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

Housingment grade ratings due to the essentiality of federallysubsidized housing. Termination risk is moreof an issue that needs to be analyzed on a case-bycasebasis. Standard & Poor’s has seen contractterms as short as one year and as long as twentyyears. Generally, Standard & Poor’s looks morefavorably on longer-term contracts, but whetherthe term is one year or 20 years, termination riskcan be offset if the project meets the standards setforth under MAHRA for contract extension, aslong as the owner is legally obligated to apply forcontract extensions.The expectation that contracts will be extended isstrengthened by language in MAHRA that theHUD Secretary shall extend at the owner’s requestsubject to appropriation under such terms and conditionsthat the Secretary deems appropriate. Thelegislation permits the HUD Secretary the option ofnot renewing due to poor financial or operationalperformance of the project owner on the subjectdevelopment, as well as other HUD subsidized projects.Therefore, Standard & Poor’s will evaluatewhether the owner and property will meetStandard & Poor’s, as well as HUD’s standards ofperformance throughout the life of the transaction.In addition, the HUD REAC score at the time ofthe rating, and on an ongoing basis, is an indicationof HUD’s assessment of the owner. A deteriorationof the REAC score below 75 could be an early signalof the failure of the owner to operate the propertyat a level needed to maintain the contract.Other factors that add to the overall credit qualityof the transaction help to make the case for theessentiality of the project, as well as its ability towithstand contract termination, include if:■ The project caters to HUD’s targeted tenancy,especially, the elderly;■ The project could potentially operate withoutsubsidy; and■ A potential sale of the property upon contractextension could generate sufficient funds to retirethe bonds.Section 8 ConversionsIn situations where the owner has a viable plan forconverting a Section 8 subsidized property tounsubsidized status over the life of the transaction,Standard & Poor’s will consider ratings up to lowinvestment-grade for bonds meeting conversion criteria,as follows:■ The feasibility of the transition from subsidizedto unsubsidized status at the targeted rent levelsshould be substantiated in an independent thirdpartyreport;■ Projects should be owned and operated by anexperienced affordable housing organization witha proven track record or have oversight of a stateor local HFA or PHA;■ The owners should present Standard & Poor’swith a written transition plan, which is, in effect,a plan of actions to be taken in conjunction withthe expiration of the Section 8 contract. The planshould incorporate the methodology that theowners will use to ensure the successful conversionof the property within the shortest possibletime frame.■ Cash flow scenarios should be run showing paymentof bonds in the event that the Section 8contract is extended and in the event that theproject converts to AHP status.Scenario 1 assumes successful relocation of existingtenants and releasing of units during a transitionperiod assumed to begin upon expiration ofthe HAP contract. The length of the transition isassumed to be the greater of two years or fourtimes the absorption rate for similar properties inthe market. During the transition period, the projectneeds to meet at a minimum only the debt servicecoverage for HAP contracts. At the end of thetransition period, the project must meet the AHPdebt service coverage levels. Reserves should not berelied on in meeting the coverage levels.Scenario 2 anticipates great difficulty in relocatingthe existing tenants and re-renting the units. TheSection 8 tenants are only assumed to vacate theunits at the historical turnover rate for the property.Under both scenarios, a vacancy rate of at least5% should be assumed, as well as a 30-day periodto turn around a unit for occupancy once it hasbeen vacated. Once the Section 8 contract hasexpired, project income will consist of the tenants’portion of the rent (30% of income) based on thehistorical rent roll of the property.Ratings on Section 8 conversions will includeonly properties where most attributes fall withinthe “excellent” category. Standard AHP debt servicecoverage levels will apply, most likely at thehigher end of each category.Section 236 Interest Rate Reduction TransactionsFor the Section 236 interest reduction payment program(IRP), financing activity tends to be for singleassetstructures involving the bifurcation of themortgage loan and the creation of debt supportedsolely from IRPs. Unlike prior Section 236 financings,which relied upon total project revenues tomeet operating costs and debt service payments,these transactions rely only on the Section 236 payments.The tenant portion of a project’s income isnot pledged to the IRP bondholders.Because of the structure of these financings andthe track record of the program, real estate risk is282 Standard & Poor’s Public Finance Criteria 2007