Uncertainty Looms Following Another Year Of HFA Strength And Stability

Despite continued warnings of economic headwinds and a possible recession, rated HFAs performed very well in fiscal 2023, a trend we expect to continue as fiscal 2024 closes. Balance sheets continued a trend of robust growth amid record levels of loan production stemming from an ever-insatiable demand for affordable housing. Together with stronger returns from investment portfolios and wider net interest margins as rates rose upward, equity positions were bolstered. Many HFAs resumed or ramped up on-balance-sheet financing for loans because of persisting adverse pricing conditions in the to-be-announced (TBA) secondary market, reinforcing equity positions at the expense of increasingly unreliable short-term profitability gains. Nevertheless, average profitability metrics marginally improved year over year as HFA revenues increased and expenses were well-managed.

HFA asset quality continued the general trend of post-pandemic normalization, with nonperforming assets (NPAs)--defined as loans delinquent 60 days or more or in foreclosure--remaining level year over year. Lastly, HFA management teams again played a pivotal role in navigating uncertain market conditions throughout the year, demonstrating strength, agility, and adaptability in the pursuit of their respective missions. Therefore, despite the possible economic and policy-related challenges envisioned in 2025, S&P Global Ratings believes HFA management teams remain extremely well-positioned to continue delivering affordable housing and social impact services to their respective states and communities.

For a third consecutive year, we took no negative rating actions on HFAs in 2023, and none so far in 2024. We raised four issuer credit ratings (ICRs) by one notch in 2023, as detailed in our last update, but have taken no rating actions to date since (see "U.S. Housing Finance Agencies 2022 Medians: Strong Metrics, Balance Sheets Reinforce Credit Quality," published Sept. 19, 2023, on RatingsDirect). As a result, the average and median rating for the sector is 'AA', with 22 of 23 HFAs rated in the 'AA' category, and the remaining HFAs rated 'AAA'. Currently, the outlook on all ICRs in this sector is stable.

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Although we don't necessarily expect near-term rating pressure from potential policy shifts by the incoming Trump administration, we believe that HFAs could face difficult decisions concerning loan production, bond financing, and over-arching strategies within the next two years and beyond. HFAs would be at least indirectly affected by any building material and labor market disruptions resulting from trade and immigration policy shifts, as well as any material changes to the administration of Fannie Mae and Freddie Mac--namely privatization--all of which could potentially place upward pressure on home prices. Changes in the postures of the departments of Housing and Urban Development or Treasury toward a number of programs and initiatives could also weaken HFA funding or financing options.

Notable among potential federal policy outcomes would be the direct effect of tax code revisions to private activity bonds, or--even more dramatically--the municipal tax exemption. In the case of the former, we believe HFA financings for multifamily development and preservation through the use of federal low-income housing tax credits could be substantially affected, prompting agencies with fewer alternative funding sources to materially reduce their multifamily financing activity. However, a renewed focus on opportunity zones could offset this impact to some degree.

In the tail-risk event of modification to, or elimination of, the municipal tax exemption as part of the expected successor tax legislation to the Tax Cuts and Jobs Act, we believe that HFAs would likely need to consider substantially modifying their financing strategies, and no longer be able to rely on the net interest margin between the tax-exempt bonds issued and taxable loans originated to support their missions. Although an increasing number of HFAs have issued taxable bonds in recent years to preserve tax-exempt volume cap, support loan programs for buyers ineligible for tax-exempt financing, and to access a wider array of investors, we believe that limiting the tax exemption could inherently blunt the ability of agencies to offer first mortgages at rates below those of conventional lenders, inevitably slowing loan production while borrowing costs increase. Even in this hypothetical scenario, we believe HFA loans would likely continue to enjoy high demand due to the availability of downpayment assistance (DPA) products, yet the ability of agencies to meet ever-growing demand for affordable housing could be considerably limited. Due to current levels of articulated bipartisan support for the tax exemption, this hypothetical outcome likely remains a remote one--for now.

HFA Management--The Steadfast Linchpin Of Agency Stability And Success

Management continues to play a pivotal role in the broad stability of HFA ratings through periods of both economic expansion and instability. HFA executive teams and boards are experienced, sophisticated, and dedicated to the pursuit of their respective missions in ways that are innovative yet sustainable. Robust oversight and governance infrastructures allow management teams to set and adhere to specific measurable financial targets, and effectively mitigate external risks. In addition, the depth of leadership expertise allows agencies to remain adaptable when faced with shifting market landscapes, pivoting strategies when necessary. Consequently, HFAs have largely endured periods of volatility and recessionary pressures with minimal negative rating outcomes. With few exceptions, negative rating actions on HFAs over the past two decades have overwhelmingly followed deliberate mission-driven decisions at the expense of credit ratios, rather than having arisen from external pressures.

HFAs adapted to rising interest rates in fiscal 2023 and still-elevated rates in 2024 to maintain their financial strength despite higher borrowing costs and slower prepayments. First-time homebuyers were similarly strained by the new interest-rate environment, but HFAs reacted by increasing the size for DPA second loans, when possible, targeting the still-largest hurdle for prospective buyers: high prices. Some agencies structured their bond issues in such a way as to achieve a lower overall cost on the short end of the yield curve (for example, more variable-rate issues), while those with whole loan-based strategies benefited from wider net interest margins in the higher interest-rate environment. Similarly, most reaped higher returns on investment portfolios because of stronger market yields, on average, thereby boosting profitability metrics. Despite continued inflationary wage pressure in 2023, HFAs successfully managed expenses that, on average, contracted 0.6% year over year, supporting net incomes that increased 41% in the same time frame. With substantial economic uncertainty ahead in 2025 and beyond, we believe that this adaptability will continue to underscore HFAs' success.

Debt-Fueled Growth Continues To Bolster Balance Sheets And Capital Adequacy

Balance sheet growth continued in fiscal 2023, but capital adequacy ratios remained level year over year. HFAs continued the multiyear trend of adding loans and program mortgage-backed securities (MBS) to their balance sheets--increasing 13.5% year over year, in aggregate--while expanding their investment portfolios by 2.5%. Of the 23 HFAs we rate, 21 finished the year with growth in their loan asset portfolios, and 15 experienced double-digit percentage growth. Consequently, average asset balances increased by a strong 10.4% from average 2022 levels. However, because much of this growth in the asset base reflected mortgage revenue bond financings, average equity rose by a lower 5.4%, culminating in an equity-to-total assets ratio that remained flat year over year at 33.8%, down from 33.9% the previous year. Net equity--calculated as audited net position, after certain adjustments such as the removal of fair value and S&P Global Ratings-calculated losses--increased on a nominal basis but decreased relative to total assets, falling marginally to 27.3% from 29.7% previously.

This trend reflected an increase in our calculated losses, on average, due to an uptick in multifamily and DPA loan origination, while loan performance remained stable. As discussed in our recent article, "U.S. Mortgage Revenue Bond Program Medians: Solid Foundations Underpin Strong Credit Quality," published Sept. 19, 2024, multifamily loan assets are assessed with higher levels of credit loss relative to single-family loans due to the lower prevalence of credit enhancement or guarantees. Although equity positions could continue to contract relative to assets based on a second consecutive year of record debt issuance in 2024, or asset quality could deteriorate and assumed losses increase, we believe that HFAs are likely sufficiently well-capitalized to avoid near-term rating pressure.

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Total debt for rated HFAs rose 14% in fiscal 2023 as agencies financed loans to meet demand in their respective markets. All but four HFAs added to their debt positions in 2023, and 16 finished with double-digit percentage growth in nominal debt. As a result, the median net equity-to-debt ratio dropped to 38%, from 45%, year over year. Following the continuation of interest rate hikes by the Federal Reserve throughout most of 2023 to combat inflation, HFA interest expenses relative to total debt reversed a three-year trend of declines, ticking up to 2.9% from 2.6% in 2022.

To offset exposure to higher-cost debt and achieve better pricing, many HFAs continued to incorporate a wide variety of financing structures into strategies, including planned amortization class bonds, as well as taxable and variable rate components--often employing hedging derivatives for the latter. Of the 15 rated HFAs with variable-rate debt outstanding, eight issued on a variable-rate basis in fiscal 2023, with more joining in fiscal 2024. Despite the near-term expectation for expansionary monetary policy and additional rate cuts, possibly reaching a neutral federal funds rate of 3.1% by the fourth quarter of 2026 as described in our most recent economic outlook (see "Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty," Nov. 26, 2024), we believe HFA debt issuance could contract over the next two years from the record levels seen in 2023 and 2024, yet remain on par with the recent historical baseline to meet the inelastic demand. However, substantive fiscal policy shifts involving core financing mechanisms, such as private activity bonds or the municipal tax exemption, could dramatically temper expectations for HFA debt issuance.

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Higher Interest Income And Investment Returns Boost Profitability In 2023

Return on average assets marginally improved on more muted 2022 results, resuming the measured pre-pandemic upward trend. Buoyed by generally higher interest income from loans and investments from the growing balances of each, average revenues across the rated HFA universe marginally improved to a recent historical maximum in 2023, growing 0.6%, while average expenses contracted 0.6% year over year. At the agency level, most HFAs finished the year with increases to both revenues and expenses, while nine agencies saw revenues contract year over year. Of these, all but three finished with expenses that also dropped. Consequently, the average HFA net income increased more than 41% above 2022 levels, while remaining below the extremely strong 2021 recent maximum of 2.7%, which at that time followed the deployment of federal stimulus and pandemic relief programs, higher rates of prepayments, and more favorable executions in the TBA market.

In conjunction with this rebound in net income, return on average assets (ROA) strengthened in 2023 to 1.8%, from 1.7% the previous year, matching the 2020 average. We expect near-term trends in ROA for 2024 and beyond will be more moderated than the period between 2020 and 2022, as asset bases generally continue to expand across the sector while net income improves. Additional interest rate cuts could alter the trajectory of this trend, however, if prepayments materially accelerate or if the Federal Reserve resumes quantitative easing, improving the viability of TBA executions.

Net interest margins benefitted from the rising interest-rate environment in 2023, even as borrowing costs broadly increased. Due to the strengthening of interest income from loans, program MBS, and investments, rated HFA net interest margins improved to an average of 1.7%, up from 1.5% in the prior two years, and equal to the trailing average over the previous four fiscal years. The median margin followed a near-identical pattern, improving to 1.7% from 1.4%. All but four HFAs finished with stronger margins year over year, with the largest increases predominately realized by issuers using whole loan-based strategies. We have observed this trend continue in 2024 year to date due to even stronger production of higher interest rate loans, but a reversion to levels closer to the historical baseline could follow in 2025 with the declining interest-rate environment.

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Strong Asset Quality Persists As NPAs Remain Level Year Over Year

At 2.5%, average NPAs in 2023--relative to total loans and real estate owned (REO)--remained essentially flat from 2022 levels, indicating loan portfolios have mostly reached at least temporary equilibrium in the post-pandemic era. Although seven rated HFAs reported markedly higher NPAs in the year on a nominal and relative basis, the median NPA balance decreased by 10.8% year over year, and 10 agencies experienced a double-digit percentage rate of annual decline in their nominal NPAs. While many states closed their rental and homeowner assistance programs, a handful of rated HFAs still administer funds to distressed renters and homeowners. Some agencies have continued to observe upticks in (primarily) single-family delinquency as borrowers have exited forbearance periods; nevertheless, HFA loan delinquency rates remained well below the Mortgage Bankers Association's estimate of 3.61% for the national average for delinquent loans in 2023. We attribute this difference in loan performance--as we have historically--to robust underwriting standards and generally stronger loan characteristics (in conjunction with the higher prevalence of federal mortgage insurance and MBS assets), prudent and mission-based asset management, and the involvement of homebuyer education. As near-term economic uncertainty looms, we expect HFA loans will continue to demonstrate relative strength, even if delinquency rates and NPAs start to rise again.

Rated HFA investment portfolios increased by 2.5% in 2023 largely due to higher rates of return in the elevated rate environment. Removing the impact of fair-value accounting, two-thirds of rated HFAs saw their cash and investment balances strengthen during the year. However, this was not a uniform trend, as the median balance decreased by 5.4%. Simultaneously, on average, loan loss reserves contracted relative to total loans to a seven-year low of 5.6% from 6.2% in 2022. We believe this is due to relatively stronger growth in overall loan balances, and a higher proportionate share of multifamily loans, DPA second loans, and program MBS, for which HFAs generally do not hold loss allowances. Nine agencies added to their loan loss reserves on a nominal basis during the year--six by more than 100%--and despite the decrease on an average basis. Nevertheless, we believe HFAs will continue to prudently maintain sufficient reserves to absorb near-term loan losses.

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Related Research

• Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
• U.S. Mortgage Revenue Bond Program Medians: Solid Foundations Underpin Strong Credit Quality, Sept. 19, 2024
• U.S. Housing Finance Agencies 2022 Medians: Strong Metrics, Balance Sheets Reinforce Credit Quality, Sept. 19, 2023