OVERVIEW AND SCOPE

1. This article describes S&P Global Ratings' methodology for rating U.S. federally enhanced housing bonds (FEH bonds). All terms followed by an asterisk are defined in the glossary (see Appendix C).

2. The methodology applies to housing bonds where full credit enhancement from U.S. federal government agencies, as outlined below, is available on the mortgage loans, mortgage-backed securities (MBS) or directly on the FEH bonds.

3. This paragraph has been deleted.

4. The ratings in scope typically include:

• Bonds backed by single-family or multifamily loans (mortgage loans) or MBS, where the mortgage loans or MBS benefit from full credit enhancement via a guarantee, insurance, or credit enhancement instrument (CEI) from U.S. federal agencies such as the Federal Housing Administration (FHA*) or the Government National Mortgage Association (Ginnie Mae)--both defined as government entities*(GEs)--or from one or more U.S. government-sponsored enterprises* (GSEs) such as the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac).
• Bonds whose debt repayment is directly enhanced by a GE/GSE (through a direct-pay or standby CEI).

5. The methodology does not apply to managed mortgage revenue bond programs (parity bond resolutions*), typically established and overseen by a state or local housing finance agency, which are rated under "Methodology For Rating U.S. Public Finance Mortgage Revenue Bond Programs," published Oct. 10, 2022.

6. This paragraph has been deleted.

7. To be rated under these criteria, issues must meet two conditions:

• The eligibility conditions for key transaction participants (KTPs*) specified under the criteria "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014, herein referred to as the "Operational Risk Criteria," and
• Transaction documents* must clearly lay out the program parameters and legal framework consistent with these criteria and the program(s) of the GE/GSE(s).

8. This paragraph has been deleted.

METHODOLOGY

9. In general, we determine the rating on an FEH bond according to the factors depicted in chart 1. Depending on the transaction, not all factors may apply. For example, for a direct-pay CEI transaction where the enhancement is provided on the bonds directly, we will not apply a cash flow analysis nor apply other criteria, as the rating is equal to the GE/GSE rating.

GE/GSE rating

10. The key characteristic of FEH bonds is generally the full enhancement by the GE/GSE. The enhancement is either directly to the bonds (through the enhancement on debt service payment), or indirectly through the mortgage loans or MBS which are backing the bonds and which receive the enhancement. The GE/GSE enhancement programs are analyzed differently as compared with the approach we take under our "Guarantee Criteria," published Oct 21, 2016. The unique approach to analyzing GE/GSE enhancement in these criteria takes into account the missions and public purpose nature of the GE/GSE(s), irrevocable guarantee or insurance, long history of the GE/GSE's willingness to fulfill its obligations, as well as the requirements of the legal and operational risk framework, as outlined below. If the analysis supports full enhancement by the GE/GSE, we pass through the GE/GSE creditworthiness to our assessment of the creditworthiness of the underlying assets. Where satisfied, the methodology is guided by a framework that uses the rating (that is, the issuer credit rating or implied rating) on the GE/GSE as the starting point of the analysis (subject to meeting the legal and operational risk framework).

11. In the case of direct-pay CEI transactions, the final issue rating is equal to the GE/GSE rating. The final rating on the transactions with mortgage loans or MBS enhancement may differ from the GE/GSE rating due to exposure to additional risk (such as cash flow shortfalls leading to declines in asset-to-liability parity*, counterparty risk, etc.) or may be eligible for a higher rating under the application of our "U.S. Government Support In Structured Finance And Public Finance Ratings," published Dec. 7, 2014 ("U.S. government support criteria").

12. Given the role of the GE/GSE in such transactions, any change in creditworthiness of the GE/GSE would likely affect the bond ratings in scope of these criteria, unless constrained by applicable caps or subject to U.S. government support criteria.

Legal framework and operational risk framework requirements

13. The legal framework is important to the transactions in scope, because it links the duties of the KTPs with the proper execution of the program.

14. Table 1 outlines the typical legal provisions we expect to be covered in transaction documents, as well as examples of typical elements of such provisions. Our legal analysis similarly 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 (e.g., more flexible, diverse, and dynamic structures that are often actively managed and affiliated with a U.S. municipal or quasi-municipal entity and hence, there may not be formal separateness covenants or requirements for independent directors).

15. If, in our view, the typical legal provisions are not present in the transaction documents or the associated legal risks are not mitigated, the transaction is not eligible for ratings under these criteria. 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.

16. In addition, to be rated under these criteria, issues must meet the eligibility conditions for KTPs specified under the Operational Risk criteria.

Table 1

Evaluation of the enhancement type

17. Our evaluation of the enhancement identifies the type of enhancement. This could take the form of a (i) GE/GSE guarantee or insurance on a mortgage loan or a guarantee on an MBS, (ii) a guarantee on the mortgage loans or bonds in the form of a GE/GSE standby CEI, or (iii) a guarantee on the bonds in the form of a GE/GSE direct-pay CEI.

GE/GSE guarantee or insurance

18. In an FEH bond transaction with a guaranteed mortgage loan or MBS, the GE/GSE(s) make mortgage loan or MBS payments to the trustee. In an FEH bond transaction with an insured mortgage loan, the GE is obligated to make payments to the trustee in the event of a default on the mortgage loan. In both types of transactions, the timing of the mortgage loan payments or MBS payments (including any recovery payments) may differ from timing of the FEH bond payments. Therefore, our analysis includes evaluation of the transaction's cash flows and the transaction's exposure to reinvestment, counterparty, and operational risk. The caps detailed in table 3 and other adjustments apply to this structure, when relevant.

Standby CEIs

19. In a standby CEI transaction, the GE/GSE is obligated to make payments to the trustee in the amount of any delinquent mortgage loan payment or payment on the FEH bonds. Similar to a transaction backed by a GE/GSE guarantee or insurance, there may be a difference in the timing of the remittance of the mortgage loan payment and the payment on the bonds. Therefore, our analysis includes evaluation of the transaction cash flows and the transaction's exposure to reinvestment, counterparty, and operational risk. The caps detailed in table 3 and other adjustments apply to this structure, when relevant.

Direct-pay CEIs

20. In a direct-pay CEI transaction, the trustee draws on the GE/GSE CEI in advance of each bond payment and uses the funds to pay debt service on the bonds. Loan payments received from the borrower will be used to reimburse the GE/GSE for the trustee draws. The direct-pay CEI may also provide coverage for preference and stay provisions or there may be other mitigating factors, such as additional funds made available to cover outstanding bonds. In addition, under these facilities, the GE/GSEs are typically obligated to cover the purchase price of tendered bonds in the event of a failed remarketing.

21. Our analysis of direct-pay CEIs consists primarily of reviewing legal provisions in the transaction documents and sufficiency of the enhancement's coverage of principal and interest on the FEH bonds. We expect that the transaction documents will require that the request and the timing of receipt of funds from the GSE will occur prior to the debt service payment dates, as well as cover certain risks such as, but not limited to: expiration or substitution, non-reinstatement of interest coverage upon an event of default, interest rate mode conversion (see Appendix A for more detail). Cash flow analysis is not required, because payments are received by the trustee prior to debt service payment dates. In addition, because the payment of the outstanding bonds is presumed to be fully covered in the event of any payment shortfall, no caps or other adjustments (including holistic analysis) apply to this structure.

Application of other criteria and caps

22. Depending on the enhancement type, we apply other criteria and caps to adjust the ratings, when relevant, as follows (see table 2):

• Reinvestment risk*, through the application of the criteria "Methodology And Assumptions For Stressed Reinvestment Rates For Fixed-Rate U.S. Debt Obligations," Dec. 22, 2016 ("stressed reinvestment rate Criteria")
• Counterparty risk, through the application of the criteria "Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019 ("Counterparty Criteria")
• Operational risk (KTP) through the application of Operational Risk criteria
• For pools only, the application of U.S. government support criteria
• Rating caps when asset-to-liability parity falls below 100%.

23. Once asset-to-liability parity falls below 100%, we believe an FEH bond should no longer be investment-grade, and rating caps apply. The rating's position within non-investment-grade category depends on the transaction structure and on the timing of when debt service coverage (DSC)* falls below 1.0x.

Table 2

24.a) Reinvestment risk.  We apply the stressed reinvestment assumptions from table 1 of "Methodology And Assumptions For Stressed Reinvestment Rates For Fixed-Rate U.S. Debt Obligations," published Dec. 22, 2016 ("stressed reinvestment assumptions") to project income generated from reinvesting periodic cash flows within transaction accounts, when:

• There is no guaranteed investment contract* (GIC*) provider; or
• The GIC provider no longer meets the requirements of the Counterparty Criteria; or
• The GIC does not extend through the bond maturity; or
• A transaction's asset-to-liability parity approaches 100.25% (in the case where the transaction has no GIC support).

25. In analyzing reinvestment risk, we introduce a 100.25% asset-to-liability parity threshold to better manage rating transitions between the investment-grade category and non-investment-grade category, which is associated with an asset-to-liability parity below 100%. This threshold replaces the existing cash flow carry forward amount of $10,000 that existed under the superseded criteria.

26. When a transaction's asset-to-liability parity approaches 100.25%, we apply the stressed reinvestment rate criteria, which could result in a lower rating unless mitigated by offsetting factors that include:

• Providing a letter of credit (LOC) or another ratable CEI; and
• Cash deposit or excess net assets in the trust that are not subject to clawback or other bankruptcy provisions.

27. Since this adjustment addresses the reinvestment risk*, it is not applicable to pass-through transactions* or FEH bonds that rely on an eligible GIC provider.

28.b) Counterparty risk.  For transactions that rely directly on funds provided by a counterparty to pay debt service (for example, through a GIC, sized to bond maturity, or exposure to swaps or derivative instruments), we apply the Counterparty criteria.

29.c) Operational risk.  For any FEH transaction exposed to operational risk, we apply the Operational Risk Criteria.

30.d) Application of U.S. government support criteria.  A transaction backed by a pool of loans may be eligible to be rated higher than the ratings on the GE/GSE if it meets the following conditions:

• It passes the stress tests described in the U.S. government support criteria and "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions," published Jan. 30, 2019; and
• Application of the stressed reinvestment rate criteria.

Cash flow scenarios and assumptions

31. Asset-to-liability parity is an important indicator of the transaction performance. To determine asset-to-liability parity, we review cash flow scenarios to verify that program assets are sufficient to cover liabilities and able to withstand stress scenarios.

32. Accumulated cash flow shortfalls could result in declines to asset-to-liability parity if there are no offsetting factors present. Cash flow shortfalls typically arise from a lag in mortgage loan payment, timing mismatch between mortgage loan payments and bond payments, negative arbitrage*, and reinvestment risk. Thus, we look to assumptions in the cash flow scenarios to address these issues. The scenarios we typically apply to FEH bonds are:

• Base-case scenario: Full origination of loans/0% PSA* prepayment experience,
• Non-origination scenario: Non-origination of any loans assuming a full redemption of bonds on the date specified in the bond documents,
• Standard prepayment scenarios for single-family transactions,
• 100% prepayment scenario: Full origination of loans/100% PSA prepayment experience,
• Three-year average life scenario: Full origination of loans/three-year average life of the mortgage loans prepayment experience,
• Rapid prepayment scenario: For transactions rated above the GE/GSE rating, full origination of loans and prepayment speed sufficient to retire all bonds within two years after origination; however, depending on the mortgage loan interest rate, this scenario may be run at slower prepayment speeds that retire all bonds within a greater number of years after origination (see table 5 in Appendix B: Cash Flow Scenarios And Assumptions), and
• Worst-case scenario: For multifamily loans, cash flows should show default or prepayment occurring at the worst possible time in the life of the bonds (see Appendix B).

33. Depending on the structure of each transaction, additional cash flow scenarios may be needed. Such scenarios are detailed in Appendix B.

34. Cash flow scenarios should demonstrate the specific assumptions as follows, further detailed in Appendix B.

• Payment lag*,
• Acquisition period,
• Fees and expenses,
• Reinvestment earnings,
• Redemption,
• Prepayment penalties,
• Surpluses,
• Recycling*, and
• FHA insured programs.

35. For variable-rate debt transactions with unhedged interest rate exposure, we assume stressed interest rates as per our criteria (see "Methodology To Derive Stressed Interest Rates In Structured Finance," Oct. 18, 2019). For transactions with hedges (such as swaps, caps, or other derivative instruments), we assess the counterparty risk exposure to the hedge provider under our Counterparty criteria and the eligibility of the hedge agreement under our "Global Derivative Agreement Criteria," published June 24, 2013. Additional information regarding assumptions for variable-rate bonds and related structures may be found in Appendix B.

Caps

36. Ratings are capped when the asset-to-liability parity is below 100% or projected to fall below 100% based on the application of 'BBB' rating level stressed reinvestment rate assumptions, unless offsetting factors are present. Our analysis of the exact rating level takes into account the timing of an insufficiency in DSC (that is below 1.0x) using speculative-grade S&P Global Ratings stressed reinvestment rates and absent any offsetting factors. This cap also applies in GIC dependent transactions (see table 3 for more details).

37. Offsetting factors include:

• Providing an LOC or another ratable CEI; or
• Cash deposit or excess net assets in the trust that are not subject to clawback or other bankruptcy provisions.

38. The rating caps outlined in table 3 are absolute, meaning that no other adjustment can lead to a rating higher than a cap, although the rating could be lower than the applicable cap.

Table 3

39. For pass-through transactions, however, the asset-to-liability parity below 100% generally means rating below 'B-' because of the limited financial flexibility and lack of potential for additional revenues of these transactions.

Holistic analysis

40. To capture a broader view of creditworthiness, we also perform our holistic analysis, as part of determining the final rating. The holistic analysis may be based on factors including our forward-looking view of an issue's financial performance, may reflect a comparable ratings analysis when relevant, or may reflect strengths or weaknesses that are not fully reflected through the application of the methodology. This analysis can result in the raising or lowering of the rating by one notch, or no change, subject to the following conditions.

41. Holistic analysis cannot result in a final rating above any rating cap and cannot override rating outcomes based on the applicable criteria unless such flexibility is allowed in those criteria. In addition, the holistic analysis alone cannot result in a rating on a transaction above the rating on the GE/GSE.

APPENDIX A: DETAILED APPLICATION CONSIDERATIONS

42. This appendix provides detailed considerations for the application of these criteria. Specifically, this appendix focuses on the following:

• GE/GSE direct-pay CEIs,
• Application of stressed reinvestment rate criteria and rating caps,
• Offsetting factors, and
• Application of U.S. government support criteria.

GE/GSE Direct-Pay CEIs

43. GE/GSE direct-pay CEIs may provide credit and liquidity support for fixed rate or floating-rate housing FEH bonds. Under the CEI, the GE/GSE is obligated to make payments to the trustee and cover the purchase price of tendered bonds in the event of a failed remarketing. The trustee draws monthly on the facility and uses the funds to pay debt service on the bonds. Cash flows are unnecessary because payments are received by the trustee prior to debt service payment dates.

44. S&P Global Ratings considers whether liquidity events such as mandatory or optional tenders are scheduled to precede the termination of the liquidity portion of the direct-pay CEI.

45. Direct-pay CEIs may include a mandatory tender upon substitution of an alternate credit facility without rating maintenance. This is a risk in the fixed-rate mode if the liquidity support has expired. To mitigate this risk, we expect transaction documents to:

• Limit substitution to the variable-rate modes;
• Provide that the credit facility portion or a liquidity facility portion will be available to back the tender;
• Indicate that credit facility expiration leads to a redemption; or
• Indicate that substitution can only occur if remarketing proceeds equal to the full purchase price of the bonds are to be on hand for the substitution to occur, otherwise the credit facility will remain in effect or there will be a redemption of the bonds if the credit facility is scheduled to expire.

Application Of Stressed Reinvestment Rate Criteria And Rating Caps

46. To determine the impact of stressed reinvestment rate criteria and applicable rating caps on new transactions, we typically review cash flows dated from the mortgage loan or MBS delivery date to bond maturity. For existing transactions, we generally request updated cash flows from issuers at least annually, or if cash flows are not available, we request trust account balances and compare them to the projected balances on the most recent scheduled bond payment date as set out in the original cash flow projections that reflect our stressed reinvestment assumptions. If the actual account balances are lower than those that were projected in the original cash flows, we may generate our own cash flow projections. We then determine the rating, based on the stressed reinvestment assumptions used, as well as whether asset-to-liability parity falls below 100%, debt service coverage falls below 1.0x and, when relevant, how soon DSC falls below 1.0x.

47. If a transaction's asset-to-liability parity approaches 100.25%, we apply the stressed reinvestment assumptions to analyze the impact on projected asset-to-liability parity and debt service coverage ratio, potentially lowering the rating unless there are offsetting factors (see the examples that follow). In addition, in case the transaction does not pass the 'BBB' stressed reinvestment assumption, we apply the speculative-grade stressed reinvestment assumption and further lower the rating as the date approaches on which projected DSC declines below 1.0x in accordance with table 3.

48. The example in chart 2 shows that, although asset-to-liability parity is approaching 100.25%, the cash flows are sufficient using the stressed reinvestment assumption consistent with the GE/GSE rating level, and projected parity remained above 100% through maturity. This demonstrates cash flow sufficiency with minimal reliance on reinvestment earnings and results in a rating equal to the GE/GSE rating (unless other adjustments apply), with the exact rating dependent on the holistic analysis.

49. The example in chart 3 assumes that asset-to-liability parity falls below 100% prior to maturity using the GE/GSE rating level stressed reinvestment assumption and no offsetting factors are present. While the cash flows are insufficient using the stressed reinvestment assumption in line with the GE/GSE rating level, they are sufficient using the 'A' rating level stressed reinvestment assumption, and asset-to-liability parity would be above 100% through maturity of the bonds. This results in the rating in the 'A' category (absent offsetting factors or other adjustments), with the exact rating dependent on the holistic analysis.

50. The example in chart 4 assumes that asset-to-liability parity falls below than 100% prior to maturity and no offsetting factors are present. This example demonstrates an iterative application of stressed reinvestment assumptions to determine an appropriate rating level that corresponds to asset-to-liability parity above 100% through maturity of the bonds. In this example, the resulting rating is in the 'BBB' category (absent offsetting factors or other adjustments), with the exact rating dependent on the holistic analysis.

51. If projected asset-to-liability parity falls below 100% under a 'BBB' stressed reinvestment assumption scenario with no offsetting factors, we apply our speculative-grade stressed reinvestment assumptions and then assign a rating in the speculative-grade category, with the exact rating based on when we project DSC to fall below 1.0x during the life of the transaction as per table 3. The further out that shortfall occurs, the more likely we are to assign a rating at the higher end of the speculative-grade range. This is because, in our view, there is a greater likelihood that circumstances could improve over a longer time, thereby enabling an issuer to avoid a potential default. For example, some issuers have, at their own discretion, opted to deposit cash from outside the trust estate (from a bankruptcy-remote source) in order to increase cash balances to a level that allows for full and timely payment of debt service through bond maturity. In other cases, we have seen issuers enter into an LOC, investment contract, or other credit enhancement that provides sufficient cash flow for the duration of the bond term.

Offsetting Factors

52. The ratings can be higher than those based on the stressed reinvestment rate criteria and above caps in table 3 if one or several of the following offsetting factors are present:

a) Providing an LOC or any alternative credit enhancement

53. To mitigate potential cash flow shortfalls or declines in asset-to-liability parity, an issuer may enter into an LOC or acquire alternative credit enhancement that enables sufficient cash flow to service the debt (sized to bond maturity), demonstrating the trust's ability to repay the drawdowns.

b) Additional deposit into the trust

54. In the event of a projected cash flow shortfall or decline in asset-to-liability parity, an issuer or other transaction party could elect to deposit bankruptcy-remote additional resources such as cash or liquid assets into the trust. We request updated cash flow scenarios reporting that there is sufficient cash flow after the deposit is made, and demonstrating DSC over 1.0x for the life of the bonds.

U.S. Government Support Criteria

55. We may rate pools higher than the rating of the GE/GSE rating, if the asset-to-liability ratio is above 100.25% after applying our cash flow stresses and if the transaction meets the conditions of "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions," published Jan. 30, 2019.

56. The cash flow stress includes:

• The haircut due to the mortgage insurer being rated lower than the rating on the transaction based on the application of the "Methodology For Assessing Mortgage Insurance And Similar Guarantees And Supports In Structured And Public Sector Finance And Covered Bonds," published on Dec. 7, 2014, and
• 0% stressed reinvestment earning assumption (a 'AAA' reinvestment rate assumption).

APPENDIX B: CASH FLOW SCENARIOS AND ASSUMPTIONS

57. S&P Global Ratings analyzes transaction cash flows to ensure that the transaction generally covers timing and sufficiency of payments, considering payment lags, reinvestment, and unscheduled prepayments. Single-family housing transactions typically experience prepayments over time because there are multiple mortgage loans as well the ability to refinance or prepay principal at any time. Multifamily housing transactions typically pay as scheduled and often will contain a prepayment lockout period, but will also typically allow for a variety of scenarios in which unscheduled prepayments may occur – including, but not limited to: non-origination (i.e., stress scenario in which non-origination of any loans results in assuming a full redemption of bonds on the date specified in the bond documents), recapitalization or refinancing, or default.

58. The assumptions used in the cash flow scenarios ("cash flow assumptions") are typically in line with applicable criteria, including, but not limited to, "Methodology To Derive Stressed Interest Rates In Structured Finance," Oct. 18, 2019 ("stressed interest rate criteria"), and "Methodology And Assumptions For Stressed Reinvestment Rates For Fixed-Rate U.S. Debt Obligations," Dec. 22, 2016 ("stressed reinvestment rate criteria"). The cash flow assumptions would also encompass variable-rate debt or debt affected by downgraded or unrated counterparties, as well as capture the effects of failed remarketings resulting in bank bonds, constraints regarding the availability of swaps, liquidity support, and market access. In addition, they may also include the effects of swap counterparty terminations and unhedged variable rate bonds under specific circumstances described in our counterparty criteria.

59. This Appendix is organized in two primary sections beginning with Cash Flow Assumptions, which identifies the structural variables underlying each transaction type that should be included in the cash flow analysis. These variables reflect the relevant credit, legal, operational, and counterparty risks that typically arise in a given transaction. Cash Flow Scenarios identifies the various scenarios that reflect a range of economic situations and structural features specific to particular transactions that should be reflected in cash flows.

Cash Flow Assumptions

60. S&P Global Ratings expects the following assumptions to be addressed in the cash flow scenarios:

• Acquisition period,
• Fees and expenses,
• FHA-insured program assumptions,
• Payment lags,
• Prepayments,
• Reinvestment earnings,
• Redemptions,
• Surpluses, and
• Variable rate assumptions.

Acquisition period

61. Generally, we expect cash flows to assume a worst-case draw scenario if mortgage loans are not originated or MBS are not delivered contemporaneously with bond closing. This stresses the transaction, as it demonstrates the least amount of interest earnings until the mortgage loan(s) fully amortizes (that is, the maximum amount of negative arbitrage). For example, if the bond proceeds are held uninvested (or invested and earning a rate of return lower than the mortgage rate), the cash flows would be modeled to assume that the loans are acquired on the last possible date that is permitted under the transaction documents. Conversely, if the bond proceeds are invested and earning a rate higher than the mortgage rate, we expect the cash flows to be modeled to assume mortgage loan acquisition immediately after bond closing.

62.Acquisition period for construction/rehabilitation.  For multifamily transactions where new construction or substantial rehabilitation is present, we compare the interest rate earned on the construction fund with the mortgage rate during construction. If the construction fund rate is less than the mortgage rate during this period, we expect cash flows to reflect the mortgage being funded at the latest possible date. We expect the drawdown date under this scenario to occur one month before the commencement of note amortization. This assumption demonstrates that, should construction delays occur, the trustee will have sufficient money to pay regularly scheduled bond payments and will be able to redeem all bonds in the event of a non-origination of the mortgage note. Conversely, if the construction fund interest rate exceeds the mortgage rate, we expect the cash flows will be modeled assuming the mortgage would be funded in its entirety at bond closing.

63.Acquisition period extensions.  For any extension of the initial acquisition period, S&P Global Ratings expects that transaction documents should specify the provision of updated cash flow scenarios and notification of the potential extension to S&P Global Ratings. Upon receipt of updated cash flows, we will review the rating on the bonds in accordance with the applicable primary criteria. In some cases, we may accept an initial cash flow scenario run to the furthest anticipated acquisition fund date, in lieu of updated cash flows at the time of extension, as long as no key assumptions changed since that time.

Fees and expenses

64. Typically, fees and expenses are paid based on the outstanding balance of the bonds or the mortgage loan balance. This ensures that the net spread will be maintained as the mortgages and bonds amortize. Typically, transaction documents and cash flows will place the payment of transaction-related fees subordinate to debt service payments in the flow of funds and all fees are capped as stated in the transaction documents. If this is not the case, or in the event that there are fixed fees, such as an annual trustee fee that does not decline as the bonds and mortgages amortize, we would evaluate the minimum level at which cash flow is maintained in the indenture to cover those fees and may request an immediate prepayment run showing the transaction's ability to cover fixed fees in the event of a large prepayment. In general, cash flows should demonstrate that there is sufficiency of assets and revenues to pay debt service and expenses under all scenarios on which the fees and expenses are calculated.

FHA-insured program assumptions

65. Multifamily FHA-insured transactions generally fall into one of three categories: cash pay, debenture pay, and risk share, although in some cases, there can be overlap. Because the FHA's regulations and practices do not provide for guaranteed timely payment (as GE/GSEs do for MBS), FHA transactions typically include liquidity and credit reserves that are sufficiently funded and available for debt service payments until the claim is paid in full. Requirements for reserve fund sizing depend on the type of FHA transaction, as timing and amount of claim payments differ for each. Where there is overlap in the transaction type, we would expect that the reserve is sized to the largest requirement of maximum annual debt service (MADS). Table 4 details the typical reserve fund requirements for FHA programs.

66. Generally, FHA insurance covers 100% of the claim, less a 1% assignment fee, so that at the time of claim, only 99% of the transaction is paid. To compensate for this cash flow shortfall, transactions have most commonly used the following methods to demonstrate coverage:

• Initial deposit of 1% cash into the transaction or third-party support--such as an LOC, a guarantee, or a surety bond--to cover the 1% assignment fee; or
• Balance of the mortgage shown at 99% of the unamortized principal.

67. Unless the 1% assignment fee is covered outside of the trust or the balance of the mortgage is shown at 99%, it must be deducted when calculated asset-to-liability parity. For FHA risk-share transactions, this adjustment to the parity calculation is not necessary because FHA pays 100% of the claim.

Table 4

Payment lags

68. Transaction cash flows should demonstrate the ability to withstand the payment lags described for each program. A payment lag occurs between the mortgage payment by the borrower and when the trustee receives the mortgage payment. We expect any additional payment lags to be incorporated on top of any standard payment lag assumptions, if applicable, to account for the fact that mortgages pay in arrears. A minimum 30-day lag (in addition to normal arrearage) in receipt of mortgage payments on newly originated and existing loans should be applied to the cash flow projections. S&P Global Ratings may request a lag greater than 30 days depending on historical delinquency levels or the program; this will be considered on a case-by-case basis.

69.GE/GSE payment lags.  Nuances for each GE/GSE program should also be considered and modeled in the cash flows. To account for additional delays in payments such as weekends or holidays, S&P Global Ratings requires an extra lag of five days for loans enhanced by Ginnie Mae, Fannie Mae, or Freddie Mac. Typical payment lag assumptions are outlined below in table 5.

Table 5

Prepayments

70. For most single-family transactions, we review cash flows that use the Standard Prepayment Model for prepayment speed assumptions from the Securities Industry and Financial Markets Association. As this model is the standard used by the industry, we expect that transaction cash flows will use it as the basis for prepayment speed assumptions (PSA). The Standard Prepayment Model (100% PSA) assumes that the prepayment rate will increase by 0.2% each month for the first 30 months until it peaks at 6% in month 30 and then assumes a constant prepayment rate in the 30th month and beyond. Prepayment speeds for cash flow stress scenarios are quoted as multiples of the 100% PSA. For example, 0% PSA would equal 0% x 100% PSA, 50% PSA would equal half of the standard model, and 200% would equal twice.

71.Alternate prepayment curves.  We may consider transactions that use an alternate prepayment speed curve on a case-by-case basis, depending on the historical information available (e.g., tax-exempt issues are required by the IRS to calculate cash flows for yield compliance by using 100% of FHA prepayment experience). If an alternate prepayment speed curve is proposed for a transaction, we would consider, among other things, the length of time over which the prepayment curve has been established, how it compares to the industry standard, and the reasoning for using it as an alternative.

72.Prepayment penalties.  No prepayment penalties should be assumed in cash flows, as payment of these penalties may not be enforceable.

Reinvestment earnings

73. In the absence of an investment agreement or permitted investment with a stated rate, table 1 of "Methodology And Assumptions For Stressed Reinvestment Rates For Fixed-Rate U.S. Debt Obligations," published Dec. 22, 2016 ("stressed reinvestment assumptions") should be used. Our stressed reinvestment assumptions also apply for any period not covered by an eligible guaranteed investment contract (GIC) or if the GIC terminates or is able to be terminated prior to mandatory bond redemption or maturity, unless there is a provision for permitted investments with a stated rate. When there is eligible GIC present, depending on the issue bond rating and GIC provider rating, in cases where the GIC providers have been downgraded and the issuer remains in the contract, but still has the option to terminate upon any future downgrade of the provider, S&P Global Ratings analyzes the cash flows assuming its stressed reinvestment assumptions.

Redemptions

74. When mortgage loans prepay, the proceeds are typically held as cash or in permitted investments that typically earn less than the bond yield plus expenses. This will result in a reduction in trust assets over time. We expect transaction cash flows to be modeled assuming the longest period of time permitted under the transaction documents prior to bond redemption once prepayments are received by the trustee. This reflects the time from when the prepayment is made until the redemption occurs and covers the impact of reinvestment risk because one earning asset (the loan) is replaced with a different (and lower-yielding) asset.

Rebate

75. All rebate fees and payments to the federal government for rebate should be demonstrated, unless provided for outside of cash flows.

Surpluses

76. Typically, cash flows should assume the availability of some surpluses (defined as revenues in excess of debt service plus expenses) for prior redemption of outstanding bonds. If releases of excess money are allowed by the transaction documents at a certain asset/liability parity level or other covenant, cash flows should accurately reflect this release.

Variable-rate transactions

77. For variable-rate debt transactions with unhedged interest rate exposure, we would assume stressed interest rates as per our criteria "Methodology To Derive Stressed Interest Rates In Structured Finance," Oct. 18, 2019. For transactions with hedges (such as swaps, caps or other derivative instruments), we would assess the counterparty risk exposure to the hedge provider under our criteria "Counterparty Risk Framework: Methodology And Assumptions," March 8, 2019, and the eligibility of the hedge agreement under our "Global Derivative Agreement Criteria," June 24, 2013.

78. Hedged transactions with counterparties that meet our counterparty criteria can be modeled at the swap or cap rate associated with the hedge. Generally, all risks identified under hedge contracts should be incorporated into the cash flow modeling projections as expenses or additional interest due on bonds. Reserve funding or interest rate spread should be shown to cover any shortfalls produced as a result of the modeling.

79.Standby bond purchase agreements (SBPA).  For transactions involving SPBAs covering liquidity, we would analyze cash flow projections that incorporate nearing termination, expiration or substitution. Cash flows should reflect alternative plans, if any, that will address the potential of increased liquidity fees upon any of these events. Absent any alternative plans, we would assume that any SBPA expiring within six months will not be extended or replaced by the expiration date and the current SBPA provider will be required to purchase the bonds and hold as bank bonds unless evidence of a liquidity commitment can be provided. The assumptions for bank bonds described below will then apply.

80. For the expiration of SPBAs beyond six months, S&P Global Ratings will analyze cash flows based on current market conditions in relation to liquidity fees being charged by providers. Higher-rated bonds will be analyzed for the potential to withstand higher liquidity fees. By taking into consideration any increased cost of liquidity and adjusting the expense by rating category, we believe that transactions exposed to liquidity fees may mitigate credit concerns.

81.Bank bonds.  S&P Global Ratings will analyze cash flow projections incorporating alternative plans the issuer may be contemplating that will address the potential effect of bank bonds on the transaction, if warranted. For SPBAs with repayment rates based on a variable rate, S&P Global Ratings will analyze cash flows assuming its stressed interest rate assumptions. Absent any alternative plans, or if bank bonds remain outstanding six months after becoming held by the bank, cash flows will be analyzed assuming bank bonds for the entire term-out period as specified by the SBPA.

82. Depending on the cause of the bank bonds, we may also analyze cash flows assuming that any bonds with liquidity support from a bank for which remarketing agents have been unable to remarket a portion of the related debt will become bank bonds as well. The same assumptions described above will apply to these bonds.

83.Basis risk.  S&P Global Ratings will assess the basis risk experienced on the outstanding variable-rate bonds of the issuer and determine any assumed adjustment based on the issuer's actual experience. Assumptions may differ for taxable bonds, or for bonds subject to the alternative minimum tax. Higher-rated bonds will be analyzed for the potential to withstand greater levels of basis risk.

Cash Flow Scenarios

84. Typical cash flow scenarios are shown in table 6, and further detailed below. The required scenarios for most housing transactions may be specified in each of the applicable criteria, with the minimum scenarios typically including:

• Base-case scenario
• Non-origination/non-delivery scenario
• Worst-case scenario

85. If applicable to the transaction structure, we may require additional cash flow scenarios listed in table 6 and as further explained below (see Other prepayment and stress scenarios).

Base-case scenario

86. For all transactions, with the exception of direct pay credit enhancement instruments and some exempt pass-through structures, we generally expect a cash flow scenario showing a base-case scenario of prepayments (also referred to as 0% PSA scenario). Under the base-case scenario, we expect the underlying mortgage loan(s) pays according to the terms of the mortgage documents with no prepayment(s) or any other unscheduled receipts such as casualty or condemnation made at any time.

Non-origination/non-delivery scenario

87. For all transactions, with the exception of direct pay credit enhancement instruments and pass-through transactions as further detailed in the applicable criteria, we expect to analyze a stress scenario in which loans related with the bond issuance are not originated or MBS are not delivered, resulting in assuming a full redemption of bonds on the date specified in the bond documents. S&P Global Ratings may waive this requirement if the transaction structure is such that the mortgage loans are originated and delivered prior to or contemporaneously with the transaction's closing (that is, there is no origination or acquisition period), or if the transaction's structure is such that the scenario is not necessary.

Worst-case scenario(s)

88. Generally, we would look for multifamily transaction cash flows to demonstrate a default occurring at the worst possible time in the life of the bonds. This scenario may vary or may include multiple scenarios, depending on the complexity of the portfolio. We may take into account certain loan or pool characteristics, such as credit quality and loan payment status, when we determine the loss timing to apply in the cash flow analysis. For example, if a pool of assets is predominantly of lower credit quality or shorter maturity, we would generally expect that defaults will occur more quickly and to a larger degree, both in terms of dollar amount and percentage of the portfolio. Additionally, we may look for the cash flows to demonstrate default occurring with the highest coupon loan(s) or strongest performing loan(s) first, such that less profitable or weaker performing loans would have to maintain a greater percentage of debt service. The timing of losses in the cash flow analysis may also account for economic cycles, or when we expect recapitalization/refinancing to occur (e.g., tax credit compliance period expiration).

89.FHA-insured programs.  For FHA-insured programs, we expect at least one cash flow scenario demonstrating the transaction's resilience to a default immediately after final endorsement, and reflecting the timing for payment of the claim based on the type of FHA insurance.

Table 6

Pass-through transactions

90. In the case of pass-through transactions, mortgage loan principal and interest payments, and prepayments are passed through to bondholders as they are received. These transactions are structured to mitigate the potential timing mismatches and negative arbitrage that can occur in structures that have monthly mortgage payments and semiannual debt service payments. These structures also reduce the risk of administrative error due to the close match of the timing of payments. Due to the monthly pass-through nature of these transactions, reinvestment risk is mitigated and does not need to be modeled into the cash flow runs. Pass-through transactions typically contain a minimum of the following structural features:

• Bond denominations matched with the securities denomination;
• Payment dates on the securities synced with or scheduled prior to the payment dates on the bonds;
• Pass-through mortgage rate(s) greater than or equal to the highest bond rate(s);
• Fees and expenses paid outside of the trust or they are expressed as a percentage of the securities outstanding and incorporated into the pass-through mortgage loan interest rate;
• Lags, negative arbitrage and applicable reserves funded at closing, and sized according to the respective program; and
• No mandatory or sinking fund redemption schedule.

91. For pass-through transactions, we typically expect to receive cash flow reports reflecting the initial transaction assumptions, including a non-origination/non-delivery scenario and worst-case scenario. There may be cases where the timing mechanics of the transaction result in the transaction creditworthiness being non-dependent on cash-flows, and as such allow us to waive our requirement for cash flow scenarios, such as if the mortgage loan(s) or MBS are delivered prior to or contemporaneously with bond closing. We typically do not receive ongoing cash flow reports for pass-through transactions but we expect transaction documents to require a cash flow certificate and, as necessary, extension cash flows if the acquisition period is extended post-closing.

Third-party verification

92. S&P Global Ratings may request that final cash flow analysis be verified by an independent third party, such as a nationally recognized accounting firm, bond firm, or other expert in the field. This may occur if the cash flow provider did not have a track record of providing cash flows for a particular type of transaction. Once a history of accurate cash flows has been established, third-party verification will not be requested.

Other prepayment and stress scenarios

93.Rapid prepayment scenario.  Transactions rated above the sovereign or GE/GSE rating should include this stress scenario. Cash flows are prepared at a prepayment speed sufficient to retire all bonds within two years after origination; however, depending on the mortgage loan interest rate and the issuer, this scenario may be run at slower prepayment speeds that retire all bonds within a greater number of years after origination, as shown below.

Table 7

94. Depending on historical prepayment speeds, we may request a rapid prepayment scenario for transactions rated at or below the sovereign or GE/GSE rating.

95.Planned amortization class (PAC) bond stress scenario.  If the bond structure includes a PAC bond, this stress run may be needed if the net interest rate on the PAC bond, factoring in any premium, is among the lowest of all bonds in the structure. Cash flows are run at the PSA prepayment percentage that the PAC bond is structured at, which is the level at which all prepayments first go toward calling the PAC bond (typically around 100% PSA), until the PAC bond is called in full, and then at 0% prepayments until bond maturity.

96.Liquidity stress scenario.  If serial bonds are present in the structure when either a PAC or super-sinker bond is present and are not called on a pro rata basis with the PAC/super-sinker, a liquidity stress run can show the result of prepayments (run at the same speed as the PAC or three-year average life for a super-sinker) shutting off at the point of greatest decline in prepayment moneys received and remaining at 0% until bond maturity.

97.Multiple mortgage rate stress scenario.  For stand-alone transactions where mortgages are originated at two or more different rates, cash flows should be run reflecting different prepayment speeds for each mortgage rate. Generally, at any given rating level, as the interest rate on a mortgage loan increases, the rate of prepayment is also expected to increase. Furthermore, at higher rating levels, we expect transaction cash flows to withstand stresses such as higher delinquencies or defaults.

98. Table 8 outlines the mortgage rates and associated prepayment speed assumptions for each rating level from AAA to BBB. When the mortgage rate falls between two numbers in the table, the rate for the higher rate loan should be rounded up and the rate for the lower rate loan should be rounded down. For example, if a transaction contained two mortgage rates at 7.35% and 6.35%, the cash flow scenario for a 'AA' category rating should reflect a 466% PSA and 196% PSA for each loan, respectively.

Table 8

99.Forty-year mortgage scenario.  Mortgage loans with terms longer than 30 years, usually generate less revenue on a semiannual basis than 30-year loans. If 30-year and 40-year loans are in the same indenture, S&P Global Ratings may request an additional cash flow with the 30-year loans prepaying at the appropriate PSA in accordance with the rating, assuming there are no prepayments on the 40-year loans. This would indicate whether the indenture could maintain debt service payments with the support of 40-year loans alone.

APPENDIX C: GLOSSARY

100.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.

101.Debt service coverage (DSC).   A measure of the transaction's ability to cover bond debt service and associated fees from mortgage loan revenues and reinvestment earnings, if any. For purposes of these criteria, DSC equals the revenue fund balance plus current mortgage loan principal and interest, less servicing and guarantee fees, all divided by bond principal, interest, and trustee fees in the same period.

102.Federal Housing Administration (FHA).   A U.S. government agency that provides mortgage insurance on loans made by approved lenders throughout the U.S. and its territories. The FHA insures mortgage loans on single-family and multifamily homes including manufactured homes and hospitals.

103.Government entities (GE).   U.S. government agencies such as the FHA or related entities such as Ginnie Mae.

104.Government-sponsored enterprise (GSE).   A type of financial services corporation created by the U.S. Congress. Well-known GSEs are Fannie Mae and Freddie Mac.

105.Guaranteed investment contract (GIC).   An agreement whereby the provider (or counterparty) provides a guaranteed rate of return in exchange for holding an investment for a fixed period of time.

106.Key transaction participants (KTP).   Any party whose failure to perform as contracted poses a risk to the credit quality of a transaction, such as to adversely affect the rating on the transaction. See also the Operational Risk criteria.

107.Negative arbitrage.   When the assets under the trust estate are earning interest at a lower coupon than the liabilities under the trust estate need to pay. Negative arbitrage is similar to reinvestment risk in that it could cause a cash flow shortfall to occur if no offsetting factors are present. Typically, negative arbitrage relates to the period of time from bond closing until the point where the mortgage loan(s) are originated and paying interest.

108.Parity bond resolution.  Parity bond resolutions are used broadly by HFAs to fund their mortgage lending programs. They are governed by a master agreement that provides, among other things, that multiple series of bonds may be issued and that owners of the each class of such bonds have an equal lien on the assets of the program.

109.Payment lag.  A delay in payment on the mortgage loan that is in addition to the time period encompassed from the date of origination until the first scheduled mortgage loan payment date.

110.PSA.   Prepayment speed assumption. For most single-family transactions, we review cash flows that use the Standard Prepayment Model for prepayment speed curve assumptions from the Securities Industry and Financial Markets Association. We may consider transactions that use an alternate prepayment speed curve on a case-by-case basis, depending on the historical information available.

111.Pass-through transaction  A transaction in which a mortgage loan or MBS pays principal and interest that is "passed through" on a monthly basis, and payments are used for debt service during the same period. Pass-through transactions typically have monthly payments and are not subject to a lag in mortgage loan or MBS payments, reinvestment earnings, or timing mismatches between the mortgage loan or MBS payment and the bond payment.

112.Recycling.   A financing tool used by housing issuers to preserve volume cap, wherein new bonds are used to refund existing bonds using the same volume cap and used to make new loans. Recycling is subject to certain time frames and provisions restricted by tax law.

113.Reinvestment risk.   When assets under the trust estate are reinvested at a rate that earns less than what is needed to pay debt service plus expenses. Reinvestment risk is similar to negative arbitrage in that a cash flow shortfall can occur if no offsetting factors are present. In general, it is associated with any unscheduled receipt of funds including other events such as casualty and condemnation receipts, insurance receipts, and other inflows from the mortgage loan(s).

114.Transaction documents.   Legal documents including, but not limited to, the trust indenture, loan agreement, mortgage, credit enhancement agreement, and other documents detailing the transaction's terms and provisions.

REVISIONS AND UPDATES

This article was originally published on Nov. 12, 2019.

Changes introduced after original publication:

On Jan. 6, 2021, we republished this criteria article to make nonmaterial changes. We deleted text related to the original publication in paragraphs 1, 3, and 8 that was no longer relevant. We updated our contact information and references to related publications, including related guidance. Additionally, we updated criteria references in paragraph 5 and in the "Related Criteria" section.

On May 27, 2021, we republished this article to make nonmaterial changes to the contact information.

On Oct. 10, 2022:

• We republished this criteria article to update the scope in paragraphs 4-6 to exclude parity bond resolutions (including hybrid programs), since these transactions are now analyzed under our criteria "Methodology For Rating U.S. Public Finance Mortgage Revenue Bond Programs," published on Oct. 10, 2022.
• We made nonmaterial changes to include content previously published in guidance articles. As announced in "Evolution Of The Methodologies Framework: Introducing Sector And Industry Variables Reports," Oct. 1, 2021, we are phasing out guidance documents over time. As part of that process, we have archived two guidance articles and moved the relevant content into two new appendices in this criteria article. We moved the relevant guidance content of "Guidance: U.S. Federally Enhanced Housing Bonds Rating Methodology," Nov. 12, 2019, to Appendix A, without substantive changes. We did not include the content applicable to parity bond resolutions because that has been superseded by the publication of our mortgage revenue bond program criteria. We moved the relevant guidance content of "Guidance: Cash Flow Scenarios And Assumptions For U.S. Public Finance Housing Bonds," Sept. 4, 2019, to Appendix B, without substantive changes. We only included the guidance that applies to the analysis of credits in scope of these criteria. We moved other content into appendices of the relevant criteria articles ("Methodology For Rating U.S. Public Finance Mortgage Revenue Bond Programs" and "Methodology For Rating U.S. Public Finance Rental Housing Bonds").
• We updated contact information.

RELATED PUBLICATIONS

Fully Superseded Criteria

• Methodology For Certain Housing Bond Transactions Supported By U.S. Government Agencies And Government-Sponsored Entities, Dec. 17, 2014
• Ginnie Mae, Fannie Mae, And Freddie Mac Multifamily Securities, June 26, 2007
• FHA Insured Mortgages, June 18, 2007
• Single-Family Mortgage-Backed Securities Programs, June 13, 2007

Related Criteria

• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 11, 2021
• Methodology To Derive Stressed Interest Rates In Structured Finance, Oct. 18, 2019
• Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Methodology And Assumptions For Stressed Reinvestment Rates For Fixed-Rate U.S. Debt Obligations, Dec. 22, 2016
• U.S. Government Support In Structured Finance And Public Finance Ratings, Dec. 7, 2014
• Methodology For Assessing Mortgage Insurance And Similar Guarantees And Supports In Structured And Public Sector Finance And Covered Bonds, Dec. 7, 2014
• Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Global Derivative Agreement Criteria, June 24, 2013
• Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
• Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012
• Principles Of Credit Ratings, Feb. 16, 2011
• Methodology For Servicer Risk Assessment, May 28, 2009

Related Guidance

• ARCHIVE: Guidance: U.S. Federally Enhanced Housing Bonds Rating Methodology, Nov. 12, 2019
• Guidance: Methodology To Derive Stressed Interest Rates In Structured Finance, Oct. 18, 2019
• ARCHIVE: Guidance: Cash Flow Scenarios and Assumptions For U.S. Public Finance Housing Bonds, Sept. 4, 2019
• Guidance: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019

Related Research

• Criteria And Guidance: Understanding The Difference, Dec. 15, 2017