Positive Rating Actions And Strong Equity

Despite the seemingly incessant headlines warning of economic slowdown and impending recession, S&P Global Ratings' rated HFAs fared quite well in fiscal 2022 with key capital adequacy ratios improving, on average, across the sector fueled largely by growing balance sheets, strengthening equity bases, and improved asset quality. We saw HFAs prudently manage their asset and debt portfolios, reducing exposure to more expensive debt while adding higher-interest-rate loans to generate annuity revenues. Nonperforming assets (NPAs), defined as loans delinquent 60 days or more or in forbearance, dropped for the second consecutive year after increasing in 2020 from 2019, indicating a return to stability following the early pandemic years. And while uncertainty and volatility remain, HFAs maintained their stride and continue to build programs providing housing and positive social-impact services in their states.

For the second consecutive year, rating actions for rated U.S. state and local HFAs were almost entirely positive in 2022 and 2023. Since our previous update, we upgraded four HFA issuer credit ratings by one notch, three of which were on positive outlook, and one that was on stable outlook. (See "U.S. Housing Finance Agency Issuer Credit Ratings Build Strength Ahead Of New Challenges" published Oct. 12, 2022, on RatingsDirect.) The upgrades boosted the average and median ratings to 'AA' for the sector, with 22 of the 23 HFAs now in the 'AA' category, and one rated 'AAA'. We affirmed the rating and revised the outlook to stable from positive on one HFA, Virginia Housing Development Authority (Virginia Housing), during the past year. The outlook on all 23 rated HFAs is stable as of the publishing of this report.

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California Housing Finance Agency (CalHFA) was upgraded to 'AA' from 'AA-' on Dec. 12, 2022. The rating action reflects our view of CalHFA's significant improvement in financial ratios over the past two fiscal years, to levels above those of peers, as well as its significant reduction in leverage and risk.

The District of Columbia Housing Finance Agency (DCHFA) was upgraded to 'AA-' from 'A+' on April 21, 2023; the last of the rated HFAs to move above the 'A' category. The upgrade is due to improving and high financial ratios, as measured by a five-year average net-equity-to-assets ratio of 25.6% and five-year average return on average assets (ROA) ratio of 2.8%, which is above the 'AA' category benchmarks and in line with those of similarly rated peers. The upgrade is also due to the change in our view of management's stability, successful track record of implementing strategic initiatives, and strong planning capabilities.

Illinois Housing Development Authority (IHDA) was upgraded to 'AA' from 'AA-' on June 5, 2023. The rating action reflects our opinion of IHDA's strengthening asset base, financial ratios that are consistent with those of higher-rated peers, and very strong and stable management.

Utah Housing Corporation (UHC) was upgraded to 'AA' from 'AA-' on Feb. 27, 2023. The upgrade reflects our view of UHC's significantly improved financial ratios over the past two years, to levels in line with those of 'AA' rated peers, combined with UHC's low-risk asset base and decreasing variable-rate debt.

Virginia Housing is rated 'AA+', with a stable outlook, which we had revised from positive on Nov. 4, 2022. The outlook revision is primarily attributed to the authority's declining equity-to-total assets and net-equity-to-total assets due to increased bond-financed lending and management's strategic decision to increase funding to its Resources Enabling Affordable Community Housing (REACH) Virginia initiative, which provides grants or subsidized rates on mortgage loans for affordable housing projects to assist elderly, disabled, homeless, and other low-to-moderate-income persons. Virginia Housing's financial metrics are still very strong and above average for the 'AA' category. In our view, the return to a stable outlook is not a reflection of any negative credit factors but rather indicates the authority's strategic decision to use equity to further its social mission and programs rather than build even more excessive reserves.

We affirmed the ratings and stable outlooks on the remaining 18 HFAs based on stable financial metrics, specifically capital adequacy ratios, which showed, on average, a strengthening equity base that improved at a greater rate than the increasing asset and debt portfolios, profitability in line with the respective rating categories, and better asset quality as indicated by the second year of declining NPAs.

Experienced Management And Proactive Strategies Are Crucial To HFA Credit Quality

Management and governance remain of essential importance

This credit factor is the cornerstone of success for HFAs. Experienced, dedicated, sophisticated management teams and executive boards are a primary reason the ratings are so high and so stable across the rated sector. HFA ratings have, for the most part, weathered financial uncertainty and market volatility with minimal negative rating actions in no small part due to capable and proactive management, quickly adapting through advantageous business decisions and risk management.

HFA management continues to demonstrate agility in fiscal 2022

As an example of this agility, over the past year and a half we saw HFAs that were relying on large one-time revenue gains from the TBA market pivot to increase on-balance-sheet lending and begin to generate annuity revenues. While we expect this shift will negatively affect profitability metrics in the year of the change, specifically return on average assets (ROA) could drop substantially, the move should generate stable ongoing revenues given the current market conditions.

HFAs adjust with the market to optimize impact and help borrowers get into homes

This was reflected by the uptick in down payment assistance (DPA) activity in 2022. As we discussed in our article "Turning Houses Into Homes: U.S. HFAs Evolve Down Payment Assistance Programs Amid Changing Housing Market Dynamics," published on Sept. 14, 2023, on RatingsDirect, DPA programs are being used more than ever, both in terms of the number borrowers opting in for the assistance and the dollar amount per down payment. The increase in utilization and dollar amount is unsurprisingly needed in tandem with rising home prices, rising interest rates, and inflationary pressure of everyday expenses. HFAs are seeing these challenges and adapting programs to best assist borrowers.

Balance Sheets Grow Again; Building For the Future

Capital adequacy

Despite expectations of contraction in 2022, HFAs grew balance sheets taking advantage of rising, but still comparatively low, interest rates into the third quarter of 2022.  On average, across the portfolio, HFAs added both loans and investments to balance sheets, increasing total assets, while adding lower cost debt, refunding more expensive legacy debt from the higher-rate period before the financial crisis. These changes, combined, on average increased HFA equity and bolstered related capital adequacy ratios. Across the 23 rated HFAs, average net equity--calculated as audited net position, after certain adjustments such as the removal of fair value and S&P Global Ratings-calculated losses--to total assets increased to 29.5% from 28.6%. On average, total assets increased 4.7% and both total equity (before calculated losses) and net equity (after calculated losses) increased 5.1%. As mentioned, the implementation of Governmental Accounting Standards Board Statement No. 91 (GASB 91), which excludes the reporting of conduit activity, was fully adopted in all fiscal 2022 audits and, in some cases, had a material impact on the loan and debt reporting for certain HFAs. Even with the removal of conduit loans and debt, average HFA loan and debt portfolios grew over the past several years, albeit at a slightly slower year-over-year rate compared with pre-pandemic years.

On-balance-sheet originations outpaced prepayments as evidenced by more than half of the rated HFAs increasing total loans and program mortgage-backed securities (MBS).  The eight HFAs that reported declines in total loans and program MBS, even if marginally, also reported decreases in existing debt, indicating prudent management of both sides of the balance sheet. On average, total loans and program MBS increased 4.6% and total investments, excluding changes in fair value, increased 3.4% while total debt increased 4.4%. As discussed in our article "U.S. Mortgage Revenue Bond Program Medians: Strong Credit Quality Keeps The House In Order," published Sept. 12, 2023, slowing prepayments and an increase in origination boosted asset-to-liability parities of single-family programs in 2022. The shift toward federally enhanced loans has also contributed to lower S&P Global Ratings' loss assumptions and stronger net equity for HFAs.

Conservative reserve strategies have helped build equity over the years keeping key ratios strong and stable in the face of economic uncertainty.  In many cases, HFAs have weathered economic turbulence better than expected and reserves have not been needed to cover losses but instead have generated additional resources to expand programs and further social missions. In years where net income has been higher, HFAs have found a balance between saving excess earnings and continuing to grow their programs. This combination has added revenue generating assets while equity bases also build.

We expect stable equity balances as both sides of the balance sheet grow in 2023 reflecting an increase in both lending and borrowing to meet demand and affordability challenges.  In our view, the role of HFAs remains as important as ever while affordability challenges continue across income levels spurring demand for single-family lending as well as multifamily development of affordable rental units. In addition, DPA programs will continue to be essential as higher home prices, coupled with high interest rates, further challenge first-time homebuyers.

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HFAs demonstrate strategic debt management in fiscal 2022 adding debt to balance sheets while managing higher interest rates.  Average debt balances increased 4.4% year over year, keeping pace with loan portfolio growth, and consistent with continued demand for housing bonds in the market. The multiyear trend in debt portfolios is slightly skewed by the implementation of GASB 91, which was fully adopted for 2022 financial statements, and 2021 restated accordingly removing conduit debt. All else being equal, removing the dip due to conduit treatment, on-balance-sheet debt increased at a slower rate in 2022 than in the previous three years, and is materially lower than the 8.6% year-over-year increase in 2020 from 2019. As a reflection of optimal deleveraging and debt management in a time of increasing rates, the average interest expense as a percent of total debt decreased to 2.6%, the lowest in at least six years. HFAs were able to achieve this by using a combination of financing structures--refunding expensive higher-cost debt and, for some HFAs, incorporating variable-rate debt, and within the HFAs risk tolerances. While median interest expense did increase year over year, the utilization of variable-rate structures and hedging kept the average effect of higher interest rates in check. Average total net equity to total debt also reached a more-than-six-year high at 91.6%, an improvement from the 76.9% in fiscal 2021 and notably higher than the 48.4% in fiscal 2017. As loans prepaid during 2022, albeit at a slower rate than in 2021, HFAs prudently paid down more expensive debt and added debt that matched higher-rate newly originated loans. We expect leverage metrics will drop again in 2023 as issuers borrow at higher rates but view the proactive debt management exhibited in 2022 to be positive given the uncertainty of the economy and fiscal policy.

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Profitability Declined In 2022 Compared With Record 2021

Profitability metrics dipped in 2022 as expenses outpaced revenue increases and strategies shifted, but, in our view, the financial strength of HFAs, on average, was impressively resilient in a year of economic uncertainty.  Return on average assets (ROA) across the rated portfolio dropped to 1.9% in fiscal 2022 from 2.7% in fiscal 2021. Fiscal 2021, however, was a year of record-level ROA as HFAs capitalized on federal and state funding and gains to be made in the to-be-announced (TBA) market. Also, as expected, HFAs that benefited from strong revenue generation in the TBA market are set to weather lower-revenue years as margins in the TBA market narrow after building equity balances. Furthermore, these HFAs are pivoting to use this environment as an opportunity to keep more loans on the balance sheet, returning to an annuity revenue model.

Average net income declines appear worse than the reality of 2022 operating results.  Average net income across all rated HFAs declined a material 42%, but the underlying data is more nuanced, with 11 HFAs reporting decreases in net income and 12 HFAs reporting increases in net income from the previous year. Furthermore, the story is not as bleak as the average indicates, with only two HFAs accounting for double-digit percentage declines in net income. For a handful of HFAs, particularly those with year-ends of June 30, expenses were materially higher in fiscal 2022 due to the timing of pandemic-relief expenditures in the first half of their fiscal years. More representative of performance and trends are the median figures related to profitability in fiscal 2022 compared with the median data for fiscal 2021. Median revenue increased by 6.4% year over year and expenses 10.2%, resulting in median net income declining approximately 2.3%. The slower rate of revenue increase in 2022 was largely due to reduced interest income from loan prepayments on higher-rate legacy loans and a reduction in TBA revenues, as we've discussed. Interest-expense trends were also a mixed bag, with average total interest expense across rated HFAs dropping 2.8% indicating that some HFAs were able to save by redeeming more expensive debt without adding new more expensive debt. The median interest expense, however, increased 9%, reflective of the rising interest-rate environment and increase in total debt across rated HFAs.

HFAs generated more revenue in 2022 compared with 2021, but total expenses increased more, wiping out the incremental improvements on the revenue side from larger loan portfolios and interest earnings.  In addition to the large pandemic-relief expenditures, unavoidable inflationary pressure and increases in overhead costs of the agencies contributed to higher overall expenses during the year for most HFAs. As inflation moderates and relief programs end, we expect fewer year-over-year expense increases even if interest rates continue to rise.

Profitability should stabilize and increase incrementally as HFAs that shifted away from selling loans in the TBA market earn annuity revenue from on-balance-sheet loans.  Earnings from newly originated loans should be higher as rates increase, but, while there is room to improve profits, we expect these margins will largely be offset by the increased cost of borrowing. Also adding to slow and steady income growth, we expect growth trends in other revenue streams, such as loan servicing and fee income from multifamily lending, will add to overall revenues in the next year. Although higher rates might dampen demand and add to national affordability challenges, the business model for HFAs of lending and borrowing in the same rate environment will serve to insulate them against more severe negative effects of higher debt costs.

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Strong Asset Quality Returns As NPAs Drop To Pre-Pandemic Levels

Average NPAs drop for the second consecutive year, continuing the trend that started in 2021 after delinquencies and forbearance across the single- and multifamily sectors rose in fiscal 2020, reaching, on average, above 3%.  Due to a combination of supporting programs and funds from federal, state, and local governments and HFAs, the trend was almost immediately reversed in fiscal 2021 and continued to improve through 2022, with NPAs to total loans dropping to 2.2%. While the higher rate in 2020 was still well below the national average, the trajectory was uncertain and HFAs braced for potentially higher losses, with many agencies increasing loan-loss reserves and provisions. The strong performance of the loan portfolios across HFAs can be attributed both to loan characteristics (for example, federally enhanced loans and MBS) and careful, skilled asset management of the whole loan programs. HFAs diligently worked with borrowers during the pandemic-era forbearance and eviction-moratorium periods to maintain the habit of paying toward their loans, even where borrowers couldn't make full payment. This practice served well to reduce the percentage of loans becoming seriously delinquent and smoothed the return to normal with many borrowers that were behind on payments now current and still in their homes.

We expect asset quality will remain strong during 2023 as HFA underwriting and stringent asset management continue to be the foundation of business strategy.  According to a report published by Black Knight, as of June 2023, the national percentage of seriously delinquent mortgages was at a 15-year low, and foreclosures were 38% below their pre-pandemic level. Furthermore, the Philadelphia Federal Reserve Bank reported that more than 95% of the 8.5 million borrowers who entered special pandemic mortgage forbearance programs had exited them by the end of 2022. We view this easing of homeowner distress as signaling positive momentum going into fiscal 2023 where we expect loan performance will remain strong. The housing market is not without its challenges, though, and as home prices continue to increase, interest rates rise, and loan sizes grow, we expect some would-be first-time home buyers will continue to rent while waiting for the buyer market to settle. The rental market, then, should remain strong, with occupancy staying high and performance of multifamily loans remaining very strong and reliable.

Investments increased marginally as loan portfolios grew and stronger-than-expected markets made investment options more favorable.  Total investment balances, on average, after removing the effects of fair-value accounting, increased approximately 3.4% from the previous year. Generally, investment balances increased due to required reserves associated with lending and borrowing. In addition, some HFAs invested the proceeds of prepayments from non-bond financed loans to capitalize on investment earnings during the year, helping to offset the loss of interest income. We expect total investments will continue to grow as loan programs expand, and earnings from investments to remain, over time, positive, reflecting high-quality, low-risk permitted investments generally required under HFA investment policies.

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