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

S&P Global Ratings' social housing provider (SHP) ratings mostly stand in the 'AA' and 'A' categories given providers' strong enterprise risk profiles, which incorporate low industry risks, along with solid market positions, good management, and, in certain cases, strong government funding (see chart 1). These SHPs consist of both public housing authorities (PHAs) and nonprofit social housing providers (NPs). In the case of PHAs, the application of our criteria for government-related entities could lead us to raise our issuer credit rating (ICR) relative to the stand-alone credit profile. This decision reflects PHAs' public policy role and strong link with the federal government as well as the moderate likelihood of extraordinary government support. (For more detail on our methodology, see "Rating Government-Related Entities: Methodology And Assumptions," published March 25, 2015, on RatingsDirect.)

We have raised the ratings on two U.S. SHPs since January 2023, both times as a result of improved financial performance. We also lowered the ratings on four SHPs: two as a result of weakened financial performance and two to reflect our view of weakened management and governance. We also assigned six ICRs, to two NPs (Mercy Housing and NHP Foundation) and four PHAs (the Housing Authority of the City of El Paso, the Housing Authority of Dekalb County, the Stanislaus Regional Housing Authority, and the Santa Clara County Housing Authority). Over this period, 50% of the newly rated SHP issuers tapped the capital markets to issue debt.

Chart 1

Growth Strategies: New Units Versus Preservation

Access to affordable housing has reached a record low--the National Low Income Housing Coalition projects a shortage of 6.8 million such units across the U.S.--in part because the cost of living has outpaced wage growth. As a result, we observe SHPs implementing growth strategies to increase the number of affordable units through acquisitions and new construction, but not when the preservation of existing units comes as the tradeoff. With finite resources for a backlog of approximately $115 billion of public housing capital needs, according to the U.S. Department of Housing and Urban Development (HUD), and an aging affordable housing stock , SHPs are prioritizing recapitalizing or repositioning their existing properties before exploring growth opportunities. Many SHPs, particularly those with a larger swath of resources, are repositioning their stock in conjunction with bringing additional units on line. As a result of this growth, a number of financing strategies have been implemented across our rated universe of SHPs.

Some organizations are also considering Transportation Infrastructure Finance and Innovation Act (TIFIA) loans and private-public partnerships with local governments and private investors to leverage more resources.

In some cases, these strategies require an initial resource outlay without the guarantee of grant or other funding, which can deter SHPs committed to growth targets. Other potential roadblocks include:

• Regulatory and zoning delays when sourcing land, which often lead to lengthy processes with local partners; and
• Difficulty in obtaining Low Income Housing Tax Credits for developments, according to our surveyed SHPs.

From a credit perspective, we view publicly issued debt in the same manner as privately placed, and depending on the structuring there are often less restrictive covenants in the public debt market that we believe could increase contingent liquidity risks. In the wake of the initial 50-basis-point drop in September and further 25-basis-point cut in November, we believe the Federal Reserve will make additional rate cuts in the coming 12 months to reach the terminal rate of 3.00% to 3.25% by the end of 2025. However, the Trump administration's proposed economic policies could create uncertainty about the timing and magnitude of the Fed's monetary policy. (See "Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral," published Sept. 24, 2024; and "After Trump's Win, What's Next For The U.S. Economy?" published Nov. 7, 2024.) The direction of fiscal policy in the coming years may make certain transactions viable that were previously cost-prohibitive in a higher-rate environment, resulting in increased bond issuance to fund overall unit count and higher leverage across the sector. We have seen a correlation between unit growth and debt incurred by SHPs, a trend we expect to continue in 2025 (see chart 2).

Chart 2

In the past year, SHPs have preferred acquisitions over new constructions, as the immediate cash flow offers less risk associated with unexpected construction costs and potential delays. In some cases, rehabilitation required on acquisitions varies significantly, but upon possession of a project the immediate cash flow can reduce the financial stress of unexpected capital outlays. Our analysis accounts for the lag in revenue from new constructions when incorporating an increased debt burden, but construction risk is greater. Although some building materials and supply chain shortages have improved since the pandemic, labor costs and higher interest rates on debt have kept some projects from getting over the finish line.

Additional staffing costs may prove a risk to operating margins in the short term and will require a well-executed strategy to maintain financial performance. We expect that growth strategies will involve some combination of debt and available cash as management teams utilize balance-sheet resources to cover financing gaps to complete projects. Interest earned on cash during the past two years, as well as potentially some cash remaining from pandemic federal support, together provide SHPs flexibility to invest in acquisition or preservation projects. That said, although the average liquidity ratio for SHPs remains strong at 5.3x, we expect it could weaken given increased utilization for development and additional debt service.

In our view, an SHP's strategic competence, operational effectiveness, and ability to manage risks are keys to maintaining stable credit quality. We believe that SHPs' management decisions are critical to balance plans to invest in existing housing stock and develop new homes while maintaining robust financial benchmarks in a high inflationary environment. 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. Examples of this include long-term forecasting and robust reserve and liquidity policies.

Rental Assistance Demonstration (RAD) conversions are picking up after recent inflationary cost pressures

As mentioned, many authorities are using HUD's RAD program to preserve and improve affordable housing. RAD conversions have become embedded as part of authorities' preservation strategies as more have realized modest, ongoing cost savings following the conversion and the initial capital injection to preserve aging stock. From our discussions with PHAs, the initial concerns are abating about how an implementation would affect operations. As a result, new RAD conversions are not slowing as occurred in 2021 and 2022 (see chart 3). The number of units awarded a Commitment to enter into a Housing Assistance Payments Contract (CHAP) rose 7% in 2023 and 6% this fiscal year to date. These commitments fuel future increases in Section 8 units, demonstrating that the RAD program remains popular.

Chart 3

As recent rising costs have affected capital and operational budgets throughout the sector, we believe that management's ability to control costs and conversion delays will remain paramount to a successful implementation. The risks and costs associated with the magnitude of the number of units converting, along with the timing and execution of any units remaining off line, could pressure an authority's operational results. We believe that reliance on an experienced management team and a commitment to allocate sufficient resources to oversee such a conversion strategy are important to averting pressure on the income statement and the rating.

Financial performance could stabilize as revenue begins outpacing expenditures

Post-peak pandemic era cost pressures from personnel, insurance premiums, utilities, and maintenance costs continue to stress SHPs across the nation. Insurance costs remain a substantial component of operating expenditures, and SHPs are considering options to maintain or limit the budgetary burden. Insurance coverage, availability, and cost for premiums can vary significantly based on state and geographical location, particularly as some areas are more prone to natural disasters such as hurricanes, flooding, and wildfires. But the theme remains: Insurance costs will continue to rise, albeit at a potentially slower rate.

Several housing authorities are working with their insurance brokers to explore alternative risk transfer programs, insurance pools, captive insurance, splitting of coverage among multiple carriers, or an increase in deductibles to maintain or reduce the premium. Organizations have also sharply focused on improving their insurance profile by investing in fire suppression strategies, such as electrical panel and fire alarm system upgrades. Furthermore, robust employee training and loss prevention strategies to reduce workers' compensation and liability claims could help balance insurance costs with sufficient coverage of potential risks and losses.

PHAs continue to balance the social mission of providing affordable housing and keeping rents as low as possible with the need to raise rents where doing so is permissible to offset the rising costs mentioned. Many management teams are determining ways to increase revenue to maintain financial stability, and some PHAs report that they can modestly raise rents if need be to increase budgetary flexibility. But this could come at a cost to residents, so management is focused on growth strategies and exploring ways to reduce vacancies across their portfolios. Although balance sheets are strong and despite some use of resources to fund the growth strategy, we expect ratings will remain stable as property-level revenue increases from additional units and as lagging HUD funding catches up to needs. We anticipate that these revenue trends will be reflected across portfolio income statements in fiscal years 2024 and 2025 (see chart 4).

Chart 4

HUD funding remained stagnant in 2024, and 2025 funding is uncertain

As a result of Congress' seeking to avoid a government shutdown, the continuing resolutions passed in February and September 2024 held HUD's 2024 budget for PHAs relatively flat. Over the past 12 years, HUD's funding support for the expansion of tenant- and project-based rental assistance programs increased by 53% and 50%, respectively, with increases of 8% and 12% budgeted for 2025. Comparatively, operating subsidy and capital grant funding has increased at a marginally slower rate of 38% over the past 12 years, with a drop in funding of 1% budgeted for 2025 partly as a result of a decrease in the nation's public housing stock through the RAD program (see chart 5). Over a shorter period of the past five years (2020 to 2024), tenant- and project-based rental assistance program and operating subsidy and capital grants increases totaled 30%, 25%, and 14%, respectively. 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.

With the recent election resulting in the President, Senate, and Congressional majority coming from the same party, the potential for political deadlocks is reduced, opening the door for the passing of HUD's budget with little partisan resistance. This could lead to widespread budgetary changes with Congress already indicating an appetite to reduce funding for programs such as tenant- and project-based rental assistance, operating subsidy and capital grants, and the Homeownership Opportunity Program while eliminating programs such as the Choice Neighborhoods Initiative. It is unclear how the recent election will affect the final 2025 budget, but funding for PHAs could likely be pressured over the next two budgetary cycles.

Chart 5

Tax Policy In Focus With Change In Federal Administration

Tax policy was at the forefront throughout Trump's campaign, and using 2017's Tax Cuts and Jobs Act as a guide we envision possible pressure for the sector's key foundation, tax exemption. Private activity bonds were part of the original discussions on the Tax Cuts and Jobs Act, and as it nears expiration at the end of 2025 any effects on the affordable housing sector that limit funding for initiatives could challenge execution of SHPs' growth strategies. Another key aspect in the sector is Low Income Housing Tax Credits, which provide an additional method to secure capital. Finally, potential changes to the corporate tax rate have become a post-election area to watch.

Where affordable housing funding gaps persist at a national level, many advocates and providers are looking to state and local ballot measures that could alleviate funding challenges. SHPs operating in California are closely watching Statewide Proposition 5, which would lower the voter threshold for passing local infrastructure and affordable housing bonds to 55% from two-thirds. Issuers are also following other state and local ballot measures, including expanding rent control authority, passing housing bond referendums, and enacting a permanent sales tax to fund affordable housing.

While some SHPs expect continued bipartisan support for key housing programs, others are looking to the balance of party politics to gauge the scale of funding they can expect until the next election cycle. We will monitor how the House, Senate, and Presidency will work together to adopt, extend, or eliminate long-standing programs and policies.