The outlook for the state housing finance agency (HFA) sector remains negative, according to the latest report from Moody's Investors Service.

"While the U.S. housing market has begun to show signs of improvement, HFA credit drivers are more closely tied to various indicators in the broader U.S. economy and capital markets," says Moody's. "We expect that these economic headwinds will continue to drive near-term challenges for HFAs."

The report is the credit rating agency's expectations for the fundamental credit conditions in the sector over the next 12 to 18 months. It does not speak to the expectations for individual rating changes.

Key credit pressures driving the negative outlook include high unemployment levels, low interest rates on investments, low conventional mortgage rates, and low home prices relative to loan originations.

"Low interest rates on investments depress profitability for both new and existing bond programs and reduce returns for HFA general funds," says Moody's.

Low mortgage rates also erode the inherent interest rate advantage of tax-exempt bonds issued by HFAs. Moody's expects HFAs to continue to struggle to issue bonds at rates low enough to finance competitive mortgage loans.

The outlook also cites an uncertainty in government policy, specifically possible changes to

or the elimination of Fannie Mae and Freddie Mac or changes to the role of the Federal Housing Administration that could impact the ability of HFAs to originate loans. On a positive note, Moody's says that HFAs are positioned to benefit if the economic recovery solidifies.

"Despite negative pressures, HFAs have weathered the recession well, maintaining a stable median asset-to-debt ratio of approximately 1.2 throughout the recession," says the report. "Furthermore, while median profitability has declined since 2007, it has stabilized between 8 percent and 9 percent over the last three years. In addition, many HFAs have taken actions to help bolster their programs during the recession, such as breaking relationships with downgraded counterparties, developing new revenue streams, creating new loan origination strategies, and/or infusing cash into single-family programs for added support."