Ratings Performance Across U.S. SHPs Remains Stable

Our social housing provider ratings include both public housing authorities (PHAs) and non-profit social housing providers (NFPs; PHAs and NFPs collectively referred to as SHPs). Due to a strong enterprise risk profile, such as low industry risks, strong market position, management, and, in certain cases, strong government funding, S&P Global Ratings' public ratings on social housing providers mostly stand in the 'AA' and 'A' categories. Because of PHAs' public policy role and strong ties with governments, the issuer credit ratings combine our assessment of a stand-alone credit profile and the likelihood of extraordinary government support. In the case of PHAs, the application of our criteria for government-related entities may raise the final issuer credit rating relative to the stand-alone credit profile. (For more detail on our government-related entity methodology, see "Rating Government-Related Entities: Methodology And Assumptions," published March 25, 2015.)

Since the beginning of January 2020, we have taken three rating actions on U.S. SHPs—including two upgrades based on a trend of improved finances and one downgrade due to a weakened financial performance. We assigned five new issuer credit ratings: three non-profit SHPs (National Community Renaissance of California, Preservation of Affordable Housing, and MidPen Housing) and two PHAs (Los Angeles County Development Authority and Everett Housing Authority).

Chart 1

HUD Continues To Provide Resources for PHAs To Address Operational Challenges

In response to COVID-19, the Department of Housing and Urban Development (HUD) supported PHAs through increased program spending as well as funds sourced from the allocation provided by the CARES Act. This increase in funding supported stable operations and a continuation of services in the midst of sector uncertainty. The 24 rated PHAs receive on average 76% of their revenues from HUD, contributions, and grants. We also rate five non-profit social housing providers which do not receive direct HUD funding and are not considered government-related entities.

Major HUD programs such as Tenant-Based Rental Assistance (TBRA) and Project-Based Rental Assistance (PBRA) have seen marked increases in funding, with 37% and 44% increases over the past 10 years, respectively, indicating the commitment by HUD to equally support the expansion of the programs. Comparatively, operating subsidy and capital grant funding has increased at a combined marginally slower rate of 30%, in part due to a decrease in the nation's public housing stocks through the Rental Assistance Demonstration program (RAD). The largest annual increase occurred in 2020 as HUD amended its budget to include an additional $2.8 billion and $1.5 billion for TBRA and PBRA, respectively, as a result of the pandemic. With HUD continuing to budget for post pandemic increases, the additional support will alleviate capital and operating cost concerns if managed effectively.

Chart 2

SHPs' operations face high inflation, supply-chain issues, labor shortage, higher interest rates, and weak economic prospects

SHPs are experiencing operating challenges in 2022 including unit turnaround time increasing by one to two weeks and turnover costs increasing by 20% to 30% mainly due to a lack of inventory, supply chain issues, and staff shortages. At the start of the pandemic, most SHPs addressed only emergency and urgent work orders to reduce contact as much as possible. As in-person inspections mostly resumed around mid-2021, SHPs performed some minor deferred maintenance but none that was significant.

The pandemic also caused SHPs to incur unexpected and unbudgeted expenses as they purchased personal protective equipment, the hardware needed for the pivot to work remotely and new systems for online services. While the pressures of these additional costs were incurred in fiscal 2020 results, they were somewhat offset by delaying other expenses as mentioned above.

Chart 3

We expect increased revenue or contributions may lag operating cost inflation, putting pressure on financial performance by reducing SHPs' adjusted EBITDA margins over the next two years. Despite these potential headwinds, we expect most ratings to remain stable, with issuers maintaining a strong enterprise risk profile and a solid liquidity position that has remained above 2x across all rating levels. While these macroeconomic challenges are contributing operational risk and major delays and increasing costs of planned construction and modernization activities, they have yet to materially weaken credit quality.

Development Activities Have Slowed Recently

Overall construction activities or potential construction pipeline actually slowed from that seen pre-pandemic, indicated by annual 15% portfolio growth (measured by land and property, plant, and equipment) from fiscal 2016 to 2019, compared to 4.1% annual portfolio growth from fiscal 2020 to 2022. Although the effects of construction cost inflation are obvious, the response of management and longer-term impacts including any increased federal funding is not yet clear. Depending on the extent and duration of current inflation in construction inputs, S&P Global Ratings anticipates SHPs will use a variety of strategies to fund their development pipelines. Generally, SHPs expect their overall capital budgets will increase by more than 25% to 35% over the next two years. We expect this will be funded in part by debt financing as we have seen a growing use of debt to fund development activity. Of total SHP public bond issuance in the last decade, 36% has been within the last 18th months, totaling over $820 million. SHPs that have historically financed developments through traditional financing products are now accessing the municipal markets as investor appetite for affordable housing products remains high, resulting in more attractive rate options--a trend we expect to continue as rates continue to rise.

Chart 4

As shown in chart 5, median debt levels increased substantially in fiscal 2020 and 2021, mainly due to rising construction and acquisition costs and limited sources of subsidies. However, higher leverage was mitigated by increasing EBITDA interest coverage with a help of additional operating grants and contribution and mortgages with below-market interest rates. Therefore, overall debt profile remains consistent and strong.

Debt profile is an important metric in our assessment of creditworthiness, but we consider a range of factors, including the strategy being pursued, the approach to financial management, the strength of market demand, the quality of assets, the level of financial flexibility, and any surpluses generated. Although increasing the proportion of debt to fund housing development might imply a higher credit risk, we don't believe that this, by itself, will necessarily imply lower ratings, particularly if an SHP manages the associated risks well and if coverage levels (perhaps boosted by higher EBITDA margin) still indicate an ability to absorb financial pressures. Higher asset values and rents may also mitigate the effect of increased debt on key financial ratios.

Chart 5

RAD Conversions Continue To Reach Record Numbers

HUD's RAD initiative continues to expand as it nears its tenth year. With many authorities now realizing modest ongoing cost savings post-conversion, our discussion with many management teams reflects an increased appetite for some or all of their public housing stock portfolio to be converted through RAD. A number of authorities have indicated to us that they were initially hesitant about the RAD program, particularly in regard to how implementation would affect operations, a concern which now seems to be alleviating. As noted in the chart 6, while the last two years indicate a slowing of new RAD conversions, the number of units that have been awarded a Commitment to Enter into a Housing Assistance Payments Contract (CHAP), which will drive future increases in RAD units, have already eclipsed total CHAP awards for 2021 and are on course for a record year.

The application of a partial or full conversion strategy depends on whether the cost savings exceeds the conversion costs through redevelopment of existing units or the subsequent construction costs associated with acquisitions and developments. In the rising cost environment that continues to affect capital and operational budgets throughout the sector, we believe that management's ability to control costs and delays once committing to undertaking such a strategy will remain paramount to the overall success of such an implementation. The risks associated with the magnitude of the number of units converting and associated costs, along with the timing and execution of units remaining offline, could pressure an authority's operational results. We believe that the reliance on a sophisticated management team and a commitment to allocate sufficient resources to oversee such a conversion strategy will be critical to avoiding a decline in the health of an authority's income statement, and subsequently maintaining sound credit quality.

Chart 6

Demand For Affordable Housing Will Keep Rising; Downside Risks Remain Substantial

We expect demand for affordable housing will continue to increase. As indicated above, SHPs have different strategies and financing resources to meet that demand using increasing debt, tax credits and other subsidies from government while affordable funding gaps continue to widen. In addition, the widening gap between rent increases and cost inflation in the upcoming financial year poses significant operational and financial challenges to SHPs in the U.S. We believe that SHPs' management decisions are critical to balance plans to invest in their existing housing stock and develop new homes while maintaining robust financial benchmarks.

SHPs with a deliberate, consistent, resourced, and integrated approach that effectively identifies and prudently mitigates risks are more likely to build long-term credit strength than SHPs with a casual, opportunistic, or reactive approach. An SHP's strategic competence, operational effectiveness, and ability to manage risks are keys to maintaining stable credit quality. A strong management and governance assessment is highly associated with a higher credit rating.

Cyberattacks lead the environmental, social, and governance concerns for social housing providers, while weather events persistently affect asset quality

As cyberattacks increase in sophistication and frequency, social housing providers are adopting an array of risk-mitigation strategies. We consider risk management and mitigation a governance factor as part of our assessment of management and governance. The cost for risk mitigation such as more sophisticated IT systems as well as insurance have significantly risen over the past few years. With regular overhauls of firewalls, cloud migrations, and wide-ranging insurance policies, protection against cyberattacks results in more resources than ever before being allocated to IT. Management teams need to be cognizant of the risks as an ineffective risk mitigant strategy could result in a more significant use of resources in the unfortunate event that the social housing provider becomes a victim of an attack.

Weather events and environmental incidents continue to threaten the asset quality of many of our issuers. In the West, wildfires remain the highest risk with housing authorities working alongside cities and their respective fire departments to mitigate the spread of wildfires through fire breaks and early detection systems. In the Central and Eastern regions, extreme weather events that have high winds or subsequent flooding remain a pressure point for our issuers' assets. The costs of repairs after an environmental event continue to increase while the loss of revenue as a result of vacancies ultimately affects operational performance. Management teams that take a proactive approach to updating their assets to their respective environmental risk codes have seen less need for repairs as well as less downtime of units, with a stabilizing effect on operations. With the cost of insurance increasing significantly in the past few years, a number of our rated issuers have joined consortiums with other issuers to lower overall insurance costs, whereas those that were already party to a consortium have noted that the increase in insurance costs have been nominal.