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ARCHIVE | Criteria | Governments | Request for Comment: Methodology For Rating U.S. Public Finance Rental Housing Bonds

(Editor's Note: This criteria article is no longer current. It has been superseded by "Methodology For Rating U.S. Public Finance Rental Housing Bonds," published April 15, 2020.)

SCOPE OF THE PROPOSAL

1. S&P Global Ratings is requesting comments on its proposed update to its methodology for rating rental housing bonds in the U.S. All terms followed by an asterisk are defined in the glossary (see Appendix A).We intend the proposed methodology to be read in conjunction with the related guidance (see Proposed Guidance in Appendix B).

2. This proposed methodology, if adopted, would apply to ratings on bonds backed by rental income from residential properties that serve a public purpose. In particular, the proposed methodology would apply to bonds backed by revenues from:

  • Affordable multifamily housing* (including mobile home parks);
  • Age-restricted independent* or assisted-living* rental housing;
  • Privatized military housing*;
  • Privatized student housing affiliated with a university, college, or community college*; and
  • Pools* of loans secured by affordable multifamily housing.

3. The primary purpose of the proposed methodology update is to recalibrate our rating analysis, following observed volatility and sharp deterioration in creditworthiness within subsectors of the issues in scope. While the proposed methodology focuses on the same key factors as current criteria, it includes the following key changes:

  • We propose to recalibrate our approach to debt service coverage (DSC), in particular through the revision of DSC ratio ranges and the introduction of new adjustments, for example, for cash flow volatility or liquidity risks. The use of maximum annual debt service (MADS) in the DSC calculation captures overall indebtedness of the transaction and the use of the volatility adjustment captures expectations of relative cash flow stability or volatility.
  • The proposed methodology would focus on borrower default risk and would no longer consider (as our current methodology does) property liquidation value determined according to our CMBS criteria framework. This is because liquidations are rare for the property types in scope of these proposed criteria, such that we consider that characteristics that increase or mitigate borrower default risk are the most relevant differentiators of credit risk.
  • In addition, we propose a more flexible approach to the analysis of a property's market position and of management and governance, which we believe will better capture nuances across different property and transaction types.

4. The proposed methodology would not apply to:

  • Continuing care retirement communities (CCRCs) or multifacility organizations where CCRCs comprise the majority of the organization. These organizations are operating entities, and require a different approach to the transaction-based framework described in the proposed methodology. They are rated based on "Senior Living" criteria, published June 18, 2007;
  • Securitizations backed by multifamily properties that do not include affordability covenants, which are rated under "Rating Methodology And Assumptions For U.S. And Canadian CMBS," published Sept. 5, 2012;
  • Federally enhanced housing bonds (FEH bonds) (housing bonds where full credit enhancement from U.S. federal government agencies is available on the mortgage loans, mortgage-backed securities, or directly on the FEH bonds), which are currently rated under "FHA Insured Mortgages," published June 18, 2007, "Ginnie Mae, Fannie Mae, And Freddie Mac Multifamily Securities," published June 26, 2007, and "Single-Family Mortgage-Backed Securities Programs," published June 13, 2007.

5. If adopted, the proposed methodology will fully supersede "Rating Methodology And Assumptions For Affordable Multifamily Housing Bonds," published June 19, 2014, and partially supersede "Higher Education," published June 19, 2007 (specifically, the aspects of that article that relate to university-affiliated privatized student housing).

Key Publication Information

  • Publication date: Nov. 4, 2019.
  • Response deadline: Dec. 18, 2019.
  • Effective date: Immediately upon publication of final methodology.
  • Impact on outstanding ratings: See Impact section.

SPECIFIC QUESTIONS FOR WHICH WE ARE SEEKING A RESPONSE

6. S&P Global Ratings is seeking responses to the following questions, in addition to any other general comments on the proposed criteria:

  • What is your view of the overall structure of the proposed methodology and clarity of its scope (type of entities rated with the proposed methodology)?
  • In your opinion, does the proposed methodology contain any significant redundancies or omissions?
  • Are our proposed criteria principles and adjustments comprehensive and clearly defined?
  • Do you believe that the proposed methodology appropriately captures credit risks and do you agree with the manner in which we propose to assess these risks (selection of key factors, their weighting, associated ratios and measures to assess these risks, associated caps)? If not, what alternative(s) would you propose?
  • Do you agree with our proposal to focus on borrower default risk rather than property liquidation value, and therefore to use DSC as the key quantitative metric of our coverage and liquidity reserves analysis rather than loan-to-value?
  • Do you agree with our proposal to apply a negative adjustment to the rating for transactions with multiple tranches of varied seniority that include a "springing-lien" provision, which results in a pro rata distribution of recovery proceeds following a default of the most senior tranche (see Table 1, and the proposed guidance document in Appendix B)?
  • Are there any other views regarding this methodology proposal that you would like to bring to our attention?

IMPACT ON OUTSTANDING RATINGS

7. S&P Global Ratings maintains approximately 310 ratings on rental housing bonds included in the scope of this methodology. Assuming that the obligations maintain their current credit characteristics, testing indicates that approximately 60% of the ratings would be unchanged, up to approximately 10% would be raised, generally by one notch, and up to 30% would be lowered, generally by no more than three notches, and in rare cases, up to six notches. We expect downgrades primarily among stand-alone transactions backed by affordable multifamily housing and age-restricted housing. Ratings most likely to be lowered are those on transactions where deteriorating financial performance has led to a tight DSC ratio, as well as those backed by smaller-scale properties.

RESPONSE DEADLINE

8. We encourage interested market participants to submit their written comments on the proposed criteria by Dec. 18, 2019, to http://www.standardandpoors.com/en_US/web/guest/ratings/rfc where participants must choose from the list of available Requests for Comment links to launch the upload process (you may need to log in or register first). We will review and take such comments into consideration before publishing our definitive criteria once the comment period is over. S&P Global Ratings, in concurrence with regulatory standards, will receive and post comments made during the comment period to www.standardandpoors.com/en_US/web/guest/ratings/ratings-criteria/-/articles/criteria/requests-for-comment/filter/all#rfc.

9. Comments may also be sent to CriteriaComments@spglobal.com should participants encounter technical difficulties. All comments must be published but those providing comments may choose to have their remarks published anonymously or they may identify themselves. Generally, we publish comments in their entirety, except when the full text, in our view, would be unsuitable for reasons of tone or substance.

FRAMEWORK OVERVIEW

10. The proposed analytical framework consists of five steps, summarized below and illustrated in the chart.

  • Step 1: Our legal and operational framework analysis focuses on typical legal provisions covered in transaction documents necessary to assign and maintain a rating to the bonds under these proposed criteria.
  • Step 2: We assess three key credit factors: coverage and liquidity reserves, management and governance, and market position. We assess each factor as "very strong," "strong," "adequate," "weak," or "very weak," which equal numeric scores of '1' to '5', respectively. The assessments for any factor can also be a midpoint between two assessment levels: for example, we may assess a factor as "very strong/strong," which equals a numeric score of '1.5'.
  • Step 3: We determine the anchor based on a weighted-average of the numeric scores for the three key credit factors. Because we believe that some factors are more likely to affect credit quality than others, we assign different weights to each of the three key factors.
  • Step 4: We adjust the anchor to capture unusual credit factors, by applying any relevant overriding factors and caps, to determine the indicative rating. Furthermore, we would apply our holistic analysis to help capture a broader view of creditworthiness.
  • Step 5: We will apply any other relevant criteria to arrive at the final rating--for example, to capture U.S. sovereign risk, financial counterparty risk, and/or operational risk.

image

11. We will base our assessment of all factors in this proposed methodology on our forward-looking view of performance, built on an analysis of historical and current performance metrics, including the volatility and trend of historical results. In some cases, our view of future performance may differ from historical or current results. Our forward-looking view is informed by our opinion of macro conditions such as economic, legislative, environmental, and regulatory; our view of entity-specific factors such as occupancy trends, capital expenditure, support level from related parties, and management actions; and the entity's own forecast when available.

LEGAL AND OPERATIONAL FRAMEWORK ANALYSIS

12. The legal framework is important to the transactions in scope, because it links the duties of the key transaction parties (KTPs) with the proper execution of the program. If, in our view, typical legal provisions are not present in the transaction documents or the associated legal risks are not mitigated, the transaction would not be eligible to be rated under the proposed methodology. Typical legal provisions include security and collateral, flow of funds, events of default, acceleration and redemptions, among others.

13. Our legal analysis also focuses on bankruptcy and other legal risks that could adversely affect the ability to pay full and timely debt service. These concepts are analyzed differently, as compared with the approach we take in our analysis of U.S. structured finance transactions, because of the unique nature of U.S. public finance housing transactions (for example, more flexible, diverse, and dynamic structures that are often actively managed and affiliated with a U.S. municipal or quasi-municipal entity, or a not-for-profit university, and hence, there may not be formal separateness covenants or requirements for independent directors).

14. Where we deem appropriate to analyze whether these legal risks are mitigated, we may request legal opinions that address one or more issues such as: automatic stay risk, preference risk, trust estate parameters, Chapter 9 status, non-consolidation, perfected security interest, enforceability of the transaction documents, or other applicable risks.

15. In addition, to be rated under the proposed methodology, issues must meet the following conditions:

  • KTPs must meet the eligibility conditions specified under the criteria "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014. Specifically, KTPs must have sufficient experience to perform their role in the transactions; KTP roles, responsibilities, and rights must be clearly defined in transaction documents; and KTP resignations may only be effective if a successor is in place, unless we have assessed that a KTP's resignation would not materially and adversely affect the securitization's performance; and
  • Where a transaction is backed by leased property, the lease term extends through the bonds' maturity, and we have concluded that risks of abatement and lessor bankruptcy are mitigated (as specified under "Issue Credit Ratings Linked To U.S. Public Finance Obligors' Creditworthiness," published Jan. 22, 2018).

DETAILS OF KEY CREDIT FACTORS

Coverage And Liquidity Reserves

16. The proposed coverage and liquidity reserves assessment evaluates two factors:

  • Coverage: The capacity for the transaction to withstand temporary declines in rental revenues and/or increases in expenses; and
  • Built-in liquidity reserves: The ability to withstand revenue interruption or stress. The focus is on protection provided by liquidity in the form of a debt service reserve fund or other available required reserves. For pools, the analysis considers liquid assets (for example, indenture investments for managed pools). The liquidity component has only a neutral or negative effect on the initial coverage factor assessment.
Determining the initial coverage factor assessment for stand-alone transactions

17. We propose to start this assessment by using the metrics in Table 1 to determine the initial coverage factor assessment. We would generally calculate the DSC ratio starting from the most recent available financial reports, incorporating adjustments that we consider appropriate to capture specific risks or to normalize our analysis across transactions. If our calculation of the DSC ratio is at or close to a cut-off point between two assessment levels, we would generally assign a midpoint assessment level. For instance, a DSC of 1.25x would generally correspond to an "adequate/weak" assessment (that is, a numeric score of '3.5').

Table 1

Determining The Initial Coverage Factor Assessment For Stand-alone Transactions
Coverage factor assessment Debt service coverage ratio (x)
1 - Very strong >=2.0
2 - Strong 1.50 - 2.0
3 - Adequate 1.25 - 1.50
4 - Weak 1.10-1.25
5 - Very weak <=1.10
Examples Of Adjustments That May Affect The Coverage Factor Assessment To The Extent That They Are Not Incorporated Into The Assessment Above
Factors that could have a positive effect Factors that could have a negative effect
We expect coverage to improve We expect coverage to deteriorate
Expected high stability of net cash flows over time Expected high volatility of net cash flows over time 
Expected substantial financial flexibility to meet debt service payments, that is not already captured in the debt service coverage ratio More limited financial flexibility to meet debt service payments than is suggested by the debt service coverage ratio
The debt is exposed to unhedged interest rate risk
We assess that atypical structural features may negatively affect recoveries following a default

18. We would generally calculate the DSC ratio for the assessment in Table 1 as adjusted net cash flow divided by MADS. However, if a development is in a ramp-up phase, and we have assessed that construction risk is fully mitigated, we will generally calculate the DSC ratio with current net cash flow divided by current actual debt service, but may also consider our projection for net cash flow during the outlook period, divided by MADS.

19. The examples of adjustments in Table 1 do not have specific numeric weights and generally would not change the initial coverage factor assessment by more than one assessment level each, or two assessment levels for cumulative adjustments.

Determining the initial coverage factor assessment for multifamily loan pools

20. Multifamily loan pools generally include overcollateralization, in particular as a mitigant to credit risk on the underlying loans. The initial coverage factor assessment reflects the indenture's (in the case of managed pools) or transaction's (in the case of static pools) overcollateralization, as measured by the asset-to-liability parity ratio. To determine asset-to-liability parity, we would review cash flow scenarios to ensure that program assets are sufficient to cover liabilities and able to withstand stress scenarios. The relevant cash flow scenarios are described in "Criteria Guidance: Cash Flow Scenarios And Assumptions For U.S. Public Finance Housing Bonds," published Sept. 4, 2019.

21. The initial coverage factor assessment reflects the assumed credit loss for the default scenario, as well as the characteristics of the pool. We subtract the assumed credit loss from the asset-to-liability parity ratio. As the assumed credit loss differs for each assessment level, we assign the strongest initial coverage factor assessment for which the asset-to-liability parity ratio remains at or above 100% after subtracting the assumed credit loss.

22. Table 2 shows the base credit loss assumption commensurate with each initial coverage factor assessment. The base credit loss assumption reflects a typical affordable multifamily loan pool. For pools with characteristics that we believe increase or decrease credit risk, we may adjust the assumed credit loss, generally within a range of 0.8x-1.5x the base number. For example, for a typical pool, to support an initial coverage factor assessment of 1.0, we would assume a credit loss of 10% of the loan pool balance. However, if the pool in this example included riskier characteristics (such as a high weighted-average loan-to-value ratio, or atypically low pool DSC), we may assume a higher credit loss for the same initial coverage factor assessment of 1.0, generally up to 15% of the loan pool balance.

Table 2

Base Credit Loss Assumptions For Multifamily Loan Pools
Coverage factor assessment Base credit loss for a typical affordable multifamily loan pool (before adjustments; as % of loan pool balance)
1 10.00
1.5 8.75
2 7.50
2.5 6.25
3 5.00
3.5 3.75
4 2.50
4.5 1.25
5 0.00

23. Examples of negative credit factors that lead to an upward adjustment (multiplier above 1.0x) to the base credit loss include, but are not limited to:

  • Atypically high weighted-average loan-to-value;
  • Atypically weak historical performance of loans originated by the originator;
  • Atypically low pool weighted-average DSC;
  • High geographical concentration of the pooled assets;
  • Atypical loan provisions that we consider increase risk; and
  • Presence and percentage of construction loans and assessment of construction-related risks.

24. Examples of positive credit factors that lead to a downward adjustment (multiplier below 1.0x) to the base credit loss include, but are not limited to:

  • Atypically low calculated weighted-average loan-to-value;
  • Additional oversight at the loan level that could increase stability and performance (for example, Low Income Housing Tax Credit);
  • Atypically strong historical performance of loans originated by the originator;
  • Atypically high pool weighted-average DSC;
  • High geographical diversification of the pooled assets; and
  • Atypical loan provisions that we consider mitigate risk.

25. In addition, to capture event risk associated with large obligor concentrations, a largest obligor default test is performed for all multifamily loan pool transactions. This test may lead to an adjustment to the anchor, as described under Overriding Factors, Caps, And Holistic Analysis.

Liquidity reserves analysis (for stand-alone and multifamily loan pool transactions)

26. Our proposed analysis of liquidity reserves focuses primarily on liquidity stemming from legal provisions in the transaction documents. We generally count other sources of liquidity only if those sources are legally pledged and required to be available for debt service payments.

27. Our calibration of the initial coverage factor assessment assumes that liquidity is available to cover the applicable 12 months of debt service -- expressed as MADS for stand-alone* transactions and static pools*, and expected debt service over the next 12 months for managed pools*. Accordingly, we propose to:

  • Make no adjustment to the initial coverage factor assessment if we assess that liquidity available for debt service is equal to or greater than the applicable 12 months of debt service;
  • Add 0.5 to the initial coverage factor assessment if we assess that liquidity available for debt service is lower than MADS, but equal to or greater than 50% of the applicable 12 months of debt service;
  • Add 1.0 to the initial coverage factor assessment if we assess that liquidity available for debt service is lower than 50% of the applicable 12 months of debt service.

28. If our final coverage and liquidity reserves assessment is "very weak", we will cap the rating in the 'bb' category. If our final coverage and liquidity reserves assessment is "weak" or "weak/very weak", we will cap the rating in the 'bbb' category.

Transactions with multiple tranches of debt

29. For transactions that include multiple classes of debt of varied seniority, we will generally assign a separate coverage and liquidity reserves assessment to each class.

Management And Governance

30. The term management and governance encompasses the range of oversight and direction conducted by an entity's owners, board representatives, executives, and functional managers. We assess how management and governance is likely to affect a transaction's ability to service debt over time. Management's strategic competence, operational effectiveness, and ability to manage risks shape the entity's competitiveness in the marketplace and credit profile. If we believe that an entity is able to manage important strategic and operating risks, and that its management plays a positive role in determining its operational and financial success, then we would likely assess management and governance as "strong" or "very strong." Alternatively, if we believe that management has a flawed operating strategy or is unable to execute its business plan effectively, and its actions would likely substantially weaken the likelihood of sustained success, we would likely assess management and governance as "weak" or "very weak."

31. Overall, the assessment focuses on key parties' (owner, sponsor, developer, manager, servicer, etc., as relevant) effectiveness, involvement, and quality of financial policies and disclosures. For multifamily loan pool transactions, our assessment of management and governance generally focuses on borrower and transaction-level related parties (state HFAs, master and special servicers, etc.), rather than the property-level parties. This reflects these transactions' dependency on the collective performance of multiple properties controlled by separate owners and managers, and the transaction parties' typical level of due diligence on the property-level parties.

32. Our analysis of management and governance is qualitative, supported by evidence, and considers relative strength compared with that of industry peers. When there is insufficient evidence of characteristics related to a stronger or weaker assessment, we will typically assign a score in the middle range (numeric scores of '2.5', '3.0', or '3.5'). However, if an entity fails to disclose key management and governance information, the management and governance assessment will be "weak" to "very weak."

33. Key management and governance assessment factors are:

  • Property/Asset management overall operational effectiveness assessment. This evaluates the quality and track record of strategic planning as well as day-to-day operations, competitive position, and sophistication of financial and risk management. We consider operational effectiveness as it relates to the rated transaction as well as other properties in which the management is associated. Where applicable, we consider the board representatives and executives of the management company in the evaluation. We evaluate operational effectiveness in the context of complexity of the transaction.
  • Owner/Sponsor/Related party role, responsibilities, involvement, and incentives in the transaction. We consider their experience with the specific program/property type and their track record in all phases of the transaction (for example, developing, construction, market study, marketing, pricing, maintenance, subsidy renewal); the level of oversight and incentive for transaction success; and the link to, and support (including formal documentation of such support) from, any related party.
  • Financial policies, reporting, and transparency assessment. We evaluate the completeness, timeliness, accuracy, and transparency of disclosures, financial audits, and communication.

34. The relevance and importance of each factor may differ based on the property type, as well as specific property characteristics. Therefore, our assessment is based on the relative relevance of factors for a given property type, rather than specific weights assigned to each factor.

35. If our final management and governance assessment is "very weak," we will cap the rating in the 'bb' category. If our final management and governance assessment is "weak" or "weak/very weak", we will cap the rating in the 'bbb' category.

Market Position

36. Our proposed market position assessment captures factors that affect the supply and demand dynamics for the rental units of a specific housing development or pool of housing properties.

37. We would determine an initial assessment level by assessing each of the following factors:

  • Property-specific characteristics (such as the physical condition of the property, its curb appeal, and occupancy trends);
  • The demand and supply considerations that may affect the market position of the property or pool of properties (such as property rents versus market rents, trends in target population, and competition); and
  • For privatized student housing only, the link to the affiliated university.

38. The relevance and importance of each factor may differ based on the property type, as well as specific property characteristics. Therefore, our assessment is based on the relative relevance of factors for a given property type, rather than specific weights assigned to each factor.

39. When applicable, we may modify the initial market position assessment based on the presence of additional positive or negative adjustment factors, such as expected improvement or deterioration in current market position conditions not already captured in the initial assessment or the presence of material and partially mitigated environmental, seismic, or construction risk. The adjustments do not have specific numeric weights and generally would not change the market position assessment by more than one assessment level each, or two assessment levels for cumulative adjustments.

40. The presence of significant unmitigated environmental, seismic, or construction risk will result in a market position assessment that is no better than "weak," with the exact assessment depending on our view of the severity of the risk.

41. For student housing transactions, if we assess the link between the housing development and the affiliated university as "very weak" or "weak/very weak," the final rating is capped in the 'bb' category. If we assess the link as "weak," the final rating is capped in the 'bbb' category.

DETERMINING THE ANCHOR

42. For both stand-alone and pool transactions, we propose to derive the anchor by calculating the weighted-average score of the three key assessments (coverage and liquidity at 50%; management and governance at 30%; and market position at 20%) and applying the anchor listed in Table 3.

Table 3

Determining The Anchor
Weighted-average factor score Anchor
1.00-1.30 aaa
1.30-1.60 aa+
1.60-1.90 aa
1.90-2.20 aa-
2.20-2.50 a+
2.50-2.80 a
2.80-3.10 a-
3.10-3.40 bbb+
3.40-3.70 bbb
3.70-4.00 bbb-
4.00-4.25 bb+
4.25-4.50 bb
4.50-4.75 bb-
4.75-5.00 b category

43. When the weighted-average factor score falls at or near a cutoff, we propose to generally assign the higher anchor if credit trends are improving or we believe performance will improve, and the lower anchor if credit trends are declining or we believe performance will weaken. For scores greater than 4.75, we will determine the anchor within the 'b' category based on our views of the relative strengths and weaknesses of the obligation and whether trends and performance are stable, declining, or improving. Ratings below the 'b' category will be based on other criteria, such as "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, 2012.

OVERRIDING FACTORS, CAPS, AND HOLISTIC ANALYSIS

44. The overriding factors and caps in Table 4 would apply after arriving at the anchor. If several factors apply to any given transaction, we would adjust the rating to account for the lowest applicable cap or override. Caps are absolute where the final rating can only exceed the cap through application of holistic analysis as explained below. We may, however, select a rating level below the cap or apply stronger overrides through additional downward notching to reflect further weakness. For example, if the transaction's initial coverage factor assessment is already "very weak," and we assess that liquidity risk would otherwise lead to additional negative adjustment to the coverage and liquidity reserves assessment, we could apply additional downward adjustments below the 'bb' category rating cap.

Table 4

Overriding Factors And Caps Applied To The Anchor
Factors that cap the anchor in the 'b' category
There is perceived lack of willingness to honor the obligation(s) in full and on a timely basis.
Our calculation of the debt service coverage ratio is below 1.0x.
Factors that cap the anchor in the 'bb' category
Coverage and Liquidity Reserves assessment of "very weak".
Management and Governance assessment of "very weak".
Student housing link to affiliated university assessment is "very weak" or "weak/very weak".
Factors that cap the anchor in the 'bbb' category
Coverage and Liquidity Reserves assessment of "weak" or "weak/very weak".
Management and Governance assessment of "weak" or "weak/very weak".  
Student housing link to affiliated university assessment is "weak".
Factors that cap the anchor relative to other ratings.
Student housing transaction rating is capped at the creditworthiness of the university or system with the closest link to the transaction property.
Factors that generally would notch the anchor up
Extraordinary strong coverage, which we generally consider to be a DSC ratio in excess of 4x for standalone transactions, or an asset-to-liability parity ratio in excess of 200% for multifamily loan pools, on a forward-looking basis. The anchor would be notched up by generally one notch.
Factors that generally would notch the anchor down
Affordable multifamily loan pools (see "Largest obligor default test for multifamily pools" below). The anchor would be notched down by one or two notches, if the transaction’s available overcollateralization is insufficient to pass the largest obligor default test at the level of the anchor.
A government subsidy supporting the rental income for a standalone affordable housing property is subject to renewal risk prior to final maturity (for example, the renewal of a Housing Assistance Payments contract for a section 8 property). The anchor would be notched down by generally up to two notches, depending on our view of the particular situation, including the length of time until the next renewal, the likely frequency of renewals prior to maturity, reauthorization history, and our opinion regarding any factors that could affect the likelihood of renewal.
Largest obligor default test for multifamily loan pools

45. The largest obligor default test is a pass/fail test, which may result in an override in the form of a downward adjustment to the anchor. It compares the available overcollateralization (before any adjustment through cash flow scenarios) to the loss that would result from the default of a certain number of the largest loans in the pool, assuming a stressed recovery rate of 30%. The number of loans assumed to default varies based on the individual loans' DSC ratios and the anchor rating category, as shown in Table 5. This means, the higher the rating category threshold, the greater the assumed loss and applied stress to the pool. The pool passes the test for a given rating category if available overcollateralization is equal to or greater than the largest calculated loss number. It fails the test if available overcollateralization is less than this loss number. If the pool fails the largest obligor test at the anchor rating category, we adjust the anchor downward. The adjustment is generally one notch if the pool fails to cover the largest calculated loss number, and two notches if it also fails to cover the second highest calculated loss number for the anchor rating category. In our application of this test, we will generally aggregate any cross-collateralized/cross-defaulting loans to the same obligor as a single loan. See Appendix B for a worked example of this test.

Table 5

Number Of Loans Assumed To Default In The Largest Obligor Default Test
Anchor rating category
Loan DSC categories AAA AA A BBB BB B
All loans 2 1 -- -- --
Loans with a DSC below 2.0x 3 2 1 -- -- --
Loans with a DSC below 1.5x 4 3 2 1 -- --
Loans with a DSC below 1.25x 6 4 3 2 1 --
Loans with a DSC below 1.1x 8 6 4 3 2 1
Loans with a DSC below 1.0x 10 8 6 4 3 2

46. Alternatively, for very small multifamily loan pools (generally, consisting of about 10 or fewer loans), we would generally weak link the final pool rating to the rating that would be assigned to the weakest loan in the pool, were that loan to be rated as a stand-alone transaction under this methodology. However, we may assign a higher pool rating on the basis of structural elements that mitigate the exposure to the weakest loan (such as overcollateralization).

Holistic analysis

47. A holistic analysis is considered after applicable overriding factors and caps to help capture a broader view of creditworthiness. The holistic analysis can have a one-notch impact up or down, and is not limited by any credit specific caps or overrides. It can also result in no rating change at all. The analysis may be based on credit risk factors including our forward-looking view of operating and financial performance, if not already incorporated in the anchor. It may also reflect a comparable ratings analysis, or transaction-specific strengths or weaknesses that are not fully reflected through the application of the methodology.

THE USE OF OTHER APPLICABLE CRITERIA

48. When applicable, we factor in the influence of other criteria to arrive at the final rating. In particular, we will apply additional criteria (see "Related Criteria") where relevant to analyze U.S. sovereign risk, financial counterparty risks, operational risk, insurance, and eligible investments.

APPENDIX A: GLOSSARY

49.*Affordable housing.   Properties where low-income households occupy a minimum percentage of units, consistent with the requirements under the U.S. tax code for "qualified residential rental property." Affordable housing includes both developments that benefit from support in the form of federal rental subsidy and those that are reliant solely on tenant rent.

50.*Age-restricted independent-living rental housing.   Age-restricted residential rental properties that also provide access to services such as central dining, housekeeping, dressing, etc. These properties do not include either skilled nursing or a majority of units that provide supervision of medication, bathing, activities of daily living, etc.

51.*Age-restricted assisted-living rental housing.   State-regulated residential rental properties that provide the same services as independent living properties but provide, in a majority of units, supportive care from trained employees to residents who need assistance with activities of daily living. These properties may also include wings or floors dedicated to residents with Alzheimer's or other forms of dementia.

52.*Asset-to-liability parity.   The ratio of total assets to total liabilities, where total assets typically include but may not be limited to, mortgage loans, revenues, investments, reserves, and other fund balances, and total liabilities typically include the amount of debt outstanding in a given period and accrued interest. Asset-to-liability parity of over 100% indicates overcollateralization or net assets.

53.*Multifamily loan pools.   Pools of otherwise unrelated affordable multifamily rental housing loans, generally with different owners, securitized and pledged to make debt service payments on issued bonds. These affordable multifamily housing loan pools are generally backed by multiple loans that are diversified by loan count, guarantee or subsidy (if any), ownership, and/or geographic location.

54.*Privatized military housing.   Properties affiliated with military bases, located in the U.S. and U.S. territories, where active military personnel receive a federally appropriated basic allowance for housing. The privatized military housing developments may be on- or off-base as long as there is a clear and measurable link with the U.S. military and related base.

55.*Privatized student housing affiliated with a university, college, or community college.   Student resident properties that have a clear and measurable link to a higher education entity. While student resident properties are generally on-campus, they may be off-campus as long as a clear and measurable link to the higher education entity exists--for example, where the housing is located on university-owned land adjacent to the university.

56.*Stand-alone transactions.   Transactions characterized by a single-property loan or by multiple cross-collateralized/cross-defaulted loans associated with multiple properties but with common ownership.

APPENDIX B: PROPOSED GUIDANCE DOCUMENT

57. This proposed guidance is not proposed criteria, but it is intended to be read in conjunction with the proposed criteria set forth herein. We intend to publish this proposed guidance as a separate document following the publication of the finalized criteria article. Further information regarding guidance documents is included at the end of this article.

58. The first section includes general guidance applicable across all transaction types in scope of the criteria. Subsequent sections provide further detail on the specific application of the proposed methodology to each property or transaction type, in particular regarding the application of adjustments in our coverage and liquidity reserves assessment and the relative importance of different sub-factors in our management and governance and market position assessments.

GUIDANCE APPLICABLE TO ALL TRANSACTION TYPES

Coverage and Liquidity Reserves

59. The proposed methodology contemplates that we may incorporate adjustments to audited financial statements to arrive at our S&P Global Ratings adjusted net cash flow (NCF), which is used to calculate the DSC ratio and determine the initial coverage factor assessment for stand-alone transactions.

60. Examples of adjustments to revenues include, but are not limited to:

  • Reporting of bad debt as a contra-revenue in the calculation of effective gross income (EGI), rather than as an expense.
  • Increase in vacancy loss based on forecast occupancy rates derived from the development's occupancy trend, competing facilities, or certain macroeconomic demand factors relevant to the asset type.
  • Exclusion of interest income from operating revenues from pro forma financials for new sale transactions.
  • The reduction or elimination of one-time or extraordinary revenues that are not related to ongoing revenue streams and could misrepresent performance.

61. Examples of adjustments to operating expenses include, but are not limited to:

  • Expenses that are, in our view, necessary to the operation of the property are included for the purposes of calculating NCF and DSC, even if the expense is reported as non-operating or subordinate to debt service payment. For example, even if a transaction is structured where the flow of funds indicates insurance expense is paid after debt service, we will nonetheless include the expense as part of our adjusted NCF because insurance is an ongoing and required operating expense.
  • Property tax expense is included as an operating expense, unless documentation has been provided showing exemption from property tax has been awarded.
  • Management fees are included at the higher of the actual management fee or the industry standard management fee percentage of EGI for the asset type. If the management fee includes a subordinate incentive portion, we could exclude the incentive portion in excess of the industry standard from the net cash flow calculation.
  • Other fees or discretionary expenses, such as asset management fees or oversight agent expenses, are included as operating expenses if the benefit derived from the expense is determined to be critical to operations, even if the expense is structured as subordinate to debt service. For example, if an owner relies heavily on the duties of a third-party asset manager for oversight in addition to the management teams at the property level, it would generally be determined that the asset management role, and related expense, is essential to ongoing performance and would therefore be included as an expense in the S&P Global Ratings adjusted NCF calculation.
  • Approved withdrawals from the repair and replacement reserve are generally considered a reduction of that year's maintenance and repair expense because the NCF was stressed in the year the reserve was funded. We would not apply this credit to expenses if the repair and replacement reserve has not been fully funded as required.
  • We generally do not credit operating expenses paid from any reserve other than the repair and replacement reserve unless our NCF includes the annual funding of the reserve as a reduction to net operating income.
  • We generally reduce expenses in the amount of received insurance proceeds during the reporting period.
  • We generally reduce or eliminate one-time or extraordinary expenses that are not related to, or indicative of, ongoing operating expenses and could misrepresent performance.

62. Examples of cash adjustments to net operating income, after above adjustments to revenue and expense, to arrive at S&P Global Ratings adjusted NCF include, but are not limited to:

  • Funding of a repair and replacement reserve at the higher of the annual per-unit amount according to the most recent physical needs report, the required annual per-unit amount indicated in transaction documents, or the industry standard annual per-unit amount for the asset type.
  • Funding of other annual reserve(s) and mandatory accounts required in transaction documents or according to industry standards for the asset type.

63. The proposed methodology include an analysis of liquidity reserves and apply a negative adjustment to the initial coverage factor assessment if liquidity available for debt service is less than MADS. In stand-alone transactions, this analysis typically focuses on the amount of the debt service reserve fund (DSRF). The availability of a DSRF may be subject to the counterparty risk of a surety provider, or of a bank providing the account where the DSRF is held. Where applicable, such counterparty risk exposures are analyzed under "Counterparty Risk Framework: Methodology And Assumptions," published March 8, 2019. The application of the counterparty criteria does not constrain the rating if the analysis addresses the potential default of the counterparty. In this context, this means that if we do not consider the DSRF as available in our liquidity reserves analysis, there is no further rating constraint on account of these counterparty risks.

64. Furthermore, if a transaction is structured so the final debt service payment equals MADS plus the DSRF, where the DSRF will be required to make the final debt payment, we will not consider this reserve to be available to cover liquidity risks that may arise earlier in the life of the transaction. We will therefore not consider this reserve amount in our liquidity analysis.

65. The proposed methodology allows for adjustments to the initial coverage factor assessment for stand-alone transactions that include, but are not limited to, expected high stability or volatility of net cash flows and expected substantial or limited financial flexibility to meet debt service payments. Examples of factors that can lead to expected high stability or volatility include situations such as the property's level of deferred maintenance and projected economic environment factors that can materially affect fixed costs, such as labor and utility rates. Considerations related to financial flexibility include the ability or inability to increase rent, manage expenses, and headroom between actual and breakeven occupancy. Also, if MADS occurs in the current year and future period's debt service requirements are materially less, we could apply a positive adjustment to the coverage score to capture forward-looking coverage levels.

66. In certain cases, transactions with multiple tranches of varied seniority include a "springing-lien" provision, which results in a pro rata distribution of recovery proceeds following a default of the most senior tranche and/or a foreclosure on the property (whereas, typically, recovery proceeds are distributed sequentially to each tranche, by order of seniority). In such cases, we believe the recovery prospects of senior-ranking tranches are negatively affected in a default scenario. We would generally apply a negative adjustment to the initial coverage factor assessment, as contemplated in the proposed methodology for atypical structural features that may reduce recoveries. We would generally apply this adjustment to all tranches, except the most junior tranche affected by the provision, because recovery prospects would actually be improved for this tranche.

Management and Governance

67. Table 6 displays what best describes "very strong" or "strong," "adequate," and "weak" or "very weak" management and governance assessments. We would assign a "very strong" ("very weak") assessment if there is a combination of the stronger (weaker) characteristics, or if we view a particular strength (weakness) to be particularly significant to the transaction's credit profile.

Table 6

Management And Governance Assessment: Factors And Examples
Management effectiveness
Very Strong/Strong Adequate Weak/Very Weak
Management has considerable expertise, experience, and a record of success in operating the specific property type for which they are engaged. The management entity has good depth and breadth across its major lines of business. Management has sufficient, but unexceptional, expertise and experience in operating its major lines of business. Management's depth or breadth is limited in some areas. Management lacks expertise, experience, or resources compared with industry peers. Management's knowledge of the property, processes, and residents is superficial. The enterprise has a track record of deviation from policies, procedures, and budgets. The loss or frequent turnover of key personnel could lead to mismanagement or operational disruption. Communication with management is difficult, and can result in incomplete, inaccurate, or untimely data and information.
The management organization has a reputation and record of market leadership and of achieving financial/operational goals, supported by key performance indicators. The organization and the properties under management are successful relative to peers. Organizational plans lack depth or specific financial/operational goals. The management organization has a record of achieving most financial/operational goals. The organization's management approach is less sophisticated than that of industry leaders. There is limited evidence that organizational plans exist, or plans are superficial, lack detail and are unclear. Operational and financial strategy is inconsistent with the organization's capabilities or market conditions. The organization experiences abrupt or frequent changes in strategy, acquisitions, divestitures, or restructurings. Management often fails to achieve its financial/operational goals. Management does not possess or does not have access to resources generally needed to successfully manage the property.
Management has successfully instituted policies that mitigate key risks, and has set rigorous and ambitious, but reasonable, standards for operational performance. The entity generally remains free of regulatory, tax, reporting, or legal infractions and has stable relationships with regulatory authorities. Management has set standards for operational performance that are achievable and similar to industry norms. Management maintains average risk management function and resources relative to those of peers. Management's resources, discipline, or commitment to achieve set standards is below that of peers. Set standards for financial or operational performance are superficial or lack specificity, or set standards are weaker than those of peers. Evidence of limited or superficial risk-management infrastructure, process, or efforts relative to those of peers.
Owner/Sponsor/Related party role, responsibilities, involvement and incentives in the project
Very Strong/Strong Adequate Weak/Very Weak
The transaction benefits from a high level of oversight and incentive for project success. A strong link to and support from related party/other, which is supported by formal contracts/agreements, exists.The related entity has substantial resources, tools, ability and/or interest to support the success of the project and is likely to, or may provide financial support to the project. There is solid evidence of strategic alignment between ownership and management of the property. Neither strong nor weak. The transaction is characterized by limited or ineffective project oversight compared with industry peers. Related party/borrower/ownership entity has a weak link or provides little support to the project. The related entity has limited or no financial stake in the project or lacks sufficient resources to support project success in the long term. The governing entity is not likely to, or incapable of, intervening if the property is being mismanaged. The mission of the governing entity is not aligned with the property type.
Financial reporting, internal controls, and transparency
Very Strong/Strong Adequate Weak/Very Weak
Audited financial reports are timely, accurate, and, along with supporting schedules and documents, provide detail sufficient to support quality financial statement analysis. Project owner/sponsor or representatives are responsive and transparent on matters relevant to project operations and financial performance. Neither strong nor weak. Evidence of financial statement reporting that is not timely, inaccurate, incomplete, or presented in a format that is not understandable, or is inadequate for quality financial statement analysis. History or evidence of failure to comply with disclosure requirements for projects within the governing entity's portfolio.

68. Our analysis focuses on the key parties' track record of developing, constructing, and/or managing similar properties. We focus on historical performance because we have typically observed similar management quality across properties with the same developer/manager/owner. A strong track record relative to that of peers may support a "strong" or "very strong" management and governance assessment.

69. Due to our reliance on third-party and issuer-provided reports, our assessment of management and governance is typically informed by our assessment of the transparency and reliability of these reports. For example, if we assess the information provided by a third-party provider to be consistently unreliable, we will generally, all else equal, assign a weaker management and governance score.

Market Position

70. Table 7 sets out the typical characteristics of "very strong," "adequate," and "very weak" assessment levels for each factor of the market position assessment considered, according to the proposed methodology.

Table 7

Market Position Assessment
Very strong Adequate Very weak
PROPERTY-SPECIFIC CHARACTERISTICS
Property age and condition Excellent condition with no deferred maintenance Average condition with some deferred maintenance Poor condition with substantial deferred maintenance
Curb appeal Greatly superior quality, size, amenities, and/or services relative to comparable projects Average quality, size, amenities, and/or services relative to comparable projects Greatly inferior quality, size, amenities, and/or services relative to comparable projects
Observed occupancy rates Occupancy consistently at or close to 100% High and stable occupancy rates Low and/or volatile occupancy rates, which we believe indicate weakness in demand for the rental units
DEMAND AND SUPPLY CONSIDERATIONS
Demand Considerations
Project rents versus market rents Increasing market rents, and/or low project rents, relative to market rents, support strong future rental income from the rental units The relative position of project rents versus market rents does not significantly affect our outlook for future rental income from the rental units Declining market rents, and/or high project rents relative to market rents, represent a risk to future rental income from the rental units
Trend in targeted population Growth in the targeted demographic in the local area indicates strong future demand for the rental units Local trends in the targeted demographic do not significantly impact our outlook for demand for the rental units Local trends in the targeted demographic represent a risk to future demand for the rental units
Supply Considerations
Supply of competitive properties Local under-supply of housing alternatives for the targeted demographic indicates strong future demand for the rental units Local supply dynamics do not significantly impact our outlook for demand for the rental units Local over-supply of housing for the targeted demographic represents a risk to future demand for the rental units
For student housing projects only
Link to the affiliated university The link of the housing project to the universitystrongly supports future occupancy. This support is superior to what is typical for comparable projects The link of the housing project to the university supports future occupancy. This support is in line with comparable projects The link of the housing project to the university creates a risk to future occupancy; alternatively, the institution’s support to the project is far  below what is typical for comparable projects
Examples of factors that may result in an adjustment to the market position anchor
Positive factors Negative factors
Expected improvement in market position, for instance due to favorable local economic trends or property-specific considerations not already captured in the initial assessment Expected deterioration in market position, for instance due to unfavorable local economic trends or property-specific considerations not already captured in the initial assessment
Material but partially mitigated environmental, seismic or construction risks
Market Position: assessing property-specific characteristics

71. We base our assessment of property age and condition on the current condition of the property. In the case of a property undergoing a major rehabilitation, we will generally improve our assessment only upon completion of the work.

72. Our analysis of curb appeal focuses on the unit-level and common areas. Even if our assessment above of the property's condition is favorable, our assessment of curb appeal may be less favorable, for example due to out-of-style/less attractive appliances, flooring, fixtures, etc.

Market position: adjustments to the initial assessment

73. As contemplated in the proposed methodology, a negative adjustment to the initial market position assessment may result if there are material, but partially mitigated, environmental, seismic, or construction risks. Partially mitigated can refer to, among other things, the level and quality of insurance coverage; the use, or lack of, guaranteed maximum price or lump sum contracts; restrictions on construction fund disbursements; the availability of capitalized interest to pay debt service; depth of recovery and continuity plans in place; and other proactive steps taken by owners/managers to prevent maximum damage and destruction due to the exposed risk.

GUIDANCE APPLICABLE TO SPECIFIC TRANSACTION TYPES

Affordable Housing: Tenant Rental

Coverage and Liquidity Reserves: Application of the volatility adjustment

74. In our view, cash flow volatility risks for tenant rental developments are mostly related to the scale of the development and operating expenses. In particular, for smaller scale properties (typically fewer than 300 units), we have observed a higher frequency of large and unplanned increases in the maintenance and repair line item as well as contract expenses and utilities. For this reason, we generally apply a negative adjustment to the coverage assessment for small-scale transactions, as contemplated in the proposed methodology, for situations with higher cash flow volatility risks.

Management and Governance

75. Our analysis considers the level of oversight and incentive for success. We consider that the active oversight of an experienced and involved low-income housing tax credit (LIHTC) partner is likely to have a favorable impact on the management of a housing development. Where a strong LIHTC partner is present, we will likely assign a stronger management and governance assessment than in the absence of an LIHTC partner. However, the presence of a partner does not preclude that a "weak" or even "very weak" assessment could be assigned, if other risks are present.

Market Position

76. Our market position assessment for affordable housing properties reliant solely on tenant rent focuses on property-specific considerations, and places particular emphasis on site visits and the review of third-party reports. Tenants generally have a greater choice of properties compared with federally subsidized properties; therefore, factors such as physical condition, curb appeal, amenities, and location are more relevant, in our view, in predicting occupancy trends. For example, close proximity to public transportation, grocery stores, schools, and employment opportunities may lead us to assess the market position as "strong" or "very strong," whereas we would likely assess the market position of a property that is more isolated or in disrepair as "weak" or "very weak."

77. Our market position assessment also emphasizes the comparison of property rents to market rents, as the affordability of the rental units is a key driver of demand for the property. If we assess that property rent levels represent a risk to future rental income, our overall market position assessment will likely be "weak" or "very weak."

Affordable Housing: Mobile Home Parks

Coverage and Liquidity Reserves: Application of the volatility adjustment

78. Mobile home parks typically exhibit very high and consistent occupancy rates due to the low turnover of residents. Where this is demonstrated by park-specific historical data, we typically apply a positive adjustment to the initial coverage factor assessment to reflect the expected high stability of net cash flows.

Management and Governance

79. Our analysis of management and governance for mobile home parks generally places less emphasis on the sophistication of the property manager, relative to other property types. Property management of mobile home parks is generally more straightforward than management of other asset types because tenants own the housing units and are renting only the space at the mobile home park. Management is not responsible for in-unit upkeep, maintenance, and repair.

Market Position

80. Our market position assessment for mobile home parks, where residents own the home and are paying rent for the use of the land owned by the mobile home park, focuses on observed occupancy rates, and particularly on historical turnover rates. Generally, among the transactions that we currently rate, mobile home parks benefit from high occupancy and low turnover rates, due to resident ownership and the logistical and financial challenges involved in moving a mobile home. Under the proposed methodology, we would therefore typically assess the market position for mobile home park transactions as "strong" or "very strong."

Affordable Housing: Federal Rent Subsidy

Coverage and Liquidity Reserves: Application of the volatility adjustment

81. In our view, cash flow volatility risks for federally subsidized properties are mostly related to the scale of the property and operating expenses. While the federal subsidy can help create a stable revenue stream, there is little oversight or control related to expenses. In particular, for smaller scale developments (typically fewer than 300 units) we have observed a higher frequency of large and unplanned increases in the maintenance and repair line item as well as contract expenses and utilities. For this reason, we generally apply a negative adjustment to the coverage assessment on small-scale developments, as contemplated in the proposed methodology, in situations with higher cash flow volatility risks.

Management and Governance

82. In evaluating the owner/sponsor's experience, we focus on its track record with the specific federal program, including subsidy renewal. If an owner has successfully maintained and renewed federal subsidy contracts, it is more likely it will continue to do so, in our view. The administrative and reporting requirements can be complicated and burdensome and the loss of the federal subsidy detrimental to the transaction. Therefore, the management and governance score would usually be no better than a '4' where the owner/sponsor does not have ample experience with the federal subsidy program or where the owner/sponsor has experienced difficulty or delays in maintaining and renewing existing contracts.

83. Our analysis also considers the level of oversight and incentive for success. We consider that the active oversight of an experienced and involved LIHTC partner is likely to have a favorable impact on the management of a property. Where a strong LIHTC partner is present, we will likely assign a stronger management and governance assessment than in the absence of an LIHTC partner. However, the presence of a partner does not preclude that a "weak" or even "very weak" assessment could be assigned, if other risks are present.

Market Position

84. Our analysis of property-specific characteristics for affordable housing properties with federal rent subsidies generally places more emphasis on property age and condition than on observed occupancy rates. This is because historical occupancy rates at federally subsidized housing are often very high, even if a property's condition is deteriorating, due to the very high demand for affordable housing. The poor condition of a property may, however, lead to a sharp drop in occupancy from historical levels if higher-quality competing properties become available, or if some units become uninhabitable. Poor physical condition may also jeopardize continued eligibility for the federal subsidy, for example, under the terms of a Housing Assistance Payments contract.

85. Our analysis of physical condition is based on the information obtained during site visits to the property, as well as the review of federally prepared physical inspection reports. The Real Estate Assessment Center (REAC) assesses the physical condition of all multifamily properties within the Department of Housing and Urban Development portfolio, based on a scale from 1 (worst) to 100 (best). REAC assessments take place every three years for properties with a score of 90 or better; every two years for a score between 80 and 89; and every year for scores of 79 or below. We generally view properties with inspection scores of 79 or less to be of "weak" or "very weak" physical condition, negatively affecting our view of market position regardless of occupancy and competitive landscape, resulting in a market position score no better than '4'. Conversely, while a score of 90 or higher is viewed as a credit positive and could translate into a "strong" or "very strong" property-specific assessment, it will not, in and of itself, have an overarching impact on the overall market position assessment when other risk factors are present.

86. Our analysis of demand and supply considerations focuses on trends in the local low-income population, relative to the supply of competitive properties. Our demand analysis places less emphasis on the level of property rents versus market rents, relative to our analysis of other property types, because, based on the federal subsidy, the rent paid by tenants is a defined portion of their income.

Age-Restricted Independent and Assisted Living Rental Housing

Coverage and Liquidity Reserves: application of the volatility adjustment

87. In our view, cash flow volatility risks are generally higher for age-restricted housing, and, specifically, assisted living and memory care properties, compared with other rental housing asset types. In these property types, units can become vacant suddenly and fill slowly. It is often more difficult to maintain waitlists and occupancy can be very volatile due to health and age-related move-outs. When occupancy drops, revenue declines are typically immediate, whereas any offsetting reduction in expenses often lags, causing negative pressure on financial stability and performance. For this reason, we generally apply a negative adjustment to the coverage assessment for these property types, as contemplated in the proposed methodology. This means that, all else equal, a higher DSC ratio is necessary to support a given assessment level relative to property types with lower volatility risks.

Market Position

88. The analysis of property-specific characteristics includes an evaluation of appropriate amenities for the facility's tenants, in addition to the standard requirements of the Americans with Disabilities Act. For example, we would assess whether assisted living facilities with memory care units have appropriate safety features in place.

89. In analyzing demand and supply considerations, we recognize that age-restricted senior living properties typically have higher rental rates compared with other property types covered by the methodology. Furthermore, as the level of care increases (ranging from independent living to memory care) monthly rents can far exceed market rent for an area. Therefore, we typically place less weight on the property rent versus market rates of pure rental units, and higher emphasis on the presence and impact of competing facilities in the area offering comparable units and levels of care and the property's rental rates compared with those of these competing units.

Multifamily Loan Pools

90. Multifamily loan pools can either be static or managed. The issuer for bonds backed by managed multifamily loan pools is often a state housing finance agency (HFA). HFAs can issue bonds backed by multifamily loan pools on a parity basis within a general resolution or as conduit debt. While HFAs may be the conduit issuer or loan purchaser in static pools, these transactions are generally associated with non-HFA entities and are structured where no additional bonds may be issued or additional loans may be added to the pool.

Coverage and Liquidity Reserves: Example Application of the Largest Obligor Default Test

91. Table 8 shows the application of the largest obligor default test for a mock pool consisting of 30 loans to 30 separate obligors, with $200 million of loans outstanding, and an anchor of 'aaa'. The Gross Default column sums the balance of loans assumed to default for each obligor category, as specified in the proposed methodology (the two largest loans total $30 million, the three largest loans with a DSC below 2.0x total $28 million, and so on). The Net Loss column reflects the assumed recovery rate of 30%. The 'aaa' largest obligor default test loss amount is the largest result in the Net Loss column, in this case $24.5 million. If available overcollateralization exceeds $24.5 million, the transaction passes the 'aaa' largest obligor default test, and no adjustment applies. If available overcollateralization is below $24.5 million, the transaction fails the 'aaa' largest obligor default test, and we would adjust the anchor downward. Generally, we would adjust by one notch to 'aa+', or, if the available overcollateralization of the pool also fails to cover the second highest net loss, $22.4 million in this example, we would adjust the anchor down by two notches, to 'aa.'

Table 8

Application Of The ‘AAA’ Largest Obligor Default Test To A Sample Multifamily Loan Portfolio
Loan Loan debt service coverage (x) Loan amount outstanding ($) Gross default ($) Net loss ($)
1 2.1x 20,000,000
2 2.1x 10,000,000 30,000,000 21,000,000
3 2.1x 10,000,000
4 1.6x 10,000,000
5 1.6x 9,000,000
6 1.6x 9,000,000 28,000,000 19,600,000
7 1.6x 9,000,000
8 1.3x 9,000,000
9 1.3x 9,000,000
10 1.3x 9,000,000
11 1.3x 8,000,000 35,000,000 24,500,000
12 1.3x 8,000,000
13 1.3x 6,000,000
14 1.15x 5,000,000
15 1.15x 5,000,000
16 1.15x 5,000,000
17 1.15x 5,000,000
18 1.15x 5,000,000
19 1.15x 5,000,000 30,000,000 21,000,000
20 1.15x 5,000,000
21 1.15x 4,000,000
22 1.05x 4,000,000
23 1.05x 4,000,000
24 1.05x 4,000,000
25 1.05x 4,000,000
26 1.05x 4,000,000
27 1.05x 4,000,000
28 1.05x 4,000,000
29 1.05x 4,000,000 32,000,000 22,400,000
30 1.05x 3,000,000
Management and Governance

92. Our assessment of related parties' effectiveness for pooled transactions is based on obligor-level and transaction-level related parties responsible for loan servicing and administration. Obligor is defined as the ultimate borrower on the debt obligation and is not, for example, a tax-exempt conduit issuer. The focus on obligor and transaction-level parties reflects that, unlike stand-alone transactions, multifamily pool transactions depend on the collective performance of multiple properties located in a variety of markets, and controlled by separate borrowers, owners, and managers. The obligors in pooled transactions generally perform due diligence on the managers and owners at the property level. Specifically, for multifamily pool transactions issued as part of an HFA parity resolution, we base our management and governance assessment on the board, leadership, and senior management of the HFA. For non-HFA multifamily pooled transactions, our evaluation of management and governance is generally based on our view of the servicer(s) and/or sub-servicer(s). In addition, in the case of pass-through conduit issuances, the involvement and incentives of the conduit issuer may affect our assessment of the transaction's management and governance.

Market Position

93. To evaluate property-specific characteristics of a loan pool, we rely heavily on third-party, issuer-provided property-level data, and servicer reports. In addition, for smaller, less diverse pools, our evaluation of property-specific characteristics generally includes site visits to a representative sample of the underlying pool properties, in terms of type, location, subsidy, physical condition as indicated in third-party reports, and borrower. The sample generally includes properties whose loans comprise a minimum of 50% of the pool principal loan/bond balance and, where applicable, properties with both very high and very low levels of deferred maintenance according to third-party reports.

94. Assets that comprise loan pools are often in more diversified locations than those of stand-alone transactions. Our market position assessment considers the supply and demand characteristics of the different market areas in which the pooled properties are located, with the emphasis on the locations that represent the largest share of the pool by loan balance. State HFAs generally issue bonds backed by multifamily loan pools where all of the underlying assets are located within the issuer's state. Therefore, in these cases, we will look to the economic outlook and demographic trends of the state when considering supply and demand dynamics.

Privatized student housing affiliated with a university, college, or community college

Legal Analysis

95. Transactions backed by student housing developments typically include a fully funded debt service reserve fund equal to MADS, a 1.2x annual DSC covenant, operating and capital reserves, a business interruption insurance requirement, and 1.2x additional bonds test prior to any new housing facility.

96. In our assessment of bankruptcy risks, we consider that borrowers in typical university-affiliated privatized student housing cannot be involuntarily filed into bankruptcy, because these are typically structured as single-purpose non-profit limited liability companies.

Coverage and Liquidity Reserves

97. The analysis of coverage takes into account the stage of the development. In the initial stage (the first few years after opening of the project), we focus primarily on the annual DSC ratio (as MADS coverage is typically lower during the first few years of project operation). However, the assessment also considers our expectation of MADS coverage once the housing property ramps up. We view a swift ramp-up to adequate MADS coverage within five to six years positively. If we expect MADS coverage to weaken, or if we observe over time that the progression of MADS coverage is slower than initially expected, we may lower the initial coverage factor assessment accordingly.

Coverage and Liquidity Reserves: Application of the volatility adjustment

98. In our view, cash flow volatility risks for university-affiliated privatized student housing projects are generally higher compared with those for other rental housing asset types, mostly related to the scale and scope of the transaction, the link to the university, and the ability to reach forecast occupancy. In these property types, occupancy can fluctuate with university enrollment and beds can become vacant suddenly and fill slowly.

99. When occupancy drops, revenue declines are typically immediate, whereas any offsetting reduction in expenses often lags, causing negative pressure on financial stability and performance. For this reason, we generally apply a negative adjustment to the coverage assessment for these property types, as contemplated in the proposed methodology. This means that, all else equal, a higher DSC ratio is necessary to support a given assessment level relative to property types with lower volatility risks.

100. On the other hand, in certain cases we may assess that these risks are offset by other factors, and would therefore not apply the volatility adjustment; for example, if the university provides an occupancy guarantee or a first fill. As it is typical for student housing developments to include a requirement for students to reside in university accommodation, we would generally not consider that this standard feature alone would offset volatility risks associated with these properties.

101. In addition to occupancy risks that influence our view of cash flow stability, we analyze the development's inherent financial flexibility, for instance, as reflected in the ability to set housing rents. Typically, the university participates in rate-setting decisions in some capacity, which we view positively, but it does not have absolute control or firm approval rights.

Management and Governance

102. In assessing student housing management and governance, we review the key parties' (owner, developer, manager, etc.) role, involvement, influence, and experience as applicable to ensure the viability of the development. We specifically focus on which role the university plays in the transaction.

103. We may assess management and governance more negatively if we identify an oversight in the market study, or if we assess that mismanagement of marketing or pricing indicates significant management weakness and may have a damaging impact on the financial future of the development. Furthermore, we would generally assess management and governance as "weak" or "very weak" if the university is not involved in, or does not have a vote in, setting rental rates (typically universities are involved in setting rental rates, even if they are not managing the property).

104. The analysis of key parties' role and responsibilities related to the transaction is also important. For instance, we review management agreements or other governing documents to assess the level of the university's involvement in the development. Typically, ownership of the housing facility is transferred to the university after the bonds are paid, which usually incentivizes proper management up until and through the point of ownership transfer. However, no agreement can compensate for a lack of experience or poor oversight.

105. Financial policies can support or detract from prudent management. For instance, the lack of adequately sized reserve and replacement funds or effective policies to manage rent payment delinquencies can weaken the management assessment.

Market Position

106. In addition to assessing property-specific and demand and supply considerations, we assess the degree of linkage between the university and the affiliated student housing as part of the market position analysis.

107. Property-specific considerations focus on on-campus housing occupancy rates and trends. Curb appeal, including location, is also important. The demand and supply characteristics analysis emphasizes full-time equivalent (FTE) enrollment trends. Our analysis of the strength of the link between the university and the affiliated student housing is key.

108. In assessing property-specific characteristics, historically observed and projected occupancy rates for on-campus housing are key. Strong occupancy compared with breakeven levels attests to a good market position assessment, while high breakeven levels compared with projected occupancy allow for minimal financial flexibility. A lack of experience or poor track record in meeting occupancy goals detracts from the market position assessment.

109. Strong occupancy, in our view, is from 98% to over 100%, representing robust demand for on-campus housing that often results in wait lists. High demand and full capacity can be demonstrated, for instance, by a current need to lease hotel or external space to accommodate the students. Occupancy levels between 95%-98% are adequate, but below 95% occupancy could indicate weakness in demand.

110. Most new construction projects assume projected occupancy upon opening of 95%; opening occupancies that fall below this may indicate weakness in future demand, even if there is capitalized interest in year one to cover debt service expenses.

111. Curb appeal is reflected not only in the quality/available amenities of the housing but also its location. We view proximity to campus amenities, such as dining and student centers, as well as classrooms, as a strength. We assess the resources that will be available to maintain the curb appeal. We generally expect annual maintenance, reserve, and replacement funds to be present and sized at a minimum of $300 per bed, adjusted for 3% inflation annually. A five-year, forward-looking outlook should be provided to assess whether reserves are sufficient for that time period.

112. In analyzing the housing demand prospects, we review the enrollment trend, as expressed in FTEs, as well as the number of beds offered in the property compared to the FTE student body, specifically, the student body that has historically demonstrated demand to live on campus. We assess historical demand for housing occupancy on campus to inform our view of demand for the student housing units.

113. Demand can be boosted and occupancy risk mitigated by on-campus residency requirements instituted by the university. A first-fill occupancy guarantee or other type of vacancy guarantee by the institution is viewed as a significant risk mitigant. On the other hand, lack of historical demand data (for example, if the development is the first housing construction on campus, or if the project is intended for upperclassmen or graduate students with no historical precedent of desiring to live on campus) is considered risky.

114. The supply considerations are weighed in the context of fill-up risk and analyzed through the review of available housing on campus (for instance, replacement beds are seen more positively versus additional new beds), expectation of future construction, and competition from off-campus student housing.

115. Broader local economic trends and property location (urban versus residential setting) can further inform the demand and supply considerations and ultimately the level of property rents compared with market rents. For instance, security enforcement on campus may be seen as an advantage of an on-campus versus off-campus (especially in less safe areas) housing. Geographical features of certain campuses may also mean that off-campus housing development is less of a risk. Certain institutions (like two-year community colleges) may be more exposed to economic cycles than four-year colleges, while all schools can be susceptible to demographic changes.

116. In assessing the strength of the link between the student housing property and the university, we review the property's strategic importance to the university. For an "adequate" assessment, we expect that the new housing will be part of the student housing program, treated on an equal basis with existing on-campus housing stock, providing the same services as the university's own facilities and that the university will include the transaction property in information and marketing materials regarding student housing. We also typically expect that the university will eventually own the development, once the bonds are fully repaid. For a "strong" assessment, we expect an on-campus location and the university's active role in managing the demand (through a first fill requirement or occupancy guarantee, for instance) and that the university will eventually own the housing property once the bonds are fully repaid. On the other hand, "weak" connectivity is often primarily reflected by an off-campus location, lack of demonstrated support from the university beyond basic marketing, or the lack of oversight, management, and control, once constructed.

117. Affiliation with more than one university may negatively affect our assessment of the link assessment. Furthermore, if beds may be rented to students from other institutions and/or the general population, we generally consider that connectivity to the primary university is lower (even if the housing is on campus). We may therefore assign a worse market position score than if the housing were restricted to students from the primary university, even though the broader population of eligible tenants potentially supports occupancy rates.

Privatized Military Housing

Coverage and Liquidity Reserves: Application of the volatility adjustment

118. We generally apply a positive adjustment to the coverage score of military housing based on the inherent financial performance stability assuming the following:

  • Service members' basic allowance for housing (BAH), an allowance legislated by Congress as part of military service members' compensation with a long history of congressional support with no funding delays;
  • The financial support from the DoD through the direct transfer of money from the DoD to the trustee to pay bondholders, and the use of appropriate protections, as needed, for lenders against base closure, realignment, or deployment; and
  • The typically larger scale of military housing developments, which generally lessens cash flow volatility.

119. Our coverage assessment will also consider the historical trend and outlook of the applicable BAH rates where, for example, realized and expected declines in BAH allowances could indicate future deterioration in financial performance resulting in a negative adjustment to the coverage score.

Management and Governance

120. Our assessment of management and governance for military housing includes an evaluation of the link and oversight of military departments. Often privatized military housing developments have various types of DoD support, such as donated or leased land at nominal cost, donated housing units, cash equity investments in the joint ventures that own the housing, subsidized utilities or infrastructure, and below-market rate subordinate debt. The DoD has the legislative authority to and may make available loan guarantees for these developments in the event of mortgage defaults due to base closures, base realignments, or Armed Forces deployments. We view this additional oversight and incentive for success as a credit positive, which can result in a more favorable management and governance score.

121. In our view, owner/operators of military housing are typically well-established entities with sophisticated organization structures, due to the vetting process and barriers to entry in place by the DoD. Generally, military housing owners also fulfill the roles of asset manager and property manager, speaking to the size and capabilities of the ownership entity.

Market Position

122. For military housing developments, the trend in the targeted population of military personnel will remain stable as long as the related base remains operational. Our assessment therefore focuses on our view of the essentiality of the related military base, as analyzed under our methodology for assessing U.S. federal future flow securitizations (see Related Criteria). Where a military housing development is ranked lower than the top 25% of bases by the applicable DoD branch, the market position assessment could be negatively affected. For instance, our analysis may also consider any provisions made for alternative use of the housing units, in the event of a military-related event such as base closure, base realignment, or long-term military deployment.

123. We typically view the market position of military housing developments favorably due to strong demand at most military bases, as a result of DoD contributions that enhance feasibility while offering below-market rents. Military housing developments also typically offer amenities that are not always available in other affordable rental housing, such as modern appliances, storage areas, and community centers. The proximity of the development to the related military base can also play an important role in our assessment of curb appeal.

This appendix provides additional information and guidance to these proposed criteria, and we expect to publish this information and guidance in a separate guidance document following the publication of the finalized criteria article. It is intended to be read in conjunction with the proposed criteria herein and aforementioned cash-flow criteria. Guidance documents are not criteria, as they do not establish a methodological framework for determining credit ratings. Guidance documents provide guidance on various matters, including articulating how we may apply specific aspects of criteria; describing variables or considerations related to criteria that may change over time; providing additional information on non-fundamental factors that our analysts may consider in the application of criteria; and providing additional guidance on the exercise of analytical judgment under our criteria. Our analysts consider guidance documents as they apply criteria and exercise analytical judgment in the analysis and determination of credit ratings. However, in applying criteria and the exercise of analytic judgment to a specific issuer or issue, analysts may determine that it is suitable to follow an approach that differs from one described in the guidance document. Where appropriate, the rating rationale will highlight that a different approach was taken. For more information about guidance documents please see "Criteria And Guidance: Understanding The Difference" in Related Research.

RELATED CRITERIA AND RESEARCH

Criteria To Be Superseded:
  • Rating Methodology And Assumptions For Affordable Multifamily Housing Bonds, June 19, 2014
Criteria To Be Partly Superseded:
  • Higher Education, published June 19, 2007
Related Criteria
  • Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
  • Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
  • Issue Credit Ratings Linked To U.S. Public Finance Obligors' Creditworthiness, Jan. 22, 2018
  • Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
  • Insurance Criteria For U.S. And Canadian CMBS Transactions, June 13, 2013
  • Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
  • Federal Future Flow Securitization, March 12, 2012
  • Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations, Nov. 29, 2011
  • Principles of Credit Ratings, Feb. 16, 2011
  • Assessing Construction Risk, June 22, 2007
Related Research
  • Criteria And Guidance: Understanding The Difference, Dec. 15, 2017

This report does not constitute a rating action.

The proposed criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Once proposed criteria become final, their use is determined by issuer- or issue-specific attributes as well as our assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment.

Analytical Contacts:Joan H Monaghan, Centennial + 1 (303) 721 4401;
Joan.Monaghan@spglobal.com
Marian Zucker, New York (1) 212-438-2150;
marian.zucker@spglobal.com
Jessica L Wood, Chicago (1) 312-233-7004;
jessica.wood@spglobal.com
Criteria Contacts:Olga I Kalinina, CFA, New York (1) 212-438-7350;
olga.kalinina@spglobal.com
Andrew O'Neill, CFA, London (44) 20-7176-3578;
andrew.oneill@spglobal.com
Andrea Quirk, London (44) 20-7176-3736;
andrea.quirk@spglobal.com
Analytical Contacts (USPF Housing):Raymond S Kim, New York (1) 212-438-2005;
raymond.kim@spglobal.com
Analytical Contacts (USPF Higher Education):Laura A Kuffler-Macdonald, New York (1) 212-438-2519;
laura.kuffler.macdonald@spglobal.com

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