While we entered 2021 with an expectation of a return to normal, it proved to be anything but. As waves of virus infections, and new variants, extreme weather events, and social unrest rippled through the country, housing finance agencies (HFAs), community development financial institutions (CDFIs), public housing authorities (PHAs), and social housing providers (SHPs) proved nimble in managing the unexpected challenges they faced--as well as the opportunities provided by low interest rates, strong demand for housing, and significant federal, philanthropic, and other third-party funding.

HFAs and CDFIs enter 2022 in generally strong positions--we saw four rating upgrades and four outlook improvements in 2021--indicative of improving performance even in challenging times. HFAs' equity and assets are at record highs; CDFIs saw a similar trend with average equity and gross loan balances increasing modestly to new highs. Profitability marginally declined for both types of lending organizations last year with net interest margins for CDFIs at 3.3% and for HFAs at 1.6%. Average return on assets was 2.7% and 1.6% respectively, down from prior years, driven in part by the low interest rates.

The higher amount of government backed assets and increasing housing prices may mitigate losses for loans that proceed to foreclosure, keeping HFA program equity relatively stable. Non-performing assets varied with the type of loan portfolio: HFA single family portfolios have shown more lingering effects of the economic downturn, though now that we are past the foreclosure moratorium, and the Treasury has begun approving states' Homeowner Assistance Funds programs, we expect non-performing assets to decline. HFA multifamily portfolios experienced few if any delinquencies, and CDFIs reported an uptick in delinquencies at the start of the pandemic, which largely resolved by the end of last year.

Owners and operators of affordable housing face several challenges in 2022 as labor, materials and insurance costs are all escalating. We expect these increased expenses to further weaken the already struggling properties with thin coverage and limited reserves while stronger properties, PHAs and SHPs have the financial strength and liquidity to absorb these increased expenses. In 2021, one PHA was upgraded due to its improving position and our implementation of new criteria. Generally, PHAs and SHPs reported improving results with EBIDTA up 17% and median debt over EBIDTA decreasing to 6.11x. Should the Build Back Better legislation be enacted in its current form, PHAs stand to receive $65 billion in needed funds to repair and replace aging housing stock, a credit positive.

Nonetheless, in a sector largely secured by physical assets, environmental risks are an increasing concern. While many loan portfolios are scattered throughout a specific state, property portfolios in concentrated locations are more vulnerable to event risk.

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Questions That Matter

1. How will the economy affect housing sector performance?

How this will shape 2022

We enter 2022 with largely positive credit momentum.  This reflects favorable financing conditions and a strong economic recovery. Higher wages, robust savings accounts, and jobs for those who want them all bode well for loan performance in 2022. Households' strong balance sheets should set the stage for further expansion of the U.S. economy in 2022, although at a somewhat diminished forecast due to the continued evolution of the coronavirus and supply chain disruptions. S&P Global Economics expects U.S. GDP growth to be 5.5% for 2021 (a 37-year high) and 3.9% forecast for 2022 (a 10-year high). (See "Economic Outlook U.S. Q1 2022: Cruising At A Lower Altitude," published Nov. 29, 2021, on RatingsDirect, for more information on the economic outlook.)

Inflation, and the Fed's reaction, are likely to affect the sector in 2022.  Inflation picked up dramatically in fourth-quarter 2021. Inflationary concerns led to the Fed tapering its asset purchases late last year and our expectation of rate hikes beginning in 2022. We now expect three rate hikes in 2022, with the first rate hike at the May 3-4 Federal Open Market Committee meeting--a change from our prior expectation of one rate hike at the September meeting.

What we think and why

The financial metrics we assess rely on the ability of tenants and owners to make their monthly rent/loan payments.  Stable income is a critical building block of household resources and in most cases is linked to employment. The labor market has shown notable improvement: initial jobless claims decreased in the week ending Dec. 4, reaching their lowest level in the past 52 years, and the December unemployment rate at 3.9% is moving closer to the pre-pandemic level of 3.5%. We expect the unemployment rate, adjusted for labor force exits, to reach its pre-crisis lows inthe first quarter of 2023. Labor force participation is at a 45-year low, with the labor force three million workers below its February 2020 level, according to the Bureau of Labor Statistics. Chart 2 illustrates the steady decrease in the unemployment rate but also the sharp rise in labor force exits during the pandemic. Notably, women are overrepresented--accounting for 68% of the prime age workers who exited the labor force--likely due to child care pressures (see "Labor Force Exit Has The U.S. Economy In A Bind," Nov. 22, 2021). While we can't conclude whether these households are renters or owners, the loss of this income stream to families could dampen their ability to build savings to purchase a home or to continue to meet existing housing expenses.

Chart 2

Higher rates may be a mixed blessing.  While higher rates will further challenge affordability for first-time buyers and other borrowers, increased investment earnings for all issues and issuers will improve profitability in the U.S. public finance housing sector. Higher rates may also challenge the supply of affordable housing through higher costs to build and for debt service payments for multifamily housing.

Labor shortages could pressure certain segments of the housing sector.  Age-restricted properties, due to the services provided to tenants, are more labor reliant than other rental housing types. We expect labor shortages will further stress these properties' performance especially given their current weakened revenue and liquidity positions. Labor is also a critical component of new production and renovation efforts which could affect costs of new or renovated properties, maintenance expenses and ultimately property conditions for affordable housing owners and operators.

Supply chain disruptions continue to give rise to higher costs.  Persistent bottlenecks across the supply chain are leading to higher goods and materials costs. Lumber futures have been on a roller coaster ride, increasing by 75% in three weeks from late November into early December 2021, due to tight supply caused by flooding in British Columbia and increased demand in anticipation of import tariffs doubling.

What could change our view

Federal Reserve actions are key.  Much rests on the Federal Reserve's ability to rein in inflation in an orderly fashion rather than being forced to tighten faster than expectations which could challenge the economic recovery.

Easing the supply chain disruptions.  This could release the pressure on cost and availability of building materials and other goods.

2. What does pandemic year three look like?

Most housing sector participants have adapted to the challenges of the last two years and have pivoted to address both new and accentuated challenges of the pandemic. Significant funding flowed into the sector as many organizations became first line responders to their community's needs.

How this will shape 2022

The coronavirus continues.  While increased vaccinations help mitigate the health impact of the continued surge in the COVID-19 virus, vaccination continues to be a polarizing topic in the United States and though data is showing the omicron variant to be generally less severe, breakthrough cases in those that are fully vaccinated and boosted are becoming more common.

Putting federal and other funds to work in 2022.  CDFIs received funding over the last two years which we estimate at well over $500 billion. Similarly, state HFAs will be managing the deployment of the $9.9 billion of Homeowner Assistance Funds (HAF) authorized in the 2021 American Rescue Plan.

Pandemic inequities endure.   The pandemic disproportionately harmed the Black, Indigenous and people of color population economically and in terms of health outcomes. The unemployment rate for Black and Hispanic Americans at 6.7% and 5.2%, respectively, is well above the 4.2% national rate and 3.8% for white Americans. Although it narrowed some in November 2021, the gap between those rates, remains wide. According to the CDC: "The COVID-19 pandemic has brought social and racial injustice and inequity to the forefront of public health. It has highlighted that health equity is still not a reality as COVID-19 has unequally affected many racial and ethnic minority groups, putting them more at risk of getting sick and dying from COVID-19." Not surprisingly, The Brookings Institution found that housing inequality had gotten worse as the pandemic stretched onward. According to the Census Bureau, as of third quarter 2021, the homeownership rate was 65.4% but with stark differences between those identifying as white (74%), Asian (60.2%), Hispanic (48.3%), and Black at (44%).

Chart 3

Single family loans exiting forbearance.  With the end of the foreclosure moratoria, borrowers in forbearance have one of several possible paths, including, among others: reinstatement; repayment plan; loan deferral; loan modification; short sale or foreclosure--with varying timelines depending on the relevant state law. The Mortgage Bankers Association's survey as of Nov. 30, 2021, reported a continued decrease of loans in forbearance to 1.67% from 2.06% in the prior month and estimates 835,000 borrowers are in forbearance plans. As a proxy for HFA borrowers, as of the same date Ginnie Mae loans in forbearance decreased 42 basis points to 2.10%.

What we think and why

Declining delinquencies and HAF program deployment.  We expect HFAs' non-performing asset levels will decline in 2022, supported by the improving economy discussed above. In addition, single family program performance will improve as loans exit forbearance. The Treasury has begun approving program applications from states to implement their HAF programs, with the expectation that funds will begin to flow to homeowners needing assistance. HAF provides a minimum of $50 million for each state and the District of Columbia. While the programs may not be used exclusively for an HFA's own borrowers, they may be eligible to participate and if approved, would be a credit positive for HFA programs.

Significant grant income flowed into rated CDFIs during the first two years of the pandemic.  This has elevated net equity ratios in the sector. Average grant income in 2020 was 13% higher than in 2019, and 2021, while not as high as 2020, still looks to have exceeded 2019. Median net equity/assets for the last fiscal year topped 46%. As funds are programmed and deployed through lending activity, we would expect ratios to return to pre-pandemic levels. Median equity to debt ratios showed notable improvement, increasing to 46.6% from 42.1% due to limited debt issuance. With significant grant income still be programmed, we expect debt issuance also to be muted in 2022.

Continued stable performance for PHAs and SHPs.  With rental collections steady, contributions and grants increasing, and their oversight on expenses strong, we expect continued stable performance for PHAs and SHPs. Many PHAs experienced a decrease in maintenance expenses (on average a 0.3% decline) as Covid limited access to apartments. However, we expect an increase in this expense line as operators return to their normal maintenance activities and catch up on deferred work from the last 20 months. An increasing number of PHAs and SHPs are using the capital markets to fund their development activities and replace more expensive debt, a trend we expect will continue in 2022.

CDFIs, HFAs, PHAs, and SHPs continue to take steps to address racial inequities.  The disparate impact of the pandemic detailed above spotlighted among other issues the inequities in stable housing, opportunities to build housing wealth, and health outcomes. CDFIs, HFAs, PHAs, and SHPs have longstanding efforts to address these differences. Recently, CDFIs have dedicated new capital to support diverse borrowers, developers, and entrepreneurs from various racial and ethnic backgrounds. One CDFI included in its long-term strategic plan a goal to reach $5 billion in investments over the next decade to advance racial equity, while another committed to a $3.5 billion national initiative dedicated to end racism in housing. Several HFAs have expanded their efforts to reach first time homebuyers and expand the ranks of Black, Indigenous, and persons of color developers while streamlining their access to capital.

What could change our view

Lockdowns return.  Although not expected, should a variant emerge with more severe outcomes, we could see rapid economic contraction again.

3. How has the pandemic altered the affordability equation?

The pandemic exacerbated an already constrained housing supply. Post-Great Recession, housing starts averaged 1.2 million per year. With a historically low interest rate environment, millennials aging into prime homebuying years, a shift to work from home and an exodus from urban areas combined with the desire for larger living spaces, housing prices increased precipitously in the last year, outpacing income increases in nearly all areas of the country .

Limited housing stock.  Although we estimate annual housing starts reached 1.6 million in 2021 and will total 1.5 million this year and next, it will take many more years at that pace to address the housing deficit caused by the lower than average housing starts over the last decade. Estimates of the deficit range in the several millions. Housing starts remain challenged by labor and material shortages. In addition, not only is the resale housing stock limited, but it also isn't available for long – in November 2021, homes were on the market a median of 46.5 days, an increase from the 35.5 days in July 2021, but well below the 79.9 day of February 2020, according to the St. Louis Fed.

Demographics drive demand.  Millennials now comprise the largest population cohort, having recently overtaken the baby boomers. Since 2014, they have been the largest share of homebuyers in the country at 37%, according to the National Association of Realtors. After years of delayed entry into the housing market, due in part to financial constraints, such as student loan debt and limited job opportunities during and after the great recession, millennials are now forming families and making home purchases.

Housing prices expected to continue to rise.  With constrained supply and demographic demand continuing, we expect housing prices will continue to trend higher in 2022. S&P CoreLogic Case-Shiller Index reported a 19.5% annual home price gain in October 2021. (For more on housing prices, see "A Sudden Correction To Fast-Rising U.S. Home Prices Isn't Likely, Dec. 2, 2021.)

Chart 4

First time buyers priced out of the market?  While the share of buyers who were purchasing their first home increased in 2021 to 34% from 31% in 2020, according to the National Association of Realtors' (NAR) 2021 Profile of Home Buyers and Sellers, it remained well below the historical norm of 40% and the 44% of the market reported in 1981. Higher prices combined with the expectation of relatively higher interest rates will continue to challenge first time buyers. We have heard anecdotally that some HFAs have seen a decrease in demand due to the precipitous increase in housing prices in their markets.

HFA programs as important as ever.  With housing prices increasing, the popular and widely used down payment assistance programs provided by HFAs fill a critical need for first-time buyers. NCSHA reported an average of 82.5% of HFA mortgages benefit from down payment assistance. Further, first-time buyers are more likely to enter homeownership with a high loan to value, taking advantage of programs such as FHA mortgage insurance- which constitutes an increasing portion of HFA mortgage portfolios. The NAR survey mentioned above also reported that 28% of first-time buyers used a gift or loan from friends or family for their down payment and those who financed their home typically financed 93% of their home's sales price compared to repeat buyers at 83%.

Regional differences emerge.  According to IHS Markit, the median house price in the South in November 2021 was $318,000, compared to $507,200 in the West and $372,500 in the Northeast. This house price differential helps explain some of the population shifts seen since the start of the pandemic. From April 2020 to mid-December 2021, California and New York have lost 836,00 residents to other states while Florida and Texas have gained 475,000. (For more on house prices, see "The Shift From Under To Overvalued: What It Means For U.S. RMBS," Oct. 29, 2021)

Affordability differences are also apparent at the metro level.  The S&P Corelogic Case-Shiller 20 city index posted an 18.4% year over year gain in September 2021; the highest gains were Phoenix with a 32.3% year-over-year price increase, followed by Tampa up 28.1% and Miami up 25.7%. With some notable exceptions, most American cities have become less affordable over the last decade when considering the ratio of mortgage necessary to purchase a median priced house, to income. The three least affordable metro areas--San Francisco, Los Angeles, and New York--remain very unaffordable. However, New York became more affordable in the last 10 years, in contrast to the two California metros which continued their trend toward even less affordability. Except for Detroit, which is among the most affordable metros, and therefore calculated off a low base figure, the areas showing the largest decrease in affordability over the last decade are all in the sun belt: Phoenix, Orlando, Tampa, and Miami (see chart 5).

Chart 5

4. Will ESG and other future shocks challenge credit quality?

How this will shape 2022

Is extreme weather now the norm?  While the pandemic has highlighted social risks and disparities as discussed above, the U.S. also experienced numerous extreme weather events in the last year. With these events expected to continue, environmental risks are a threat to sectors that are largely dependent on fixed, physical assets, such as housing. Reuters reported that weather related damage in 2021 at $105 billion was the fourth highest on record. (See "ESG In U.S. Public Finance Credit Ratings: 2022 Outlook And 2021 Recap," Nov. 29, 2021, and "Extreme Weather Events: How We Evaluate The Credit Impacts In U.S. Public Finance," Nov. 2, 2020, for more information.)

Increased insurance expenses are part of our future.  As risks from weather and cyberattacks increase, insurance companies are raising their premiums sharply and often year-over-year. Part of last year's premium increase was due to the low interest rate environment limiting insurers' investment earnings, but we have also seen a trend of rising premiums in reaction to extreme weather. California homeowners in wildfire prone areas have seen premiums double or triple. We have seen similar increases for insurance premiums at rental properties in flood or hurricane prone areas across the country.

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Cyber risks increase.  Cyberattacks are becoming more sophisticated, frequent, and costly. We have seen more credit-relevant cyber events in the last six months than in the previous six years. At least one rated PHA experienced a cyber incident last year, with no delay to its dissemination of rental subsidies for tenants. In addition, the first structured finance transaction reported an operational disruption following a ransomware attack on the originator and servicer. While HFA program resolutions may have more robust oversight than the transaction that experienced the attack (see "Fraikin Recovering From Cyber Attack; Eurotruck Lease Securitizations Ratings Unchanged At This Time," May 27, 2021) neither these programs nor the entities themselves are immune from this increasing threat. HFAs, CDFIs (much like other financial institutions) and PHAs possess a wide range of personal data and operate in an increasingly digital manner, which could make them vulnerable targets for hackers.

LIBOR elimination on the calendar.  The London Inter Bank Overnight Rate is no longer being cited in many currencies but remains as the reference rate in many housing issuers' derivative documents. All affected entities will need to act in 2022 to prepare for this transition. Some but not all HFAs have already transitioned to SOFR as their reference rate.

What we think and why

Management and governance are key to the continued stability of the housing sector.  Cyber, weather, a pandemic, or economic volatility--they all require continued vigilance, planning, and systems in place to address any emerging risks effectively and quickly. We generally view the management teams of HFAs, PHAs, SHPs, and CDFIs to be strong, resilient, and nimble; their continued leadership, strong governance and risk management is critical to the continued stable performance of their organizations.

Robust cyber governance remains a must for the foreseeable future.  As discussed in "ESG Brief: Cyber Risk Management In U.S. Public Finance" (June 28, 2021), all USPF issuers should be taking steps to mitigate their exposure to event risk stemming from a cyberattack and to have cybersecurity as part of their risk management plans. Most in the housing sector have recognized this risk and taken steps to secure their data, implemented testing, fire walls and obtained cyber insurance. (For more on cybersecurity in ratings, please see "Cyber Risk In A New Era: Are Third-Party Vendors Unwitting Cyber Trojan Horses For U.S. Public Finance?," Oct. 25, 2021.)

5. What additional factors might affect the sector?

How could federal policy change the credit profile of affordable housing?  Build Back Better and its over $150 billion in proposed housing investments is mired in gridlock in Washington as of this writing. The House-passed version contains significant resources that support affordable housing through increased funding to PHAs, for rental assistance, and down payment assistance for first generation buyers and other wide-ranging and significant investments to spur the development and accessibility of affordable housing. If enacted as currently proposed, funds are likely to benefit PHAs, SHPs, CDFIs, and HFAs, with additional program resources and program administration funding. The legislation also halves the volume cap amount needed to generate low income housing tax credits. In addition, at the end of last year, FHFA increased Fannie Mae and Freddie' Mac single family and multifamily affordable housing goals for 2022.

Social bond issuance is expected to increase.  In 2021, housing sector entities issued over $7.2 billion of bonds labeled as social or sustainable bonds, aligning with the United Nations Sustainable Development Goals (UNSDGs). At least 22 HFAs, four PHAs/SHPs, and four CDFIs have issued debt linked to these goals. Agencies have also issued green labeled bonds, which together with social and sustainable labeled bonds may either be self-designated or designated by a third party. We expect to see a continued increase in labeled issuance throughout 2022 and a push for more consistent disclosure as may be indicated by the Municipal Securities Rulemaking Board's recent Request For Information on ESG practices.

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Appendix

Table 1

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