The New York Times
By: Diana B. Henriques
November 9, 2010
It is not just retired savers who are struggling with a sharp reduction in their investment income as interest rates hover near zero. Hundreds of affordable housing projects across the country are feeling the pain, too.
That sets them apart from most borrowers in the municipal bond market, who see today's low rates as a rare spot of cheer amid shrinking tax revenues and rising pension costs.
But this battered collection of public borrowers is learning that low rates can be a two-edged sword -- one that can slice their credit ratings to the bone, as detailed in a report to be released Tuesday by Standard & Poor's Ratings Services.
These borrowers, primarily affordable housing projects across the country that are allowed to raise money in the tax-exempt bond market, had been relying on the interest they earned on their spare cash to help them pay off their outstanding bonds. Like other investors, they are now earning far less on those cash reserves than ever anticipated.
As a result, their bond ratings are being cut sharply, reducing the value of their bonds to investors and potentially making affordable housing less available or more expensive for senior citizens and lower-income families who rely on such projects for shelter.
The magnitude of the pain is clear in the report from Standard & Poor's, one of Wall Street's largest credit-rating agencies, of a sweeping review begun last spring of nearly 600 tax-exempt housing bonds.
The changes are stark. The number of AAA-rated bonds, the blue chips of the bond market, fell by more than half, to 271 from 552. The number of bonds in the "junk" category -- too low to be considered investment grade -- rose to 46 from just 9, and the agency said it anticipated that 10 of those issues could default over the next decade.
The ratings for 256 more bond issues were withdrawn, either because they were no longer outstanding or because the issuers did not respond to the agency's request for more information.
"We have seen years of record-low short-term interest rates cause stresses across the housing revenue bond spectrum," said Valerie White, senior director of tax-exempt housing at the rating agency. "We have observed this to be particularly true of bonds whose revenues or cash flows rely on investment earnings from short-term investments such as money market funds."
As a result, although the mortgages that secure the bonds are federally insured, the projects that issued the bonds are at greater risk of falling short of the cash needed to repay bondholders, the S.& P. analysts said.
One of the most severe downgrades was for the Riverside Plaza apartment project in downtown Minneapolis, a high-rise project once used as the backdrop for "The Mary Tyler Moore Show."
For the project, which is home to more than 4,000 people, the AAA rating on its outstanding bonds was cut to CCC, almost as low as a rating can fall unless the bond is on the brink of default. That six-step tumble was the most severe in the final round of S.& P. downgrades, announced in late October, but five other projects in the final round of reviews had their ratings fall at least two steps.
The downgrade for Riverside Plaza came as it was preparing to refinance the affected bonds, explained George Sherman, the president of Sherman Associates, which owns and manages the project, a linchpin in the city's supply of affording housing.
"Just to have the issue off the table," he said, his private company "will step up in December and cover the small interest shortfall" the project faces, which he estimated at a few thousand dollars. But not every project downgraded has access to that kind of emergency cash.
The new Riverside Plaza bonds will be issued based on "much more conservative assumptions -- essentially assuming zero investment income," Mr. Sherman said.
Moody's Investors Service, another major credit-rating agency, undertook a similar review of its ratings on housing bonds this year, but its downgrades were not as steep or as numerous. According to a summary from that agency in June, more than 80 percent of the roughly 200 reviewed issues kept their original ratings.
But Moody's analysts warned then that "if interest rates continue to remain at current levels, we would anticipate further downgrades."
Since so many of the downgraded issues had glittery AAA ratings before the latest review, there has been some grousing in the market that the rating agencies were overreacting to criticism that they were too generous in rating the controversial mortgage-backed bonds that blew up in the financial crisis of 2008.
"Some people say they are like the cat that got burned stepping on the stove and now won't even go back in the kitchen," said Bernard Beal, chief executive of M.R. Beal & Company in New York, an investment bank that is an active underwriter of housing revenue bonds.
"But I think they are being legitimately cautious about the opportunities for these housing issues to make a comeback in the short run," Mr. Beal said. "The deals are going to be more difficult to do, and there simply will not be the large-scale issuance we've seen in the past."
He cited a deal in his own firm's pipeline. "Three years ago, it would have been a no-brainer. Now, with the very same project, we are finding very, very few lenders for it."
The tighter rating standards may cause more housing-bond issuers to go to market without a rating -- a step that narrows the market for the bonds and can raise the cost of new housing projects.
"You pay up in a number of ways if you go to market unrated," Mr. Beal said. "But that may be better than having a low rating that can affect your entire portfolio."