at 13% of spending, is about average for states for fiscal year 2012. Many states are struggling to adopt balanced budgets while dealing with the phase-out of federal stimulus aid, weak revenue growth, and significant spending pressures. The governor¡¯s biennium budget proposal incorporates spending reductions in school aid ($749 million), Medicaid ($500 million), higher education ($250 million), and local government aid ($96 million). The cuts in primary school aid and local government aid are accompanied by measures that severely limit local entities¡¯ ability to increase local property taxes. The limitation on raising property taxes reduces local governments¡¯ and school districts¡¯ ability to offset the proposed cuts in state aid, but is mitigated by the governor¡¯s controversial call for increased public employee contributions to pension and retiree healthcare plans. Under Governor Walker¡¯s budget, certain public employees will be required to contribute 5.8% of their salary to the pension system and 12% of their salary to the retiree healthcare system; currently, public employees contribute a significantly lower amount to both the pension and retiree healthcare plans, although the amounts differ among various unions. Governor Walker¡¯s proposal would equalize the contributions, increasing all of them. The increased contributions are projected by the governor to bring an additional $300 million in savings to the state general fund. Additionally, the increased contributions would give local governments and school districts budget savings, alleviating spending pressure on local governments and making it easier for schools and municipalities to absorb the state aid cuts without increasing property taxes. Wisconsin experienced significant revenue declines during the recession, made worse by rising expenditure costs, primarily in Medicaid. In the current fiscal 2009-11 biennium, the state resolved a $6.3 billion budget gap with a mix of revenue increases, spending reductions, and federal stimulus funds. With just three months remaining in the current biennium, the state has to close a budget gap of $137 million. The governor previously proposed a budget repair bill that authorized a debt refunding to achieve $165 million in budget savings immediately. The budget repair bill has not been approved by the legislature because a provision in the bill would eliminate collective bargaining for certain public employees, which Wisconsin¡¯s Democratic state legislators strongly oppose. At this time, the governor¡¯s fiscal 2012-13 budget proposal incorporates solutions for the current year $137 million gap.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Enactment before the end of the current fiscal year would be credit positive. A budget resolution (at least for the current-year gap) has to be made before the end of the current fiscal year on 30 June. While the new fiscal year begins on 1 July, the state has a history of late budget adoption and given the difficult and contentious fiscal and political environment, budget adoption is likely to be delayed again.
Dmitriy Plit Analyst +1.212.553.7463 dmitriy.plit@moodys.com
Congressional Proposal Significantly Weakens Public Housing Authority Credit
Last Tuesday, the US Senate put on its legislative calendar the proposed Full-Year Continuing Appropriation Act of 2011, which would significantly reduce funding to the Public Housing Capital Fund administered by the Department of Housing and Urban Development. The legislation, which passed the House on 19 February, proposes a 42.9% reduction from the 2010 funding level. Such a reduction is credit negative for the public housing sector, as it will result in a considerable erosion of debt service coverage levels. Public Housing Authority (PHA) capital fund financings are bonds issued by, or on behalf of, PHAs and rely on federal appropriations as their primary source of debt repayment. Since the bonds are repaid solely from capital fund allocations, adequate appropriations to the capital fund are vital in maintaining sufficient coverage levels and directly affect an issuer¡¯s ability to repay the bonds. Annual funding levels are appropriated by Congress and distributed by HUD via a formula to approximately 3,200 PHAs. As shown in the exhibit below, the funding for the program has been volatile, with six years of consecutive cuts in federal appropriations from 2002-07, followed by stabilization in 2008-10. Public Housing Authority Funding 2001-2011
Federal Fiscal Year Appropriation (In Billions) % Change
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (proposed)
Source: HUD Office of Public and Indian Housing
$2.99 $2.84 $2.71 $2.70 $2.58 $2.46 $2.44 $2.44 $2.45 $2.50 $1.43
-5.0% -4.6% -0.6% -4.3% -4.5% -1.0% 0.0% 0.5% 2.0% -42.9%
At the time of issuance, PHA bonds generally have at least 3x coverage of debt service by the individual PHA¡¯s capital fund allocation. This debt service coverage level is meant to allow the debt to withstand the risk of deep cuts, up to a two-thirds cut on average, in appropriation levels. However, the extent of the proposed 42.9% decrease in funding in one year is well above our baseline assumption supporting the ratings on these bonds.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
If the proposed appropriation is enacted into law, we expect significant deterioration in coverage levels, as the PHA bonds would have less ability to withstand further cuts in appropriations in the future. Only those bonds with high current debt service coverage levels (above the 3x following the proposed reduction in funding) will maintain sufficient coverage to absorb future reductions and are likely to maintain their current rating levels. For most of the sector, which includes 20 bond financings with current ratings ranging from Aa2 to A2, and approximately $927 million of aggregate bonds outstanding, we would expect to see downgrades of one to seven or more notches if the legislation is enacted, owing to their sharply reduced debt service coverage.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS Securitization
Lori Marks Assistant Vice President - Analyst +1.212.553.1098 lori.marks@moodys.com
Credit Implications of recent worldwide news events
Ventas¡¯s Acquisition of Nationwide Health Is Credit Positive
On 28 February, Ventas (Baa3 review for upgrade) announced a definitive agreement to acquire Nationwide Health Properties (NHP, Baa2 stable), another diversified healthcare real estate investment trust (REIT), in an all-stock transaction valued at $7.4 billion. This acquisition has positive credit implications for Ventas because it will increase its scale, enhance its tenant diversification, and improve its secured debt levels and overall leverage. It is the latest in a series of recent healthcare REIT acquisitions that are credit positive for the industry. Increased scale lowers tenant concentration. Ventas will more than double the size of its healthcare real estate portfolio, and with increased size Ventas will be making great strides towards reducing its tenant concentration. This concentration, which has long been the weakest aspect of its credit profile, had declined over the years and is lower under the acquisition, albeit still high at 19% of pro forma net operating income. Increased size also means an increased number of operator relationships across multiple healthcare property sub-sectors, including senior housing, skilled nursing facilities, hospitals, and medical office buildings. These relationships are important sources of transactions to fuel Ventas¡¯ continued growth. Metrics improve. Another key credit positive of the NHP deal is the all-stock consideration being paid, which will have an immediate positive impact on Ventas¡¯s secured debt level, its weakest financial credit metric. Bigger is better in today¡¯s market. The Ventas-NHP deal is one among a series of transformative transactions recently announced in the healthcare REIT sector, all of which are credit positive for the industry. Last December, HCP (Baa2 stable) announced a $6 billion sale-leaseback agreement to acquire most of the real estate assets of privately owned HCR ManorCare, a best-in-class skilled nursing operator. More recently, Health Care REIT (Baa2 stable) announced five large transactions totaling $4.6 billion, the most significant of which was a sale-leaseback with Genesis Healthcare, a large skilled nursing provider. All of these transactions are credit positive as the three largest healthcare REITs are increasing their scale, creating a large size gap between them and their smaller REIT peers. With increased size, modest leverage, and diversification across a spectrum of property sub-types, these REITs will improve their cost of capital. With access to attractively priced capital, the three largest healthcare REITs will be able to accommodate operators¡¯ growth in the senior living, post-acute, and medical office sub-sectors. These REITs have established relationships with some of the best and largest operators, which are seeking to grow within their respective sub-sectors. The continued economic recovery, combined with a growing population of seniors and limited new supply of senior living facilities supports the expansion of senior living businesses. In this sub-sector, demand is improving as the economic recovery improves seniors¡¯ ability to sell their homes and afford high monthly rental payments.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Expansion for REITs and their operators is also occurring in the post-acute and outpatient subsectors. Post-acute care facilities are where patients receive treatment after discharge from a hospital. The tenets of healthcare reform stress improved efficiency and quality of care, which favor care outside of a hospital in either a post-acute or outpatient setting. A wave of consolidation has already occurred in the post-acute space, and post-acute providers are trying to establish larger, more efficient businesses in order to compete in the new era of post-healthcare reform.
Yehudah Forster Vice President - Senior Analyst +1.212.553.7995 yehudah.forster@moodys.com
New York Court¡¯s Rejection of MERS Mortage Assignment Is Credit Negative for RMBS
On 10 February, the US Bankruptcy Court in the Eastern District of New York issued a ruling that limits servicers¡¯ ability to foreclose on MERS loans whose borrowers declare bankruptcy in the Eastern District of New York.23 The decision in this case, In re: Ferrel L. Agard, will encourage borrowers to continue to raise technical challenges to foreclosures on MERS loans and has negative repercussions for residential mortgage-backed securities. However, it is too early to tell if the decision will spread to other jurisdictions or if it will have longterm ramifications. An appeal of the court¡¯s very narrow reading of MERS¡¯s authority is likely and two other courts that addressed the same issue last month came to the opposite conclusion. Further, potential workarounds may exist to address the New York decision. MERS matters. The issue of whether the electronic mortgage registration service has the right to assign the mortgage is important for RMBS. MERS is reportedly listed as the owner of record and nominee for the lender on more than 50% of the outstanding mortgages in the US. Servicers typically produce an assignment of mortgage document assigning the mortgage out of MERS¡¯s name and into the name of the RMBS trust prior to initiating a foreclosure. If MERS doesn¡¯t have the right to assign the mortgage, a court may not permit the servicer to foreclose for lack of standing. Rejection of MERS¡¯s authority to assign mortgages. The Agard decision concluded that MERS did not have authority to assign the mortgage to the securitization trust. The court ultimately ruled in favor of the servicer on other technical grounds, but had it not done so, its conclusion about MERS would have left the servicer without standing to foreclose or seek relief from the automatic stay. The court very narrowly applied MERS¡¯s rights under the documents and under New York agency law. In future cases, the servicer would need to show additional proof that the RMBS trust validly holds both the note and the mortgage in order to prove standing to foreclose. Decision applies only to one jurisdiction so far. The Agard decision will stymie foreclosures on MERS loans whose borrowers declare bankruptcy in the Eastern District of New York. For those cases, servicers may not be able to foreclose unless they can show additional proof, aside from the assignment by MERS, that the RMBS trust owns the mortgage. The adoption of Agard¡¯s reasoning by other jurisdictions would have a broad negative impact on RMBS; however, at this point it is doubtful that other jurisdictions will do so. Two other courts that addressed the same issue in February reached the opposite conclusion.24 Furthermore, it is also
23 24
The Eastern District of New York covers Staten Island, Brooklyn, Queens, and Nassau and Suffolk counties. See In Re: Henry Lopez (US Bankruptcy Court, District of Massachusetts, Eastern Division), 9 February 2011, and John J. Powers and Rose M. Powers v. Aurora Loan Services (Superior Court, Cheshire, New Hampshire), 14 February 2011.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
doubtful whether the Agard reasoning will ultimately stand, even in the US Bankruptcy Court for the Eastern District of New York. An appellate court will ultimately review the Agard¡¯s case conclusion. Workarounds possible. Even if the Agard decision becomes the law in some jurisdictions, parties will, in many cases, be able to work around the issue. For example, some servicers will try to prove a trust¡¯s ownership in the mortgage by producing documents other than the assignment. Another option is for MERS to amend its membership agreement to state more explicitly that lenders give it the power to assign the mortgage on their behalf. Yet, the broader concern that the Agard case raises for RMBS is the increasing phenomenon of borrowers attacking foreclosures on technical grounds, and courts being unwilling to accept the economic reality that the RMBS trust owns the loan. Even if the industry finds a way to deal with the Agard case, the question remains as to what the next issue will be.
Mack Caldwell Senior Vice President +1.212.553.4106 mcginnis.caldwell@moodys.com
Revived New York Bill Weakens Auto Loan ABS
As of 1 March, after six months of silence, proposed New York State legislation that disrupts