A $291 million bond issue by the Chicago Housing Authority (CHA) in December 2001 represented the first such issue by a public housing authority (PHA) in decades. A little more than a year later, smaller PHAs are preparing their own bond issues by banding together and committing their combined resources.

The "resources" in both of these cases are annual capital grants provided to PHA's by the U.S. Department of Housing and Urban Development (HUD). Like other housing authorities, the CHA receives annual grant money from HUD to be used for capital improvements. The annual grant amount fell short of CHA's immediate needs under an aggressive $1.5 billion capital program to produce 25,000 new or rehabilitated public housing units over 10 years. Proceeds from the bonds allowed CHA to move forward quickly on its modernization program, so that the authority is now two years ahead of schedule toward meeting its goal.

With HUD's commitment, subject to congressional appropriation, that its annual funding of CHA would cover the debt service, the CHA bond issue was rated Aa3 by Moody's Investors Service, AA by Standard & Poors and AA- by Fitch Ratings. These strong ratings were possible only with HUD's commitment, and also because the annual debt service is equal to just 33 percent of the amount HUD historically has provided to CHA. If HUD were to cut its capital funding of CHA in half, the debt service would continue to be paid on schedule. A higher percentage of grant money required to pay debt service could have resulted in lower credit ratings and thus a higher interest rate for CHA. In assigning their ratings, the rating agencies considered the historical level of funding by Congress, through both Republican and Democratic administrations, for public housing capital grants.

HUD's commitment was structured so that HUD pays the debt service directly to the Trustee rather than to CHA, and the amount paid is not subject to recapture. HUD established a system of direct payments by wire transfer or otherwise to the trustee. HUD also agreed that no subsequent charge in the permissible use of capital fund program moneys and no administrative sanction regarding CHA will reduce capital fund allocations to CHA, except as may be required by law, below the levels needed to pay debt services. It should be noted that the bonds are not obligations of or guaranteed by HUD or the United States.

The CHA transaction was the first publicly offered securitization of federal public housing capital grants ever undertaken in the United States. It was accomplished in accordance with the Quality Housing and Work Redevelopment Act. Enacted in 1998, the legislation authorized PHAs to pledge HUD capital grants as security for financings.

Once CHA blazed the trail, other PHAs followed quickly. Philadelphia's housing authority issued $80 million in bonds in 2002 using a structure similar to the CHA deal. But most PHAs do not receive enough funds from HUD to justify the costs of a stand-alone bond transaction. For these smaller PHAs, pooled deals are emerging as an effective structure.

In several regions of the country, small and medium size PHAs have been working toward implementing the securitization structure on a pooled basis, where bonds or other obligations are issued to finance capital projects for multiple PHAs. By pooling obligations, the higher upfront and ongoing costs of the program can be allocated among several PHAs, rendering the program cost-effective.

One such pooled transaction scheduled for completion in the first quarter of 2003 consists of 42 housing authorities throughout Alabama. This pooled deal will result in an issue of approximately $120 million, with annual debt service that is 25 percent of the expected annual grant levels from HUD. PHAs in other states and regions are undertaking similar structures in order to leverage their capital funds and benefit a greater number of public housing residents.

Several issues arise from the use of a pooled structure, including:

* A pooling vehicle must be created to effectuate the sale of the pooled obligations. Possibilities include revenue bonds of a central issuer which will buy the bonds of individual authorities; certificates of participation reflecting certificated interests in the individual authority bonds; or a grantor trust which simply passes through on a pooled basis the debt service payments on the individual authority bonds.

* The issue of cross-liability must be resolved-whether there will be any joint PHA liability for the obligations of each, and whether there will be any common debt service reserve fund securing the bonds.

* There must be one central entity which can perform functions, rather than allowing multiple PHAs to arrive at differing and possibly conflicting decisions. Examples include choice of Trustee and other fiduciaries, credit enhancement decisions, rating agency choice and selection of professional consultants.

* HUD and/or the rating agencies now will require third party review of PHA project construction to ensure compliance with all applicable Capital Fund Program requirements.

At a time when many government agencies are faced with capital shortfalls - and are seeking ways to step up efforts to help low-income families make ends meet -securitization of HUD capital grants is proving itself to be a highly workable solution that benefits bond buyers, PHAs and their constituents alike.

Matthew Lewin is a partner with Chapman and Cutler, a Chicago-based legal firm specializing in financial services law. Lewin is a partner in the Public Finance Group at Chapman and Cutler and has been practicing law at the firm since 1981. Mr. Lewin has devoted his career to serving as bond counsel and underwriter's counsel on a wide variety of municipal financings, including private activity and general governmental bond issues, throughout the United States.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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