CHICAGO -- When Standard & Poor's Corp. affirmed the ratings on more than $1 billion of Illinois Housing Development Authority debt on Oct. 28, it marked a continuation of a trend that bases rating affirmations on self-supporting factors and not a state's moral obligation pledge on bonds.
Dana Bunting, a vice president at the rating agency, said there were enough factors such as the authority's general obligation pledge, mortgage insurance, subsidies, reserves, liquidity, cash flows, and investments to warrant an A-plus rating for $992 million of the debt and an AA rating for $18 million of debt. The A-plus rating on another $1.1 billion of housing debt had been affirmed in July based on similar self-supporting criteria.
If the ratings had been based only on Illinois's moral obligation pledge, the housing authority's ratings -- which along with other state debt had been placed on CreditWatch with negative implications in February -- would have faced a downgrade to A. This downgrade would have been one full rating category below the state's GO rating, which was downgraded Aug. 2 to AA from AA-plus.
The Illinois agency is the most recent example of a state housing agency asking Standard & Poor's to ignore a state's moral obligation pledge and base ratings on self-supporting factors. Other state housing agencies have also gone that route as financial pressures over the last two years led to the placement of their state's GO and moral obligation debt on CreditWatch with negative implications.
Like Illinois, some of the housing agencies have been successful. Over the last two years, Standard & Poor's has affirmed ratings on nearly $2.8 billion of housing debt that had been placed on CreditWatch because of a moral obligation tie to a state. With the exception of $238 million of Michigan State Housing Development Authority debt, which had its ratings affirmed when the state's GO rating was affirmed in August, the rest of the agencies were able to maintain their debt ratings based on self-supporting factors.
Standard & Poor's has downgraded about $2.5 billion of housing debt that carries a moral obligation pledge, and is currently reviewing another $4.1 billion of debt to determine if its ratings can be maintained based on self-supporting factors.
Meanwhile, several other agencies, including the Pennsylvania Housing Finance Agency, had their moral obligation debt rated at initial issuance based on self-supporting factors, thereby avoiding being placed on CreditWatch with their state.
"Because of the level of uncertainty, a lot of [housing agencies] are getting away from the moral obligation," said Steve Schrager, a vice president and manager of institutional research at PaineWebber Inc. "As more and more states are getting into fiscal trouble, sometimes a moral obligation could be an anchor hanging around someone's neck."
That is because moral obligation debt is generally considered by Standard & Poor's to fall one rating category below a state's GO rating, so once the GO rating goes down, the rating on moral obligation debt is likely to drop as well.
Standard & Poor's is the only rating agency that recognizes a moral obligation pledge. Bonds backed by a moral obligation pledge do not carry the full faith and credit of the state, which has no legally enforceable obligation to replenish insuffiencies in a capital reserve or debt service reserve fund.
While debt other than housing may carry a state's moral obligation pledge, Todd Whitestone, a managing director at Standard & Poor's, said housing debt is more likely able to substitute its own security for the state's pledge.
Housing debt "seems to be something states want to apply their moral obligation to, and it also has underlying credit strength," he explained, adding that not many other kinds of state debt "fit both those bills."
Ms. Bunting said that if a housing agency wants the rating agency to look beyond the moral obligation and instead consider other credit enhancements contained in the bond indenture, the agency will do so.
"Some agencies, when they structure their debt, solely rely on the moral obligation," she said. "Other state agencies, although they have a moral obligation in place, structure their issues upfront as if they don't have a moral obligation."
Peter Dwars, executive director of the Illinois housing authority, considered asking Standard & Poor's to review ratings apart from the moral obligation pledge as "a good thing to do" because the ratings were affirmed.
"We think our bond resolutions are strong," he explained. "And in light of the state going down and the possibility of us going down just on the basis of the moral obligation, we asked [Standard & Poor's] to take a look at a stand-alone situation."
A time factor may also come into play to determine if a bond issue can be self-supporting.
"If a state agency has a fairly new indenture that has not been outstanding long enough and has not had time to build up its reserves, the chances are less likely they will not rely on a moral obligation rating," Ms. Bunting said.
That was the case with the Rhode Island Housing and Mortgage Finance Corp.'s debt, which was placed on negative CreditWatch on Jan. 14. Standard & Poor's affirmed an A-plus rating on $285.2 million of single family and multi-family bonds in February, while it subsequently downgraded $58.9 million of multifamily debt following the downgrade of the state's GO rating to AA-minus from AA in July.
Mike Rylant, chief financial officer of the Rhode Island agency, said the A-plus rating was maintained because the debt it covered was more mature and less reliant on the state's moral obligation pledge. The debt, issued from 1977 to 1986, also was able to maintain its rating based on standard & Poor's "top-tier" designation, which included the corporation's "strong administrative ability, expert management, excellent portfolio quality, and its ability to lend financial support to transactions if necessary."
Most of the debt that was downgraded was issued from 1988 to 1990 and had its resolution's capital reserve fund, which was secured through a moral obligation "refill pledge" of the state, as its primary credit enhancement.
The ability of state housing debt to maintain ratings on its own may became an even more important factor in the future. Mr. Schrager pointed out that due to fiscal problems and concerns about their own GO ratings, "a number of states are not encouraging moral obligation debt at this point in time."
Massachusetts, for example, has been asking state agencies not to use its moral obligation pledge on debt issues, according to Marty Vaananen, a spokeswoman for the Massachusetts Housing Finance Agency.
The state "believes it represents a potential draw on the commonwealth's funds down the road," she explained.
Ms. Vaananen said the preferred route in the eyes of the state is to incorporate in the eyes of the state is to incorporate other credit enhancements in the bond issues and not to use the state's pledge, something that she said the housing agency has been doing for several years with its single and multifamily debt.
In Illinois, a recently enacted law requires the governor to approve of new moral obligation debt. Mr. Dwars said his agency would continue to carry the state's pledge on its debt.
"We still want to be tied in with the state through its moral obligation, but we also want the flexibility to go back and forth to what makes more economic sense," he said.