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

Unenhanced Affordable Housing Project DebtProject Evaluationstrustee a right to cure the borrower’s default underthe ground lease. This gives the trustee the abilityto prevent a termination of the ground lease. Thereal estate ground lease criteria, can be found in theStandard & Poor’s U.S. CMBS Legal andStructured Finance Criteria located on www.standardandpoors.com.Bond Structure And ReservesBond structures typically incorporate fully amortizingdebt In addition, this debt can have bond maturitiesof up to 30 years, as long as the engineeringreport and site review indicate the structural soundnessof the property for the bond term, and appropriatereserves are set aside for ongoing preventivemaintenance and capital improvements.Generally, Standard & Poor’s will look for a debtservice reserve fund (DSRF) equal to maximumannual debt service on the bonds, which may befunded with bond proceeds. Exceptions would bewhere an acceptable servicer agrees to make servicingadvances in the event of temporary debt serviceshortfalls. Extremely high DSC may also providesufficient liquidity to obviate the need for a separatereserve. Monies for the debt service reservefund should be invested in investment grade securities(‘BBB-’ or higher), and be available to pay debtservice in the event of a shortfall.The cash flows should incorporate a 30-day lagon mortgage payments. Adequate reserves shouldbe initially set up and maintained in accordancewith the ongoing preventive maintenance andreplacement schedule indicated by management andconfirmed with a structural engineering report.Additional reserves may be necessary to bring theproperty up to environmental standards. MortgageStandard & Poor’s evaluates the property and the management and assigns aproject ranking from “poor” to “excellent. This ranking is a major determinant inthe final rating. Standard & Poor’s project evaluations are based on information inthe rating process, as well as the on-site property and management review.The guidelines for project evaluations focus on the following factors:■ The evaluation assigned to the project owner.■ Capacity, experience, and track record of on-site manager■ Historical vacancy.■ Market conditions in the project area, including a review of the overallcompetitiveness of project in the real estate market, including existing andcompeting projects planned for completion in the next few years.■ Overall project design and condition.■ Adequacy and condition of amenities.■ Local, regional, and state economy.reserves may be provided in the form of cashreserve funds or servicing advances.Subordinate debtSubordinate debt is frequently needed to make theprojects financially feasible. Standard & Poor’s mayexclude subordinate debt in its calculation of LTV.For example, if the debt is public purpose in nature,comes from governmental or municipal entities, andis a cash flow mortgage that is nonforeclosable.Standard & Poor’s will need to review the termsof the subordinate debt to ensure that it does notimpair the financial feasibility of the project.Standard & Poor’s will look for intercreditor agreementsbetween the trustee on behalf of the holdersof the rated securities and the subordinate lender toensure that the rights of the holders of the ratedsecurities to receive timely payments of principaland interest are not impaired.Construction And Lease-Up RiskMultifamily housing construction projects containsome degree of construction risk; that is, the possibilitythat the project will not be completed on timeor in accordance with specifications, thus causing adelay in debt service payments. For constructiontransactions, the level of construction risk the projectentails will be evaluated, and will be determinedto be low, moderate or high. If the level of constructionrisk is moderate to high, further analysiswill be undertaken, and could include the use of anoutside construction consultant. (See Public FinanceCriteria: Assessing Construction Risk)The more significant credit risk in new housingconstruction transactions is lease-up risk. New projectsmay fail to achieve projected income levelsbecause they cannot rent up properties to projectedoccupancy levels for market reasons such as excesssupply due to new construction, reduced demanddue to recession or the relative attractiveness of single-familyhome purchases compared to renting.Failure to achieve projected rents can occur for thesame reasons. While multifamily rehabilitationtransactions have the advantage of prior occupancyand established rental rates, loss of tenants duringrehabilitation can cause delays in achieving targetedoccupancy after completion of construction.History shows however, that in the affordable housingsector additional resources, such as soft secondloans from municipalities, developer, syndicator andnot-for-profit equity in tax credit transactions, andHFA funds, can help projects over these difficulties.In addition, capitalized interest and liquidityreserves can help tide a project over until lease upand stabilization are reached. Lease up risk must beadequately addressed for affordable housing transactionsto be rated investment grade or higher.www.standardandpoors.com267