S&P - Public Finance Criteria (2007). - The Global Clearinghouse

HousingStandard & Poor’s will review the agency’sintended investment of these monies, including thequality and liquidity of proposed investments,which should be invested in investments rated ashigh as the desired rating on the bonds. All SIFinvestment earnings and all premiums charged andreceived from a portfolio must first be applied torestoring the SIF to its initial requirement beforebeing released to the agency or used to redeembonds. All SIFs should be maintained at the originalloss coverage amount, drawn down only forlosses incurred, but not reduced based on theamortization or prepayment of the mortgage portfolio.Lastly, in addition to the net worth maintenancereserve overlaying the SIF, Standard &Poor’s will look at an agency’s fund balance toensure that the remaining 55% of the loss coverageexposure is available.The SIF reserve ratio is higher than that of a privatemortgage insurer because of the increased riskinherent in statewide portfolios, compared withnationally dispersed pools. Geographic concentrationincreases the possibility that the SIF might haveto make larger claims settlement payments duringlocal economic downturns without earning any offsettingpremiums in unaffected regions. The level ofreserves, including SIF reserve and net worth maintenanceamong others, reflects Standard & Poor’sanalytical assessment that the SIF might remain solventand meet all drawdowns, even in the event ofsignificant economic stress.Risk share agreements. Several pool insuranceproviders have entered into risk share or sharedloss agreements with HFAs. Traditionally, thesearrangements provide the housing agency withmore flexible loan underwriting requirements andlower premiums in exchange for the housing agencytaking on some of the real estate risks of the portfolio.Usually, the housing agency is responsible fortaking on the second or middle layer of risk.Because this risk is significant, Standard & Poor’sreviews all risk share agreements in detail prior tothe sale of the bonds and issuer’s acceptance ofsuch arrangements. Collateral or fund balances similarto those used for the self-insurance fund alternativemay need to be pledged to achieve thedesired ratings.Economic stress cash flows. Another method thatcan be used to address loss coverage involves thecapitalization of assumed worst-case scenario lossesinto the structure of the issue. This scenario incorporatesStandard & Poor’s criteria for directly simulatingthe effects of economic stress on a givenmortgage portfolio. This simulation, or “economicstress scenario,” is based on the same criteria usedto compute loss coverage and is incorporated intoall cash flow runs required in the rating process.The objective of the scenario is to demonstrate thata bond issue can undergo the worst-case assumptionsused to determine loss coverage and still meettimely debt service.The economic stress simulation occurs over thefirst three years after the first month of mortgageorigination wherein mortgages equal to one-third ofthe assumed foreclosures continue for one year, atthe end of the year, the nonpaying mortgages areforeclosed. All accrued interest is recouped and allprincipal recovered, less an amount equal to theloss severity. This scenario is repeated in each of thethree years, and all amounts are based on the initialportfolio balance.The losses incurred can be discounted at themortgage rate and deducted from total assets atloan origination, or deducted from the cash flowsas they occur. If the latter approach is used, cashflows reflecting the economic stress scenario mustbe sufficient to pay two bond payments during thefirst 12-month stress period without the benefit ofrecoveries from foreclosed loans. An additionalmethod is the establishment of a reserve amountthat, when invested at a particular rate, is sufficientto cover any losses created under the economicstress scenario. Cash flows should demonstrate theability to meet debt service and expenses under allorigination and prepayment scenarios loss coverage.Furthermore, it is important that the economicstress scenario not result in a reduction in the bondissue’s asset-to-liability parity ratio after origination.Such reductions in asset coverage indicate thatassets other than those earmarked for loss coveragesubstitution are utilized.LOCs. LOCs have been used by several HFAs tosatisfy loss coverage. The LOC must be issued by afinancial institution whose long-term unsecureddebt rating is at least as high as the desired ratingon the bonds. The LOC should provide credit andliquidity coverage and should provide for reinstatement,if the delinquency is cured by the mortgagor.General obligation pledge. Rated HFAs maypledge their general obligation to all payment obligationsunder a bond issue or restrict the pledge tospecific funds, such as reserve funds. Loss coveragemay be met in this way as long as the HFA’s ratingis as high as the rating on the bonds and the exposureto potential losses does not adversely affect theHFA’s ICR rating. In some instances, an HFA’s ratingmay be a full rating category below the bondrating and still qualify. Unless the HFA has anacceptable liquidity rating, only credit losses maybe covered in this way.Subordinate bonds. Several HFAs have used subordinatebonds to meet loss coverage. The size of thesubordinate issue must equal the amount of loss coverageneeded to secure the senior bonds’ mortgage234 Standard & Poor’s Public Finance Criteria 2007