Ratings Performance Across U.S. Social Housing Providers Remains Stable

Due to their strong enterprise risk profiles, which incorporate low industry risks, along with solid market positions, good management, and in certain cases, strong government funding, the social housing providers (SHPs) we rate mostly stand in the 'AA' and 'A' categories. These SHPs include both public housing authorities (PHAs) and nonprofit social housing providers (NFPs), which we collectively refer to as SHPs. In the case of PHAs, the application of S&P Global Ratings' criteria for government-related entities (GREs) could raise the final issuer credit rating (ICR) relative to the stand-alone credit profile due to PHAs' public policy role and strong link with the federal government, and the moderate likelihood of extraordinary government support. (For more detail on our GRE methodology, see "Rating Government-Related Entities: Methodology And Assumptions," published March 25, 2015, on RatingsDirect.)

Since January 2022, we have raised our ratings on two U.S. SHPs, both based on improved finances. We have also lowered our ratings on two SHPs, one due to weakened financial performance and the other based on our view of weakened management and governance.

We have also assigned nine new ICRs: five to NFPs (National Community Renaissance of California, Preservation of Affordable Housing, Mid-Peninsula Housing Coalition, Mercy Housing, and NHP Foundation) and four PHAs (Los Angeles County Development Authority, Everett Housing Authority, Jacksonville Housing Authority, and Housing Authority of the City of El Paso).

Chart 1

SHPs' Operations Face Inflationary Pressures

SHPs continue to battle mounting operating costs relating to increasing insurance premiums, inflationary labor and material prices, and rising interest rates, while offsetting revenue and contributions continue to lag, resulting in depressed EBITDA margins as evidenced in chart 2. Despite these pressures, we expect ratings will remain stable given the strong liquidity positions across each rating level, with projected property level revenue increases directly from portfolio growth as well as U.S. Department of Housing and Urban Development (HUD) funding.

SHPs continue to face rising property and casualty insurance costs. The scale of this pressure can vary significantly based on the geographical location of the assets; for example, some surveyed SHPs in areas of higher risk for natural disasters, such as hurricanes, flooding, and wildfires, have indicated they could face annual insurance cost increases of 40% whereas SHPs in less risky areas will experience more modest increases. These increases relate to the greater frequency of weather-related events and the number of insurers who are leaving certain markets, as well as the inflation-affected cost of repairs and the overall increases in property values throughout the U.S. To reduce the impact on operating performance, management teams have undertaken a range of strategies, including reviewing coverage limits and implementing risk management measures to reduce claims.

Cyber insurance costs also continue to rise, with ransomware attacks increasing 25% annually in 2022 ; likewise, S&P Global Ratings projects annual cyber insurance premiums will increase 25% through 2025. Management teams continue to implement a variety of risk-reducing measures such as more robust technology protections to offset rising premiums.

During the height of the pandemic, most SHPs addressed only emergency and urgent work orders to reduce physical contact with tenants as much as possible. Although there were no noted significant maintenance deferrals once in-person inspections resumed mid-2021, supply-chain issues, staff shortages, and inflationary costs proved challenging. Throughout 2023, SHPs note that although inflationary material costs still pose a burden, supply-chain disruption and staff shortages have eased. S&P Global Ratings believes that overall cost pressures related to deferred maintenance will moderate over the next two years, eventually returning to pre-pandemic levels.

Chart 2

The 26 PHAs we rate receive, on average, approximately 80% of revenues from the HUD, as well as contributions and grants. We also rate seven NFPs that do not receive direct HUD funding and are not considered GREs. With HUD continuing to budget for inflation and the additional risks PHAs face from the rise in environmental damages, the additional support will alleviate capital and operating cost issues if managed effectively.

For the past 11 years, HUD has continued to support the expansion of tenant-based rental assistance (TBRA) and project-based rental assistance (PBRA) programs, increasing funding by 54% and 50%, respectively, with further respective year-over-year increases of 8% and 7% budgeted for 2024. Comparatively, operating subsidy and capital grant funding has increased at a combined marginally slower rate of 38% over the past 11 years, in part due to a decrease in the nation's public housing stocks through the Rental Assistance Demonstration (RAD) program. It is important to consider these increases in the context of the conversion of nearly 30,000 public housing authority units to Section 8 units since the inception of RAD in 2013.

Notably, in the past five years (2018-2022), TBRA, PBRA, and operating subsidy and capital grant funding increases per unit totaled 15%, 19% and 23%, respectively. The largest annual increase occurred in 2020 as HUD amended its budget to include an additional $2.8 billion and $1.5 billion for TBRA and PBRA, respectively, to aid residents during the pandemic. We note that the 7% increase in PBRA programs in 2023 was a direct response to the increase in natural disasters as HUD committed to $989 million to Renewal Emergency Funding, ultimately keeping contract renewals flat, before rolling the additional funding into contract renewals in 2024. TBRA's 10.5% increase in 2023 is predominately associated with contract renewals followed by administrative fees, with an 8.1% further increase in 2024.

Chart 3

What Would Happen In A Government Shutdown?

PHAs are well positioned to navigate a short-term shutdown given high reserves and access to existing funding.

Although the government avoided a shutdown last week, passing a 45 day continuing resolution, S&P Global Ratings has reviewed the operational effect that SHPs would have faced in a shutdown. Our assessment consists of HUD releasing a contingency plan to identify and address the disruption caused by such a shutdown and SHPs' current cash position. S&P Global Ratings believes that in a government shutdown, SHPs' credit quality would remain stable due to the high level of cash available (unrestricted and restricted cash, cash equivalents, and investments) throughout the sector; however, a prolonged shutdown would increase the likelihood that credit quality would suffer.

Although PHAs are not part of the federal government, and there is no expectation that any PHA will close in the event of a government shutdown. Without administrative or operational funding, these issuers will rely on using their existing available cash to maintain operations. Therefore, it's possible that PHAs might reduce operating hours or services to limit costs and maximize available cash. HUD recommends PHAs maintain at least 120 days' operating reserves and we believe these entities are well positioned given their increased cash situation in recent years, with median days' cash on hand increasing 17% from 2016, to 186 days as of 2022 audited results.

During a shutdown, PHAs will be able to continue to access funds from HUD's line of credit control system where funds have already been obligated, which includes grants. A similar scenario will occur for housing choice vouchers, where payments are expected to be disbursed as long as the funds have already been obligated to the respective PHA before a shutdown. HUD will not review any new grants or vouchers during the government shutdown; however, the ability to submit will remain open and will be reviewed on passage of the appropriations bill.

NFPs are not considered government entities and do not have direct funding from HUD; however, median days' cash on hand is significantly higher than that of PHAs at 458 days as of 2022; therefore, we do not believe that SHPs will face material pressure from a government shutdown.

Acquisitions And Developments Are Ramping Up With Debt Levels Expected To Remain Strong

Inflationary costs as well as a rapidly rising interest-rate environment have tapered off median debt levels in recent years because some SHPs targeted alternative financing arrangements for their development and acquisitions. S&P Global Ratings believes that the Fed will increase rates 25 basis points at its November meeting and that the U.S. economy is poised to slow down for the rest of 2023 (see "Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted," published Sept. 25, 2023) , with S&P Global Ratings Economics' current recession forecast within the next 12 months remaining elevated at 30%-35% ( see "U.S. Business Cycle Barometer: Recession Risk Still Elevated Amid Uncertain Growth Prospects," Sept. 20, 2023). We have seen a notable uptick in the acquisition of naturally occurring affordable housing by both NFPs and PHAs, and based on our survey responses, both have indicated their appetite to pursue strategies that improve and expand their housing portfolios. We also believe that construction pipelines that paused during the pandemic have resumed and additional developments are already underway, accelerating growth over the next two years.

Generally, SHPs expect their overall capital budgets will increase by more than 5%-10% over the next two years as development activity resumes. We expect that strategies for growth will involve varying degrees of debt and cash as management teams become comfortable with increased project budgets, and a higher interest-rate environment, and as an overall increased cash position allows a cushion for financing gaps to help get deals across the finish line.

We expect to see continued use of debt for development and acquisitions. In the past decade, SHPs have issued more than $2.6 billion in debt, of which 63% has been proposed for redevelopment activity. SHPs that have historically financed developments through traditional financing products are now accessing the municipal markets because investor appetite for affordable housing products remains high, resulting in more attractive rate options. Indeed 46% of total public bond issuance in the past decade has been sold within the past two years. We expect this increase in bond issuance will continue given the development and acquisition pipelines and a more attractive rate environment in the public market.

Chart 4

Although increasing the proportion of hard and soft debt to fund housing development might imply a higher credit risk, we don't believe that this, by itself, will necessarily imply lower ratings, particularly if an SHP manages the associated risks well and if coverage levels (perhaps boosted by higher EBITDA margin) still indicate an ability to absorb financial pressures. Higher asset values and rents could also mitigate the effect of increased debt on key financial ratios. Given the measured approach to debt levels in recent years and stabilized financial performance, we believe overall debt metrics (as measured by non-sales adjusted EBITDA/interest and debt/non-sales adjusted EBITDA ratios) will remain consistent and strong.

Chart 5

RAD Conversions Continue Despite Inflationary Cost Pressures

The HUD's RAD initiative continues to expand as we move beyond the program's 10th year. With many authorities now realizing modest ongoing cost savings post-conversion, they have an increased appetite to convert some or all of their public housing stock through RAD. From our discussions, their initial concern about how an implementation would affect operations now seems to be alleviating. As noted in chart 6, there is no slowing of new RAD conversions: The number of units to date awarded a Commitment to enter into a Housing Assistance Payments Contract (CHAP), which will drive future increases in RAD units, has somewhat slowed from record highs in 2022. The number of RAD units that have closed has also stagnated in recent years, indicating the inflationary cost pressures such projects face.

In the rising cost environment that continues to affect capital and operational budgets throughout the sector, we believe that management's ability to control costs and delays once committing to undertaking such a strategy will remain paramount to the overall success of such an implementation. The risks associated with the magnitude of the number of units converting and associated costs, along with the timing and execution of any units remaining offline, could pressure an authority's operational results. We believe that reliance on a sophisticated management team and a commitment to allocate sufficient resources to oversee such a conversion strategy will be critical to avoiding a decline in the health of an authority's income statement, and subsequently maintenance of sound credit quality.

Chart 6

The Demand For Affordable Housing Will Keep Rising Amid Funding Gaps

We expect demand for affordable housing will continue to increase and SHPs are ramping up through different strategies and financing resources to address that demand using increasing debt, tax credits, and other subsidies from government while affordable funding gaps continue to widen. We believe that SHPs' management decisions are critical to balance plans to invest in their existing housing stock and develop new homes while maintaining robust financial benchmarks pressured by significant cost inflation.

SHPs with a deliberate, consistent, resourced, and integrated approach that effectively identifies and prudently mitigates risks are more likely to build long-term credit strength than SHPs with a casual, opportunistic, or reactive approach. In S&P Global Ratings' view, an SHP's strategic competence, operational effectiveness, and ability to manage risks are keys to maintaining stable credit quality.

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