S&P Global Ratings expects continued stability in military housing ratings based on several credit factors: the strong demand for on-base housing, as demonstrated by a steady increase in personnel throughout the U.S. armed forces; the continued bipartisan support for the Department of Defense (DoD), with a long history of appropriations by Congress; and strong debt service coverage ratios throughout most of our rated projects. Eighty-eight percent of our ratings in the sector are in the 'AA' and 'A' categories, reflecting the projects' strong financial metrics, professional management, and generally high occupancy rates.

However, there are challenges in the near and medium term for these projects. The homes built under the military housing privatization initiative, including many built during the early 2000s, have accumulated physical capital needs which could require refinancing existing debt or issuing additional debt. We have also observed accelerating increases in insurance expenses throughout the sector, which could pressure some ratings, especially those below the first lien position; and the increased focus on tenant rights and accountability following numerous complaints in recent years has led to rising expenses in maintenance, repairs, and payroll.

Positive Trends In Staffing And BAH Rates

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The military housing sector is supported by the growth in the basic allowance for housing ("BAH," a component of compensation for U.S. service members), and by the expansion of U.S.-based active duty personnel over the past five years. The DoD's budget line item for BAH, the primary source of revenue for the projects we rate, has increased steadily from just over $20 billion in 2017 to $22.6 billion in 2021, while active duty personnel based in the U.S. have also increased from about 1.1 million service members in 2015 to over 1.2 million in 2020. Projects rated by S&P Global Ratings typically only serve about a third of the service members assigned to a given installation.

Aging Housing Portfolios Will Require Additional Capital

Several military housing operators have announced that they will either issue additional debt or refinance existing debt to meet upcoming capital needs and add on new units. Many of the privatized military housing projects we rate have been in operation since the early 2000s, and require significant upgrades to stay competitive with local private homes and apartments located off-post. The Army announced in January 2021 that it has authorized an additional $1.1 billion in borrowing for several bases, including Fort Hood, Fort Campbell, Fort Knox, and Fort Wainwright. Fort Hood and Fort Knox both have public ratings with S&P Global Ratings.

S&P Global Ratings Recalibrated Ratings In 2020

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Military housing bond ratings are among the strongest in the public finance housing sector, with 90% of our public ratings in the 'AA' or 'A' category. All but one of the 90 public ratings are rated 'BBB' or higher. The average maximum annual debt service coverage (DSC) is 2.05x on first lien debt and 1.82x on second lien debt. From April 2020 to February 2021, 57 ratings were affirmed, or had their outlooks revised to stable. As of April 2021, there was only one rating with a negative outlook in the sector. Twenty-four ratings were lowered and 17 ratings were raised partly due to implementation of our criteria, "Methodology For Rating U.S. Public Finance Rental Housing Bonds," published April 15, 2020. Fifteen of the 24 downgrades were by one notch; the remaining nine were by two or more notches.

Many projects reported increases in maintenance, payroll, and insurance expenses in the 2019 fiscal year. The maintenance and payroll expense increases are largely due to the increased scrutiny on military housing operators and calls for greater accountability on maintenance requests from tenants. Several project owners accelerated unit upgrades by opting to replace rather than repair flooring, appliances, and other fixtures over the past two years.

We also observed significant increases in insurance expenses throughout the portfolio in fiscal 2019, with an increase in aggregate insurance expenses to $78.4 million from $64.2 million in the prior year, an increase of 22%. The Government Accountability Office (GAO) identified insurance coverage as a concern for military housing operators in a recent February 2021 report; while projects have had sufficient coverage for extreme weather events, recommendations from the GAO included service branch reviews of coverage for natural disasters and cost sharing agreements between the service branches and their projects' developers.

We updated our management and governance assessment of each project owner as part of our criteria rollout in 2020. Most of our rated projects have an assessment of strong for management and governance under our criteria; military housing operators are typically part of larger real estate development and management organizations with extensive experience in design, construction, and property management. Forty of the 46 projects rated by S&P Global Ratings have parent companies with extensive military housing portfolios, including Hunt Companies (52,000 units), Balfour Beatty Communities (50,000), Lendlease (40,000), Lincoln (36,000), and Clark Realty (12,000).

New criteria's assessment of coverage and liquidity

Several issues we rate have a debt service reserve surety policy from a bond insurance provider that is either no longer rated or is non-investment grade. According to our rental housing bond criteria, released in 2020, a non-investment grade debt service reserve fund provider is considered to be a credit weakness, resulting in a lower assessment of a project's coverage and liquidity score (for example, to "strong" from "very strong," or to "adequate" from "strong"). Our criteria also calls for lower liquidity assessments for projects with reserve funds at less than 12 months maximum annual debt service; typically these project had reserve funds sized at six months debt service.

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