ment grade ratings due to the essentiality of feder-
ally subsidized housing. Termination risk is more
of an issue that needs to be analyzed on a case-by-
case basis. Standard & Poor’s has seen contract
terms as short as one year and as long as twenty
years. Generally, Standard & Poor’s looks more
favorably on longer-term contracts, but whether
the term is one year or 20 years, termination risk
can be offset if the project meets the standards set
forth under MAHRA for contract extension, as
long as the owner is legally obligated to apply for
contract extensions.
The expectation that contracts will be extended is
strengthened by language in MAHRA that the
HUD Secretary shall extend at the owner’s request
subject to appropriation under such terms and con-
ditions that the Secretary deems appropriate. The
legislation permits the HUD Secretary the option of
not renewing due to poor financial or operational
performance of the project owner on the subject
development, as well as other HUD subsidized proj-
ects. Therefore, Standard & Poor’s will evaluate
whether the owner and property will meet
Standard & Poor’s, as well as HUD’s standards of
performance throughout the life of the transaction.
In addition, the HUD REAC score at the time of
the rating, and on an ongoing basis, is an indication
of HUD’s assessment of the owner. A deterioration
of the REAC score below 75 could be an early sig-
nal of the failure of the owner to operate the prop-
erty at a level needed to maintain the contract.
Other factors that add to the overall credit quali-
ty of the transaction help to make the case for the
essentiality of the project, as well as its ability to
withstand contract termination, include if:
■The project caters to HUD’s targeted tenancy,
especially, the elderly;
■The project could potentially operate without
subsidy; and
■A potential sale of the property upon contract
extension could generate sufficient funds to retire
the bonds.Section 8 Conversions
In situations where the owner has a viable plan for
converting a Section 8 subsidized property to
unsubsidized status over the life of the transaction,
Standard & Poor’s will consider ratings up to low
investment-grade for bonds meeting conversion cri-
teria, as follows:
■The feasibility of the transition from subsidized
to unsubsidized status at the targeted rent levels
should be substantiated in an independent third-
party report;
■Projects should be owned and operated by an
experienced affordable housing organization witha proven track record or have oversight of a state
or local HFA or PHA;
■The owners should present Standard & Poor’s
with a written transition plan, which is, in effect,
a plan of actions to be taken in conjunction with
the expiration of the Section 8 contract. The plan
should incorporate the methodology that the
owners will use to ensure the successful conver-
sion of the property within the shortest possible
time frame.
■Cash flow scenarios should be run showing pay-
ment of bonds in the event that the Section 8
contract is extended and in the event that the
project converts to AHP status.
Scenario 1 assumes successful relocation of exist-
ing tenants and releasing of units during a transi-
tion period assumed to begin upon expiration of
the HAP contract. The length of the transition is
assumed to be the greater of two years or four
times the absorption rate for similar properties in
the market. During the transition period, the proj-
ect needs to meet at a minimum only the debt serv-
ice coverage for HAP contracts. At the end of the
transition period, the project must meet the AHP
debt service coverage levels. Reserves should not be
relied on in meeting the coverage levels.
Scenario 2 anticipates great difficulty in relocating
the existing tenants and re-renting the units. The
Section 8 tenants are only assumed to vacate the
units at the historical turnover rate for the property.
Under both scenarios, a vacancy rate of at least
5% should be assumed, as well as a 30-day period
to turn around a unit for occupancy once it has
been vacated. Once the Section 8 contract has
expired, project income will consist of the tenants’
portion of the rent (30% of income) based on the
historical rent roll of the property.
Ratings on Section 8 conversions will include
only properties where most attributes fall within
the “excellent” category. Standard AHP debt serv-
ice coverage levels will apply, most likely at the
higher end of each category.Section 236 Interest Rate Reduction Transactions
For the Section 236 interest reduction payment pro-
gram (IRP), financing activity tends to be for single-
asset structures involving the bifurcation of the
mortgage loan and the creation of debt supported
solely from IRPs. Unlike prior Section 236 financ-
ings, which relied upon total project revenues to
meet operating costs and debt service payments,
these transactions rely only on the Section 236 pay-
ments. The tenant portion of a project’s income is
not pledged to the IRP bondholders.
Because of the structure of these financings and
the track record of the program, real estate risk isHousing282 Standard & Poor’s Public Finance Criteria 2007