Standard & Poor’s will review the agency’s
intended investment of these monies, including the
quality and liquidity of proposed investments,
which should be invested in investments rated as
high as the desired rating on the bonds. All SIF
investment earnings and all premiums charged and
received from a portfolio must first be applied to
restoring the SIF to its initial requirement before
being released to the agency or used to redeem
bonds. All SIFs should be maintained at the origi-
nal loss coverage amount, drawn down only for
losses incurred, but not reduced based on the
amortization or prepayment of the mortgage port-
folio. Lastly, in addition to the net worth mainte-
nance reserve overlaying the SIF, Standard &
Poor’s will look at an agency’s fund balance to
ensure that the remaining 55% of the loss cover-
age exposure is available.
The SIF reserve ratio is higher than that of a pri-
vate mortgage insurer because of the increased risk
inherent in statewide portfolios, compared with
nationally dispersed pools. Geographic concentra-
tion increases the possibility that the SIF might have
to make larger claims settlement payments during
local economic downturns without earning any off-
setting premiums in unaffected regions. The level of
reserves, including SIF reserve and net worth main-
tenance among others, reflects Standard & Poor’s
analytical assessment that the SIF might remain sol-
vent and meet all drawdowns, even in the event of
significant economic stress.
Risk share agreements.Several pool insurance
providers have entered into risk share or shared
loss agreements with HFAs. Traditionally, these
arrangements provide the housing agency with
more flexible loan underwriting requirements and
lower premiums in exchange for the housing agency
taking on some of the real estate risks of the portfo-
lio. Usually, the housing agency is responsible for
taking on the second or middle layer of risk.
Because this risk is significant, Standard & Poor’s
reviews all risk share agreements in detail prior to
the sale of the bonds and issuer’s acceptance of
such arrangements. Collateral or fund balances sim-
ilar to those used for the self-insurance fund alter-
native may need to be pledged to achieve the
desired ratings.
Economic stress cash flows. Another method that
can be used to address loss coverage involves the
capitalization of assumed worst-case scenario losses
into the structure of the issue. This scenario incor-
porates Standard & Poor’s criteria for directly sim-
ulating the effects of economic stress on a given
mortgage portfolio. This simulation, or “economic
stress scenario,” is based on the same criteria used
to compute loss coverage and is incorporated into
all cash flow runs required in the rating process.The objective of the scenario is to demonstrate that
a bond issue can undergo the worst-case assump-
tions used to determine loss coverage and still meet
timely debt service.
The economic stress simulation occurs over the
first three years after the first month of mortgage
origination wherein mortgages equal to one-third of
the assumed foreclosures continue for one year, at
the end of the year, the nonpaying mortgages are
foreclosed. All accrued interest is recouped and all
principal recovered, less an amount equal to the
loss severity. This scenario is repeated in each of the
three years, and all amounts are based on the initial
portfolio balance.
The losses incurred can be discounted at the
mortgage rate and deducted from total assets at
loan origination, or deducted from the cash flows
as they occur. If the latter approach is used, cash
flows reflecting the economic stress scenario must
be sufficient to pay two bond payments during the
first 12-month stress period without the benefit of
recoveries from foreclosed loans. An additional
method is the establishment of a reserve amount
that, when invested at a particular rate, is sufficient
to cover any losses created under the economic
stress scenario. Cash flows should demonstrate the
ability to meet debt service and expenses under all
origination and prepayment scenarios loss coverage.
Furthermore, it is important that the economic
stress scenario not result in a reduction in the bond
issue’s asset-to-liability parity ratio after origina-
tion. Such reductions in asset coverage indicate that
assets other than those earmarked for loss coverage
substitution are utilized.
LOCs. LOCs have been used by several HFAs to
satisfy loss coverage. The LOC must be issued by a
financial institution whose long-term unsecured
debt rating is at least as high as the desired rating
on the bonds. The LOC should provide credit and
liquidity coverage and should provide for reinstate-
ment, if the delinquency is cured by the mortgagor.
General obligation pledge. Rated HFAs may
pledge their general obligation to all payment obli-
gations under a bond issue or restrict the pledge to
specific funds, such as reserve funds. Loss coverage
may be met in this way as long as the HFA’s rating
is as high as the rating on the bonds and the expo-
sure to potential losses does not adversely affect the
HFA’s ICR rating. In some instances, an HFA’s rat-
ing may be a full rating category below the bond
rating and still qualify. Unless the HFA has an
acceptable liquidity rating, only credit losses may
be covered in this way.
Subordinate bonds. Several HFAs have used subor-
dinate bonds to meet loss coverage. The size of the
subordinate issue must equal the amount of loss cov-
erage needed to secure the senior bonds’ mortgageHousing234 Standard & Poor’s Public Finance Criteria 2007