong and extensive history of the federa government's support for pubic housing programs; Significant ongoing need for affordabe renta housing for the owest income segment of the renta popuation; Predictabe mechanisms for aocating Capita Funds to individua housing authorities; Potentia for strong support by HUD; and Bond structures that provide adequate reserves, additiona bonds tests, and segregation of Capita Funds needed to support bond debt service. The main factors that affect where the rating wi fa within the spectrum of ow to high investment grade are: The eve of debt service coverage on the bonds, stressed under a variety of scenarios, evidenced both by revenue projections and the coverage provided by the additiona bonds test. A investment grade structures shoud incude a maximum annua debt service reserve fund; PHA's track record of HUD funding and creation of mechanisms to enhance predictabiity of funding eves; Evauation of PHA's capita improvement pan, incuding ongoing Capita Fund everaging as we as management's abiity to undertake the scope of work; HUD support for the PHA's financing pan incuding prior approva both of the pan of deveopment and bond structure; How we the financing insuates bondhoders from recapture or withhoding of the Capita Funds for any reasons, incuding HUD sanctions due to performance, prior iens which may be paced on the funding, or fow of funds probems at the PHA eve; Strength of ega structure; and Avaiabiity of a diversified stream of revenues, especiay important at higher rating eves. The greatest risk to bondhoders investing in PHA debt secured by Capita Funds is the risk that funds wi not be appropriated by the federa government in amounts sufficient to pay debt service. This risk cannot be eiminated by the federa government except through direct support of debt service through some form of fu-faith-and-credit pedge. The risk can be offset, as discussed beow, through reserves and debt service coverage that anticipate funding cuts. But in order to arrive at an acceptabe eve of support for rating purposes, the risk has to be understood through a thorough review of federa funding history, practices, and factors that have affected and can continue to affect funding.

2 Pubic Housing Reform With the atest estimates of the backog of modernization needs exceeding $20 biion, and the average wait for a pubic housing unit at 11 months, Congress needed to aunch new methods of funding the upgrade of the pubic housing stock and system. In a variety of new programs cuminating in the Quaity Housing and Work Responsibiity Act of 1998 (QHWRA), Congress set the stage for pubic housing reform in severa important ways. It focused on the four critica eements of pubic housing the condition and configuration of the housing stock, PHA management, socia aspects of the system, and monitoring and oversight of the program. Pubic housing reform, expressed in programs and egisation such as HOPE VI, the Moving to Work Demonstration Program, and, utimatey, QHWRA, promotes the concept of mixed finance and mixed income housing aimed at creating more sociay and economicay integrated communities and estabishes programs to break the mod of pubic housing as housing of ast resort programmaticay designed to attract and retain the poorest of the poor. Financia fexibiity granted under pubic housing reform aid the groundwork for PHAs to turn around their aging, outdated, and diapidated housing stock with the hep of the capita markets principay by aowing HUD funding to be appied to pay debt service. More than anything ese, this opened the door for securitization of the pubic housing Capita Fund, a significant new deveopment in the financing of affordabe housing and a major breakthrough for PHAs in the acceeration of the modernization of their housing stock. Through securitizations, PHAs can achieve arge-scae modernization efforts on a timetabe that meets the needs of their deveopment pan, free from the constraints of year-to-year funding. QHWRA aims as we to improve the industry by examining methods of evauating PHAs and other affordabe housing providers and requiring annua and five-year pans aimed at encouraging PHAs to pan effectivey to carry out the new Federa mission for pubic housing. Through pubic housing reform, the Federa government hopes to preserve its $90 biion investment in pubic housing by introducing more fexibiity, accountabiity, and sef-sufficiency into the system. In doing so, it has taken a giant step forward in improving the creditworthiness of pubic housing funding. Essentiaity, Longevity, and Predictabiity In evauating the history of pubic housing, three eements are cear contributors to the potentia creditworthiness of capita funding: The essentiaity of housing for ow and very ow-income peope; The ong track record of funding for pubic housing by the federa government; and Increasing predictabiity of funding eves for individua pubic housing authorities. Essentiaity. The need for the pubic housing program is at the heart of gauging the federa government's continuing commitment to the program. A review of the demand for pubic housing, the genera dearth of affordabe renta housing, and the ikey continuation of the undersuppy indicates a high degree of ikeihood that pubic housing wi continue to be the centerpiece of the nation's suppy of housing for those in greatest need. Pubic housing is a significant part of the federa government's $31 biion annua expenditure in HUD-assisted housing, with the important distinction of being the soe government-owned housing program. The demand for affordabe renta housing has been we-estabished for years by government surveys and waiting ists for pubicy and privatey owned subsidized housing. The 1999 American Housing Survey indicated that amost 14 miion househods have critica housing needs defined as paying more than 50% of income for housing or iving in substandard housing. In 1997, subsidized housing programs served just over 3 miion of that popuation. Pubic housing accounts for roughy one-third of that number and has waiting ists averaging amost one year, with some cities, such as Los Angees, having waiting ists as ong as ten years.

3 There are many reasons why we can expect the need for deepy affordabe renta housing to continue. The federa government is no onger in the business of deveoping deepy subsidized pubicy and privatey owned housing and has moved toward a paradigm of mixed-finance, mixed-income housing that can sustain affordabiity by renting to higher-income tenants. The number of existing deepy subsidized federay assisted units is expected to decrease due to the federa government s ban on new conventiona pubic housing and the conversion of privatey 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, athough affordabe, are targeted at higher-income tenants. Some segments of pubic housing tenancy, such as the edery, who make up 32% of pubic housing tenants, are expected to increase significanty in coming years. Federa funding history. The pubic housing system was originay authorized in the Nationa Housing Act of The program was envisioned by the Act to be of permanent standing with no sunset provisions. The history of federa funding for pubic housing spans six decades and 12 presidentia administrations, and is as much an evoution of the federa government's reaction to the pight of American individuas and famiies in need of decent, affordabe housing as it is an attempt to address the needs of the pubic housing system it created. In the eary post-depression years, the goa of the pubic housing program was the eradication of sums, creation of empoyment opportunities, and provision of decent affordabe renta housing. The federa government's investment in pubic housing, reported to be $90 biion, funded the deveopment of over 1.3 miion apartments in 13,000 deveopments. Because of federay imposed rent restrictions, the federa government has funded an increasingy arger and arger operating subsidy for PHAs to make up the difference in operating costs and the extremey ow, and sometimes nonexistent, rents that most pubic housing tenants can afford to pay. The funding has increased to over $3 biion in 2001 since its inception in Whereas, under QHWRA, both operating and Capita Funds coud potentiay be pedged to pay debt service, at present the criteria for pubic housing securitizations ony addresses debt where the primary support is a PHA's Capita Fund aocation. To propery assess a pedge of operating funds, it woud be necessary to evauate the history of the operating fund in the same way we have evauated the history of the Capita Funds and perform an in-depth evauation of the entire operations of the PHA invoved. Whie the above heps to estabish the commitment of the federa government to the pubic housing program, examination of modernization funding is the main focus in understanding Capita Fund securitizations. Because deveopment funding for pubic housing did not incude ongoing reserves for improvements, by 1968 Congress needed to address the severe deterioration in the housing stock through a modernization funding program. That eary program has grown from initia appropriation to fund specific modernization needs of $35 miion in 1977 to the Capita Fund program of today, which was funded at amost $3 biion in 2001 (see chart). Since 1977, Congress has appropriated amost $46 biion for pubic housing modernization. The history of modernization funding shows an upward trend in funding with some arge increases and decreases as the government deveoped its poicy regarding modernization, with a maximum decrease of 38% in Because of the severe modernization needs of pubic housing, the ong history of increasing funding, and the importance of the program to the federa government, it is reasonabe to assume that funding wi continue for many years. However, as the history shows, Congress has taken bites out of modernization funding when needed on a year-to-year basis. As the pubic housing inventory undergoes modernization, the need for Capita Funds may decrease over time. Therefore, prudent everaging and reserve sufficiency shoud be a critica component of a investment grade PHA Capita Fund securitizations.

4 Predictabiity of PHA funding eves. As part of anayzing appropriation risk, Standard & Poor s has carefuy considered the methodoogy for aocation of Capita Funds to the individua housing authority. Positive changes have taken pace since the 1980s when PHAs had to compete for modernization funds. Formua funding was introduced for arger PHAs in Further changes in the Capita Fund aocations effected under QHWRA greaty enhance the predictabiity and stabiity of aocations to the individua PHAs by: Merging the funding of modernization programs (the Comprehensive Improvement Assistance Program and the Comprehensive Grant Program) into one fund, the Capita Fund, which eiminates any PHA competition for modernization funds except for a sma performance reward factor; Estabishing a formua for the Capita Fund arrived at through negotiating ruemaking, which heps to ensure consistency of methodoogy over the years; Increasing predictabiity of the formua through carification of factors that can affect funding; and Aowing for a repacement housing factor which aows PHAs to receive funds over a period of time for units that have been demoished. Athough there are many factors that coud change a PHA's funding eve, such as ongoing and backogged needs, impact of unit reduction, and performance reward factors, projecting increases in PHA funding woud not be consistent with investment grade ratings. What is consistent with investment grade ratings is the deveopment of a worst case funding eve. In addition to appropriation risk, Standard & Poor's wi stress anticipated Capita Fund receipts through adjustments for potentia reductions in units, unit mix, and the effect of the performance reward mechanism. Another significant factor that can affect PHA funding eves are sanctions that HUD is within its right to empoy based upon PHA performance, discussed ater under "The Importance of HUD Approvas". For each PHA transaction, Standard & Poor's wi deveop assumptions for funding eves based upon the PHA's actua Capita Fund aocation over time. In cases where the PHA has obtained a funding agreement, such as under the Moving to Work demonstration, Standard & Poor's wi assume that the PHA wi receive the funding eve identified in the agreement for the term of the agreement recognizing it may sti be subject to appropriation risk. HUD shoud ceary state that performance issues cannot affect the eve of funding whie the agreement is in effect. Assessing the PHA Redeveopment Pan As part of the rating process, Standard & Poor's wi review the PHA's redeveopment pan incuding scope of work, financia pan, integration with the PHA's other deveopment and redeveopment pans, reocation panning and resident communications, integration with the surrounding community, and strategy to ensure competion of work in a timey fashion. Communication with HUD and timey submission of one- and five-year pans are critica. The depth of the review depends to a great extent on HUD's wiingness to waive its right to sanction the PHA. If the PHA's performance in competing its redeveopment pan or submitting additiona one and five-year pans is an issue, a fu evauation of the PHA's capacity and an in-depth review of the deveopment pan woud ikey be needed. Debt Service Coverage Athough there is a ong and positive track record overa for pubic housing authority funding, there is the potentia for reductions in program funding, especiay on a yearto-year basis. There are two eves of appropriation risk that must be considered. The first eve is that the federa government wi reduce the amount of capita funding to PHAs as a whoe. The second eve is that the individua PHA wi suffer reduced funding as a resut of issues directy associated with PHA performance or the method of aocating funds to the PHA. The key ingredient to offsetting these risks is to provide for adequate debt service coverage in the transaction to take into account these potentia decreases. In this instance, debt service coverage means the amount of annua Capita Funds avaiabe to cover annua debt service on the bonds. In determining the appropriate stresses for rated debt, Standard & Poor's considers the foowing factors:

5 Historica federa funding eves, taking into account argest decreases in funding; Method of aocating PHA share, accounting for key aspects of the formua funding such as the impact of unit reduction; and PHA risk and performance issues as we as track record in funding receipt. For investment-grade ratings, coverage eves assume that Capita Funds go directy to the bond trustee and that HUD has provided ega covenants that funding wi not be withhed due to poor PHA performance (see "The Importance of HUD Approvas" beow). In anayzing the appropriate coverage eve for individua transactions, Standard & Poor's wi anayze the actua coverage as we as the coverage required in the bond documents to issue additiona bonds in conjunction with the eve of capita needs and ikey everaging. The higher the coverage eves, the greater stress the revenue stream can withstand without jeopardizing debt service. Coverage eves are meant as genera guideines for rated transactions, and can be adjusted for specific transactions due to factors such as: A HUD agreement for the ife of the transaction that sets PHA funding; A diversified revenue stream beyond Capita Fund, such as a backup pedge from a rated entity; Cosed bond resoutions; and Shorter bond maturities. The Importance of HUD Approvas HUD is the administrator of PHA funding. For that reason aone, HUD approvas pay a very important roe in PHA securitizations and may account for rating differences depending on HUD approvas each PHA is abe to secure. In addition, HUD has indicated its wiingness to provide ega assurances that go a ong way toward removing PHA performance risk from the transactions, as we as provide set funding for some period of time, subject to federa appropriation. PHAs that take advantage of these options wi greaty enhance their abiity to secure higher ratings. In a investment grade transactions, Standard & Poor's expects that the PHA wi secure HUD approva of the deveopment pan and the bond transaction upfront. Athough sedom used in the past, HUD does have the right to appy sanctions for poor PHA performance that coud affect funding eves. Therefore, reducing the risk of sanctions or other actions that coud interrupt funds fow is a critica component of investment grade transactions if they can be suppied in a egay vaid document such as the Annua Contributions Contract. It is unikey that HUD wi egay give up a rights to sanction PHAs; however, cear statements that funds wi aways be avaiabe to pay debt service, abeit, subject to appropriations, wi be viewed positivey. HUD agreements, such as the Moving to Work agreement, can provide important assurances as we, especiay regarding funding eves and evidence of the federa government's recognition and support of these financings. Congressiona appropriation risk has not been removed from these transactions thus far, so it is important to remember that funding is sti subject to Congressiona appropriation. Standard & Poor's views HUD's agreement to provide these and other assurances outined in "Key Lega Features" beow in a positive ight. Without the support of HUD and without HUD's wiingness to consent to key ega provisions that remove critica risks in this type of PHA financing, it woud be difficut, if not impossibe, for PHAs to achieve investment grade ratings. The Roe of Reserves Reserves are necessary to ensure that no bond payments are missed due to government shutdowns, resuting ate appropriations, and/or temporary severe reductions in appropriations. A investment grade transactions shoud incude a debt service reserve fund (DSRF) sized at maximum annua debt service on the bonds. The reserve fund can be funded from bond proceeds, shoud be funded upfront, and, if invaded, shoud be repenished in the fow of fows before any Capita Funds can be reeased to the PHA.

6 The DSRF can aso serve to protect against any administrative deays in the receipts of Capita Funds by PHAs. Typicay, the funds appropriated by Congress for Capita Fund become avaiabe in the October/November of the year foowing the beginning of the federa fisca year (Oct. 1). The carefu timing of debt service payment dates, couped with the DSRF, can provide a significant cushion to bondhoders and insuate them against the risk of ate budgets or other deays impacting debt service. Aso viewed favoraby wi be representations from HUD that protect debt service against any deays caused by the process whereby PHAs requisition and receive approva for their aocation of Capita Fund. This occurs as part of the PHA's annua pan submission to HUD, which coud be subject to deays either at HUD or the PHA. Key Lega Features Investment grade transactions shoud incude certain ega provisions. To achieve an investment-grade rating, issuers and their advisors may wish to consider incorporating the foowing features in their transaction documents: The PHA shoud grant the indenture trustee or coatera agent on behaf of the bondhoders a perfected security interest in the Capita Fund program moneys to be received by the PHA; Debt service payments shoud be egay separate from a other Capita Funds received from HUD. Debt service payments and any repenishment of reserve funds shoud be ceary deineated and have a priority of payment ony to bondhoders, if possibe before any remaining funds are reeased to the PHA; Capita Fund monies shoud fow directy from HUD to the indenture trustee or coatera agent to pay debt service without passing through the PHA; Capita Fund monies to be used for debt service shoud be hed under the indenture or deed of trust and shoud not be comminged with any other funds of the PHA; The pedge to bondhoders shoud incude not ony Capita Fund monies but aso the PHA's contract rights pursuant to which the Capita Fund monies are paid as we as the PHA's rights under any successor program; An "additiona bonds" test shoud estabish the required coverage ratios for any future debt; and HUD shoud stipuate contractuay that (1) use of Capita Funds for debt service payments is a permissibe use of funds, (2) no subsequent change in the permitted use of Capita Fund monies wi affect HUD's obigation to pay the Capita Fund monies, (3) amounts pedged to the payment of debt service sha not be avaiabe for any other purpose, and (4) amounts payabe to the indenture trustee or coatera agent are not subject to recapture for any reason whatsoever. Standard & Poor's wi aso review the ega covenants made by the PHA and indenture trustee or coatera agent to ensure compiance with the etter and spirit of the Capita Fund program. For exampe, the PHA shoud notify the indenture trustee or coatera agent immediatey upon being notified by HUD of the avaiabiity of the annua Capita Fund aocation. The indenture trustee or coatera agent shoud then, in turn, proceed to requisition the Capita Funds immediatey from HUD and hod these funds in appropriatey rated investments unti paid to bondhoders. It is anticipated that, at east initiay, Standard & Poor's may request ega comfort as to the perfection and priority of the security interest granted by the PHA in (or as to the nature of absoute assignment by the PHA of) a coatera hed by the indenture trustee or coatera agent, the status under the U.S. Bankruptcy Code of the PHA, and the effectiveness of the grant by HUD of a representations, warranties, covenants, approvas, permits, and waivers necessary to effect the transaction.

7 Surveiance Standard & Poor s wi review these ratings annuay as part of our secondary market review process. The review wi consist of two parts: First, an ongoing review of the federa appropriations process to determine whether there is any evidence of a weakening commitment to pubic housing in genera, or the Capita Fund program in particuar. Second, a review of the PHA s progress in meeting their redeveopment pan objectives. To the extent the PHA is abe to meet pan goas and objectives in a timey fashion, the ikeihood that there wi be any reductions in Capita Fund receipts wi be reduced. Aso, to the extent the PHA s portfoio composition shifts away from what was outined in its pan documents, the funds received from the Capita Fund formua is subject to change, which coud have an impact in the coverage provided to bondhoders. Poitica Factors Ameie Cage, Washington, (1) There are a number of factors at the federa eve that coud affect funding and support for pubic housing--positivey or negativey. Whie the state and oca eves of government can be factors, the federa eve is the most reevant since funding and program design at that eve drive the way PHAs operate today. Even with greater fexibiity, PHAs wi continue to be impacted by decisions of the federa government. Both the executive branch and the egisative branch are key to pubic housing programs. Each year the President submits to the Congress a budget that incudes a funding request for pubic housing programs. But beyond the important budget area, the executive branch is responsibe for impementing egisation through HUD. HUD reguations can hep or hinder programs. Funding formuas may be workabe or tie the PHA's hands. Reguations providing specific direction on how PHAs operate can hep or hinder smooth deivery of service. The first key factor is authorization egisation. It is the authorizing egisation that directs the overa program. Congress originay estabished the pubic housing program in Whie a permanent authorization is in pace, that egisation has been amended many times over the years. Amendments to the authorizing egisation have brought significant changes to the program and need to be recognized.

8 Another factor at the federa eve is appropriation. Pubic housing programs are funded on an annua basis as part of the HUD budget that is incuded in the arger federa discretionary funding. Each February the president sends his budget requests for the next fisca year to Congress. Congress then determines fina eves in its annua budget resoution. These eves serve as a guide for the appropriations committees. Authority for funding is incuded in the authorization egisation. QHWRA authorized pubic housing operating and capita funds for a five-year time horizon, currenty through FY At the end of the five years, Congress must extend the authority for new monies to fow to PHAs. Providing muti-year authority for programs is a standard budgetreated procedure for the federa government. Timing of appropriations is aso a factor. The federa fisca year begins on Oct. 1. Ony twice since 1989 have a 13 appropriations bis been in pace by that date. During those years when appropriations are not competed by Oct. 1, Congress usuay provides for agencies to function on the prior year's amounts through continuing resoutions. But it can create some uncertainty. Since 1990, post-oct. 1 deiberations asted as few as five caendar days in 1993 to as many as 208 days in A third major factor at the federa eve is HUD. HUD is the executive branch department responsibe for impementing egisation and monitoring the use of funds by PHAs. Programs created by authorizing egisation are converted to reguations that can hep or hinder the work of the PHA. HUD aso estabishes the process for deivery of funds to PHAs and monitors the use of those funds. Whie there are numerous factors that can affect the pubic housing programs positivey and negativey, the 65-year od program continues with support form the federa government each year. In addition to funding and programs, this ong history offers a weath of data for anaysis of funding and program evoution. This report was reproduced from Standard & Poor's RatingsDirect, the premier source of rea-time, Web-based credit ratings and research from an organization that has been a eader in objective credit anaysis for more than 140 years. To preview this dynamic on-ine product, visit our RatingsDirect Web site at Standard & Poor's. Setting The Standard. Pubished by Standard & Poor s, a Division of The McGraw-Hi Companies, Inc. Executive offices: 1221 Avenue of the Americas, New York, NY Editoria offices: 55 Water Street, New York, NY Subscriber services: (1) Copyright 2001 by The McGraw-Hi Companies, Inc. Reproduction in whoe or in part prohibited except by permission. A rights reserved. Information has been obtained by Standard & Poor s from sources beieved to be reiabe. However, because of the possibiity of human or mechanica error by our sources, Standard & Poor s or others, Standard & Poor s does not guarantee the accuracy, adequacy, or competeness of any information and is not responsibe for any errors or omissions or the resut obtained from the use of such information. Ratings are statements of opinion, not statements of fact or recommendations to buy, hod, or se any securities.