Chart 1

Issuers Have A Solid Foundation For 2023

The stable sector view reflects our opinion that housing entities have the financial strength and management expertise to navigate through the economic uncertainty of 2023. Inflation likely peaked in Q3 2022 and the job market has remained strong, which provides the foundation for households to continue making their monthly housing payments and resolve COVID-related homeowner and tenant delinquencies. Nonetheless, home purchases remain out of reach for many first-time buyers due to the sharp rise in rates and the still-elevated housing prices.

Housing finance agencies (HFAs), community development financial institutions (CDFIs), social housing providers (SHPs) and public housing authorities (PHAs) enter 2023 in generally strong positions, indicative of their managements' ability to produce stable performance results even in challenging times. (S&P Global Ratings economists are forecasting a shallow recession in the first half of the year. See "Economic Outlook U.S. Q1 2023: Tipping Toward Recession," published Nov. 28, 2022, on RatingsDirect.)

Housing finance agencies

HFAs' equity and assets are at record highs; total equity to assets rose to 31.6% from 30.6% in 2022 and net equity to assets to 26.6% from 25.4%, the largest increases in the last five years. Profitability as measured by net interest margins decreased for HFAs by 20 basis points to 1.4%, and average return on assets remained at 2.6%. We expect HFAs will continue their trend of issuing bonds to fund their single-family programs which accelerated in the second half of 2022, and which will continue to add to their asset base.

Community development financial institutions

CDFIs saw a similar trend with average equity and gross loan balances increasing modestly to new highs. Profitability measures have increased, with net interest margins growing 30 basis points to 3.6% and average return on assets increasing to 3.8% from prior years. CDFIs saw a huge inflow of capital during the pandemic which they are still programming and are therefore unlikely to access the capital markets in 2023.. The receipt of additional funding since 2020 helped fuel a 7% average increase in short-term investments for rated CDFIs.

Rental housing bonds

Rental housing bond owners and operators of affordable rental housing face several challenges in 2023 as labor, materials and insurance costs remain elevated and, in the case of insurance premiums, continuing to escalate. While pandemic-related delinquencies have abated in many properties and, where possible, higher area incomes have allowed for rent increases, we expect these higher, and in some cases, escalating expenses to further weaken the already struggling properties with thin coverage and limited reserves much as we saw in 2022.

Public housing authorities and social housing providers

PHAs and SHPs and properties with more robust coverage levels have demonstrated the financial strength and liquidity to absorb these increased expenses. While we expect increased revenue or contributions may lag operating cost inflation, putting pressure on financial performance by reducing PHAs' and SHPs' adjusted EBITDA margins over the next two years it is likely not sufficient to cause rating movement. Generally, PHAs and SHPs have reported strong results with EBIDTA/revenues at 17.6% and median debt over EBIDTA 11.8x. Several PHAs and SHPs obtained first-time ratings in 2022 and accessed the capital market--$820 million in the last 18 months--a trend we expect will continue in 2023 as large owners and operators of affordable housing seek to diversify their funding sources.

Rating downgrades in the housing sector outnumbered upgrades slightly more than two to one in 2022 with the downgrades largely centered in rental housing bond transactions. We saw continued weakness in some standalone rental housing bond transactions, with 15 downgrades and 26 unfavorable outlook changes. Most of these changes were the result of deterioration in a particular military housing portfolio.

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Sector Top Trends In 2023

Higher rates ripple through the sector

The Federal Reserve's actions to combat inflation by raising rates seven times--including four unprecedented 75 bp moves--meant not only a quick and sharp increase in interest rates, but unsurprisingly led to a softening in the housing market. Thirty-year mortgage rates started the year at 3.11% and climbed to slightly over 7% in October, before dropping to 6.27% in late December. The higher rates and the Fed's tightening also constrained the profitability of conventional market to-be-announced (TBA) executions for HFA single-family programs. Additionally, conventional 30-year mortgage spreads to the 10-year Treasury rate remain abnormally high, providing a rate advantage for HFA lending programs as many shift from the TBA market to bond financing. We expect this trend to continue in 2023 with HFAs funding their single-family programs with tax-exempt and--where needed for non-complying loans or volume cap constraints--taxable bonds. We also note the trend of increased use of variable rate bonds to help achieve a lower cost mortgage rate.

Chart 4

Housing affordability remains a challenge nationally

The combination of higher rates and housing prices pushed the National Association of Realtor's Housing Affordability Index below 100 for September and October 2022, which means that a family with the median income cannot qualify for a mortgage on a median-priced home. Affordability remains a challenge even as housing prices finally cooled in the second half of 2022; in October the S&P Corelogic Case-Schiller National Composite Index dropped for the fourth consecutive month, down a cumulative 3% from its peak in June, though year over year the National Composite index was up 9.2%.

Chart 5

While the price drops have been minimal nationally, some markets have seen larger decreases, particularly those that experienced the largest pandemic driven appreciation such as Austin, Tex. and Phoenix, Ariz. However, the constrained housing supply--October's housing starts were 1.425 million, 8.8% lower than the October 2021 figuree of 1.56 million--is likely to keep prices in most markets above their pre-pandemic levels.

Chart 6

Unemployment remains low with the labor market close to full employment

The unemployment rate edged down to 3.5% as of December 2022, although job gains softened slightly indicating a loss of momentum after two years of record growth. Wage gains were up 4.6% year over year, the narrowest increase since mid-2021, and still well below the 6.5% increase for CPI, keeping real wage gains negative for the 21st straight month. The labor force participation rate of 62.3% is well below its pre-pandemic rate. With over four million fewer workers participating in the labor force, S&P Global Ratings' chief economist expects it will be difficult to see wage pressures easing without a shock to the economy and we forecast unemployment to rise to 5.6% by the end of the year. Labor shortages have caused construction and approval delays and challenged organizations to fill staffing vacancies, which has slowed, among other activities, the ability of housing owners to address maintenance issues at their properties.

Inflation is leading to higher expenses for both operating and developing affordable housing

Development pipelines have slowed as rising costs create funding gaps that must be solved. While supply-side inflation has recently begun to moderate as supply chains normalize, increased rates and labor costs will likely linger through the year, increasing operating expenses and construction budgets.

Extraordinary outside support is slowing

During the pandemic the federal government and philanthropies provided unprecedented sums directly or indirectly to the housing sector. While many of these efforts are ending, funds continue to flow to CDFIs and all but six states' Housing Assistance Fund (HAF) programs are still open and accepting applications. The provision of federal funds was an important counterbalance to the mortgage and rent forbearance provisions of the CARES Act allowing homeowners and tenants to catch up on missed payments. The continued availability of HAF may help resolve the elevated delinquencies still being reported by some HFAs. While delinquencies remain low in all HFA multifamily portfolios, following the closure of Emergency Rental Assistance programs, some states and municipalities are making available additional resources to help tenants and encourage the development of additional affordable housing. PHAs, which typically rely on the federal government for most (76%) of their funding benefitted from increased CARES Act funds during the pandemic. The Department of Housing and Urban Development has continued to budget for increased funding, though that is likely to grow at a somewhat slower pace. The recently passed fiscal 2023 omnibus bill includes a modest funding increase in public housing operating subsidies, flat capital fund grants, and additional funds for project-based Section 8 assistance, providing a stable foundation for PHA ratings.

Demographic trends will continue to pressure housing price

Millennials, the most populous cohort, continue to comprise the largest share of first-time buyers. According to CoreLogic, about 72% of all first-time buyer mortgage applications in 2022 were by millennials. Millennials are still aging into peak homebuying age and should continue to constitute the largest share of first-time buyers for the next several years. The Gen Z cohort saw an increase in 2022 to 9% from 6% of first-time buyers, expected to increase over time. Another factor propelling housing prices and rents was the shift to remote work, which drove more than half the increase in home prices and rents during the pandemic according to research from the Federal Reserve Bank of San Francisco.

Social bond designations increase

Last year saw a continuation of the issuance of self-labeled social and sustainable housing bonds and was the second consecutive year where housing bonds were the largest component of labeled debt in the municipal market. Issues included single-family programs, multifamily programs, PHAs and SHPs and municipalities' housing gap fund bond issues. Labeled issuance saw a significant uptick in 2021; our initial data indicates that labeled issuance declined in 2022, although labeled bonds' market share increased, and we expect housing bonds will continue to push the labeled/sustainable municipal bond market forward in 2023. Housing bonds constitute the largest component of social bonds and social bonds are now the largest labeled component of the market.

FICO score change

The FHFA recently announced its intention to implement a replacement of the "classic FICO," which is used by HFAs and the conventional residential lending market as the borrower credit score of choice (see "New FHFA-Approved Credit Scores Will Require Mortgage Industry To Transition," Oct. 27, 2022). While this will take several years to bring about, the proposed replacements incorporate additional payment information from borrowers, including rent, utility, and telecom payments, which could expand lending opportunities to previously underserved borrowers and help expand HFA lending programs.

How Will Credit Quality Be Affected?

More bonds, likely to marginally erode ROA and parity

Post financial crisis, many HFAs transitioned from bond financing to the TBA market for their single-family programs. With quantitative tightening, TBA executions have not provided the premium advantage many HFAs depend on to fund their down payment assistance programs. As a result, we saw a noticeable uptick in bond issuance in the second half of 2022 that we expect will continue into 2023. This increase will add to HFAs' already large asset portfolios--last year a robust $4.03 billion on average. For those HFAs switching to bonds from TBA, we expect to see a decrease in their ROA as assets increase and returns are constrained by tax compliance rules. Based on our criteria, program parity for whole loan and 'AAA' rated mortgage-backed security portfolios is also likely to erode somewhat as newer loans, with their higher loan to value ratios, will exert some downward pressure on parity levels in the near term.

Down payment assistance programs will continue to support HFA programs

Saving for a down payment has always been a critical step toward home ownership for first-time buyers. HFAs have expanded and evolved their programs to reach and attract more borrowers. On average, nearly 85% of HFA loans were originated in conjunction with down payment assistance loans or grants according to the National Council of State Housing Agencies' most recent survey. The amount of the average down payment assistance increased 7% from the prior year.

Prudent underwriting and government support will counter market downturns

In a recent survey, HFAs reported an average 58% of their loans are within five years of origination. Another nearly 16% were between five and 10 years old and 26% were over 10 years old. While newer loans with higher loan-to-value ratios may be more susceptible to non-payment, most HFA programs have credit characteristics that should allow them to sustain an increase in delinquencies without rating pressure due to the federal insurance or GSE guarantee on their assets.

Single-family programs will experience lower prepayments

HFAs experienced elevated prepayments during the pandemic-induced low-rate environment. The current higher rate environment, coupled with the recent vintage of loans (as discussed above) should lead to a slowing of prepayments. Over time, as prepayments slow, loan portfolios will generate more revenue and result in increased net assets adding to program equity (parity) and strengthening HFAs' bond programs.

Growth in CDFI equity should continue

Grant and contributions continued to flow into CDFI balance sheets resulting in equity growth of 14% in 2022. Interim financial statements indicate a continued inflow of third-party funding, which will lead to stronger equity ratios over time. Some CDFIs have pursued strategies to diversify their revenue resources by increasing their fee-based activities; aggregated median fee income increased by 18% in fiscal 2021 compared to fiscal 2020. The increase in interest rates generally has slowed the high levels of prepayments received in recent years for CDFIs, and we expect to see new loan activity pick back up in 2023.

PHA and SHP revenue growth may slow as development pipelines face delays

Housing owners and operators are experiencing six months to one-year delays in construction pipelines, and housing preservation and acquisition activities have also slowed, limiting unit growth and the attendant increase in revenues. While inflation and income increases may allow for higher rents on existing portfolio assets, these increases may be eroded by increasing expenses--especially utilities, insurance, labor, and operating and maintenance as owners catch up on pandemic delayed repairs.

Post-pandemic resolution of delinquencies

Loan forbearance will continue to resolve, but the challenge of modifying single-family loans in an environment of elevated rates may slow the process. Rental owners may need to absorb higher bad debt expense as the emergency rental assistance programs fully deplete their funding and/or tenants reach the limits of their funding eligibility.

Related Research

• U.S. Social Housing Providers: Unprecedented Federal Pandemic Support And Beyond, Nov. 17, 2022
• U.S. Housing Finance Agency Programs Have The Resilience To Navigate The Uncertain Economic Landscape, Oct. 20, 2022
• U.S. Housing Finance Agency Issuer Credit Ratings Build Strength Ahead Of New Challenges, Oct. 12, 2022
• CDFIs Demonstrate Strengths Post-Pandemic, But Are Equity Increases Only Temporary?, Aug. 10, 2022