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

HousingFHA Insured Multifamily MortgagesThe security for Federal Housing Administration(FHA)-insured multifamily mortgage-backedissues consists of several components, primarily theinsured mortgage note, investments, and reserves.Standard & Poor’s Ratings Services assumes that amortgage default may occur at any time during theterm of the bonds. Since the FHA’s regulations andpractices do not provide for immediate claims payments,reserves need to be available to pay thebonds until the claim is paid in full.The FHA has given Standard & Poor’s assurancesthat HUD, of which the agency is a part, providespriority processing for insurance claimsinvolving projects financed with rated bonds. TheFHA permits processing to go forward when workoutsare being pursued, a concept often referred toas “dual processing,” which is necessary to ensurereserve sufficiency in the event that the workout isunsuccessful. Moreover, the agency has indicatedthat it will act to process claims expeditiously sothat final payment is received within a reasonabletime frame, assuming that the trustee acts expeditiouslyduring the assignment process. Standard &Poor’s sets its reserve fund guidelines based on theserepresentations and an assessment of the potentialfor delay based on actual defaults. These factors, aswell as demonstrated coverage of other inherentprogram shortfalls defined below, enableStandard & Poor’s to assign ratings as high as‘AAA’ to these issues.Standard & Poor’s criteria for FHA-insured mortgagesincludes multifamily, hospital and nursing homeprograms, as well as the HFA risk sharing program.Supports And ShortfallsStandard & Poor’s looks for coverage of the potentialshortfalls cited below at bond closing to protectbondholders in case of a mortgage default and aloss of interest earnings. Credit enhancement mechanismsinclude cash, third-party supports, and otherstructuring mechanisms.Liquidity ReservesReserves provide the liquidity needed to offsetpotential interruptions in debt service in the eventthat a mortgagor defaults. Bond proceeds can fundthese reserves, since interest paid on mortgageinsurance benefits should be sufficient to replenishthe reserves.Debt service reserve fundsStandard & Poor’s has concluded that, in cash payoutprograms, a debt service reserve fund equal toeight months’ maximum bond debt service shouldbe sufficient, based on the following:■ Mortgage insurance is paid in two installments.■ In a worst-case scenario where the default occursprior to final endorsement, the first portion of70% of mortgage insurance is paid within sixmonths of the date the notices of default andintention and election to assign are sent. HUDpays this amount following the recording of theassignment of the mortgage loan to the FHA.Bonds should be redeemed with this insurancepayment on the earliest practicable date.■ Standard & Poor’s assumes that the claim’sremaining 30% may not be received until the sixmonths after the first payment. This is becausethe trustee is required to obtain information anddocumentation from hazard insurers, the mortgagor,the servicer, and other third parties, andreliance on these third parties can cause delays.A debt service reserve fund (DSRF) equal tomaximum annual bond debt service is needed indebenture pay issues where the insurance claimis paid in one installment. Debentures areassumed to be received within one year of thenotice of default.Bond proceeds typically fund the debt servicereserve fund, although other methods, such as lettersof credit (LOCs) issued by banks rated as highas the bonds, or cash, are sometimes used. Theinvestment of DSRFs in investment agreements forthe life of the issue eliminates market risk. Whenthe reserve is funded with bond proceeds, if thereserve is called on, the expended portion is nolonger earning expected investment income.Depending on when the drawdown occurs,Standard & Poor’s has found that a shortfall maybe created. The shortfall may be offset by theinterest component of the FHA insurance proceeds.A sufficiently high debenture interest rate,relative to the owner’s mortgage coupon, can mitigatethe lost earnings on the debt service reservefund. Any shortfall that arises needs to be coveredat the time of the rating.250 Standard & Poor’s Public Finance Criteria 2007