WASHINGTON, March 7 (Reuters) - The credit quality of U.S. state finance agencies is still at risk from low mortgage rates and home prices, high unemployment and uncertainty over federal policy, Moody's Investors Service said on Thursday.
Despite signs of life in the housing market, the ratings agency is keeping its negative outlook for the entire state housing finance agency sector, it added.
The agencies "weathered the recession well," Moody's said.
According to the credit rater, the agencies maintained a steady median asset-to-debt ratio of approximately 1.2 throughout the 2007-09 recession, and their median profitability has now stabilized between 8 percent and 9 percent over the last three years after dropping in 2007.
"If the economic recovery continues along the expected timetable and the economy experiences lower unemployment, higher interest rates and higher conventional mortgage rates in 2014, housing finance agencies will benefit," it said.
"However, given that the economic recovery remains shaky and may proceed slowly in the near term, we believe that the negative outlook remains appropriate for the next 12 to 18 months," it added.
The agencies are charged with creating affordable housing, and their primary financing tool is issuing municipal bonds. When the credit freeze descended on the bond market in late 2008, the agencies struggled to provide financial help to homeowners who had been hit by the housing market downturn.
The housing sector has been steadily improving of late, Moody's said. But now the main concern is that the unemployment rate is above 6.5 percent.
When unemployment is high borrowers are more likely to fall delinquent on loans from the finance agencies and the rating agency said it does not expect the country's jobless rate to dip below 6.5 percent through 2014.
Unemployment could also fuel foreclosures. As housing prices remain below their peak levels, the agencies may not be able to sell foreclosed homes at prices to recoup their losses.
Meanwhile, the Federal Reserve is indicating it will keep its federal funds rate low until unemployment is below 6.5 percent, making it hard for the agencies to achieve investment returns that they can use to make loans.
At the same time, the central bank is buying agency mortgage-backed securities, keeping mortgage rates depressed, and Moody's expects housing agencies "to struggle to issue bonds at rates low enough to finance competitive mortgate loans."
Uncertainty from the federal government could also hurt the agencies. It is still weighing whether to change or eliminate Fannie Mae and Freddie Mac and to modify the role of the Federal Housing Administration. In the same light, Congress and President Barack Obama have discussed limiting the tax exemption for interest paid on municipal bonds, which could result in higher borrowing costs for the agencies.
Moody's is also looking at the banks and mortgages insurers who act as counterparies to the agencies and who also have negative outlooks, and at the agencies who have issued variable-rate demand obligations with high liquidity fees. In some cases, the fees have risen since the bonds were first issued, putting pressure on the agencies.