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What's Behind Our Sector View?

Housing finance agencies (HFAs), community development financial institutions (CDFIs), social housing providers (SHPs), and public housing authorities (PHAs) enter 2024 with generally strong financial balance sheets, indicative of their management teams' abilities to produce stable performance results even in challenging times.  In the face of prolonged national housing affordability challenges, higher-for-longer interest rates during--at least--the first half of 2024, and an uncertain insurance landscape, housing entities will have to balance robust demand with competing operational costs.

High mortgage interest rates through the first half of 2024 will support bond-financed lending by HFAs.  We expect HFAs to continue making on-balance-sheet loans for their single-family and multifamily mortgage revenue bond programs in 2024 as interest rates remain higher-for-longer. On-balance-sheet lending, where loan receivables generate stable annuity revenue over time as borrowers repay mortgages, generally leads to lower profitability metrics compared to one-time profits received from bundling mortgages to sell in the secondary market. Furthermore, locking in revenue at higher rates will, over time, somewhat offset the drop in return on average assets from this financing shift and help build strong equity bases. Rated HFA loan portfolio balances, on average, reached an all-time high of over $2.5 billion in 2023. The ability to subsidize mortgage interest rates through single-family loan programs will likely prolong borrower demand for HFA first-time homebuyer programs. Likewise, as financing gaps remain for multifamily borrowers from high construction costs and expanded capitalization rates, HFAs will continue using program equity to lend at below-market rates for transaction financial viability. However, as HFAs add new loans with higher loan-to-value ratios, we expect S&P Global Ratings' calculated loan losses to increase and lead to marginal downward pressure on asset-to-liability parity ratios for whole loan and 'AAA' rated mortgage-backed security programs.

Despite this, HFAs' collective capital adequacy is at a record high with five-year average equity to assets rising to 29.5% as of fiscal 2022. Nonperforming assets, defined as loans delinquent 60 days or more or in forbearance, dropped for the second consecutive year, to 2.2% of total loans, indicating a return to stability following the early pandemic years. These favorable credit fundamentals, coupled with proactive and strong management teams and oversight of MRB programs with low operational risks, will likely lead to credit stability for HFAs in the next year.

We expect CDFIs will maintain equity consistent with historical trends and advance growth strategies, while sustaining other key credit strengths.  In 2023, we raised five CDFI ratings, of which three had a positive outlook, largely due to stronger net equity and sustained strength in other key credit factors. We expect CDFIs' net equity will decrease modestly in the near term as institutions incur additional debt to expand loan portfolios and meet high demand. Many CDFIs participated in applications for funding through the $27 billion Greenhouse Gas Reduction Fund – the September 2024 deadline to obligate funds could mean the grants, technical assistance, or new loans may benefit entities' financial strength this year. CDFIs may also see expanded interest rate margins in 2024, as loans financed prior to 2022 pay off and CDFIs continue to attract lower-cost capital. We think rated CDFIs will maintain three defining characteristics: sound underwriting, strong portfolio oversight, and patient capital.

Rental housing owners and operators will face rising costs, and some may struggle to maintain operating performance without offsetting rent increases.  Although cost pressures from inflation and building materials may have subsided, owners and operators of rated affordable rental housing are facing both old and new challenges in 2024. Insurance coverage availability is waning in some regions more exposed to natural disasters and physical risks, particularly where higher initial construction and repair and replacement costs are necessary for resiliency efforts. Furthermore, insurance premiums remain elevated and escalating in some areas, and technology requirements to curtail cyber threats could weaken operations amid limited revenue raising flexibility. These higher, and in some cases, escalating expenses could hinder already struggling properties with thin coverage and limited reserves, resembling the trend of the previous two years. However, properties with strong oversight and management, close monitoring of operating metrics, and prudent expense management will fare the best in the coming year.

Rising costs outpacing revenue growth may pressure EBITDA margins for some SHPs in 2024; however, we expect rating stability.  SHPs faced increasing operating costs from insurance, labor, and rising interest rates in fiscal 2022, resulting in the lowest median EBITDA-to-operating revenues since 2017. We expect SHPs will continue facing higher property-level costs as their portfolios increase, though federal funding partly mitigates these pressures along with strong liquidity and management's strategic operational effectiveness. Maintenance of stable credit quality will be underpinned by projected property-level revenue increases directly from portfolio growth as well as potential increases from U.S. Department of Housing and Urban Development funding. In 2023, several SHPs obtained ratings for the first-time--a trend we expect will continue, particularly should changes to the Low-Income Housing Tax Credit program or private activity bond caps come to fruition.

Sector Top Trends

Housing affordability fell to a low point in 2023 with an unlikely recovery in 2024

Buyers and sellers largely remained on the sidelines in 2023, in the face of conventional mortgage rates peaking at more than 7.0% for 17 weeks and limited existing single-family housing supply of less than four months' inventory that together pushed up median home prices and curbed the likelihood that existing homeowners would move and finance a new mortgage. As 2023 ended and the Federal Reserve held its benchmark interest rate steady through the final meetings of the year, mortgage rates finally dropped and remained only about 20 basis points above the year-end reading in 2022 (see charts 2 and 3). In addition, S&P Global Ratings' economic forecast includes interest rate cuts beginning in June 2024, which may lead to lower borrowing costs in the second half of 2024 and into 2025 (see "Economic Outlook U.S. Q1 2024: Cooling Off But Not Breaking," published Nov. 27, 2023).

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HFAs and SHPs helped support affordable housing construction in 2023 through substantial loan production of single-family offerings with down payment assistance (DPA), resumption of construction pipelines post-pandemic, and with an uptick in acquisitions of affordable properties. Demand was fueled by the ability of lenders to subsidize the single-family conventional mortgage interest rate with accumulated equity or other program incentives. To keep up with demand, and as capital markets remain tight despite the Federal Reserve holding the nominal rate steady, state HFAs may lean on financing innovation such as increased variable-rate issuance, which could bring inherent risks. Our forecast for housing starts shows between 1.3 million and 1.4 million annually through 2026, below 2021 and 2022 levels, which will likely underscore HFAs continuing their strong lending activity in the near term.

DPA programs and other lending initiatives will remain important tools for housing access and affordability

Rated HFA borrowers' use of DPA products increased considerably in 2022 from 2017.

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We believe the gap between HFA borrowers' incomes and home prices will be mostly unchanged in 2024--that coupled with the lack of supply, high interest rates, and low-to-moderate income and first-time homebuyers might continue delaying home purchases (see chart 5). We expect DPA will remain a critical component for HFAs to support sustainable first-time homeownership in their states. As agencies adapt their programs to the evolving needs of borrowers, the impact and structure of these programs could also change but will still serve HFAs' public mission without weakening capital adequacy or balance-sheet strength.

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Expanded opportunities for CDFIs from changes made to the Community Reinvestment Act in 2023, which specifically directs capital and investment in low-to-moderate income communities, could also bolster lending for affordable housing projects. The rule provides automatic favorable consideration of bank loans, investments, and services in CDFIs that have undergone the U.S. Department of the Treasury's certification process and meet requirements for maintaining CDFI certification. While most of the rules are effective Jan. 1, 2026, the intervening period provides time for these institutions to undertake the certification process and prepare by implementing oversight and reporting mechanisms.

Demographic trends could lead to supply and demand location changes

According to the World Economic Forum, millennials are now the largest generation, comprising 23% of the global population. Furthermore, from research published in 2019, the Pew Research Center found that four-in-ten millennials hold a bachelor's degree or higher, the highest of any generation. As a result of these characteristics, their home purchase decisions appear more pragmatic and underpinned by robust internet research on price and location, typically prioritizing proximity to work, friends, and family. The National Association of Realtors reports that first-time homebuyers accounted for 32% of the market in 2023 and were, on average, 35 years of age (typically considered older millennials). This cohort is likely to influence the location and product type for affordable housing for the immediate future, pressuring limited supply in certain markets until existing home sales increase as mortgage rates decline, and multifamily units become available.

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Elections could create some federal funding uncertainty for housing lenders and operators

With unemployment and inflation reaching lows not experienced since before the pandemic, and with other federal priorities such as providing support to Ukraine and Israel, federal funding for housing programs beginning with the next administration may be deprioritized. This could pressure federally subsidized cash flows, particularly for PHAs that typically rely on about 80% of funding from the federal government through various programs (see chart 6). Still, affordable housing availability is typically a bipartisan issue, which could lead to positive legislative developments and additional funding. Certain congressional legislative initiatives, if signed into law, would temporarily increase Low Income Housing Tax Credit (LIHTC) allocations and lower the 50% bond financing threshold to 30% for private activity bonds. This and other proposed legislation could affect issuer lending and development activity, and potentially be somewhat positive for credit quality. Although the federal funding landscape may be uncertain, we think the sector will generally weather any changes, as we saw in recent unprecedented support for operating subsidies that provide a stable foundation for most affordable housing projects.

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Cost uncertainty for emerging risks could pressure financial performance

Although supply chain issues and inflation eased in the latter part of 2023, alleviating some pressures for operators, management teams may need to pivot and focus on emerging risks to projects and properties. Among the top priorities are IT investments to safeguard systems from cyber events, planning for energy efficiency regulations and higher utility costs, and retrofitting properties or constructing new projects adapted for more severe and frequent weather events. In 2023, there were 28 severe weather events causing $1 billion or more in losses, according to the National Oceanic and Atmospheric Administration--an increase from 2021 and 2022 when there were 22 and 18 events, respectively. The economic losses from these events (see chart 7) could be curtailed with measures such as building materials adapted for high winds or wildfires, or placement considerations for heating, ventilation, and air conditioning systems (roof versus basement) to protect against flooding damage. Incorporating resiliency measures into new construction or preservation efforts may lead to higher up-front costs but could limit damage and repair costs while reducing insurance claims following an acute event. Compounding location decisions by millennials noted previously, this age group is also the most likely to cite climate change as a reason to move in 2022 among a third of respondents to a recent survey by Forbes Home.

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