What do recent changes in the sector mean for debt financing?
It’s all change in the social housing sector. Rent reduction, Office of National Statistics reclassification, Right to Buy and special administration are among the known challenges faced by the sector. The question is: what does this all mean for debt financing?
Change creates uncertainty; debt providers don’t like uncertainty and the risk that comes with it. Does this mean raising debt in the sector is going to become more difficult? Not necessarily. But it does mean lenders are looking at the sector differently - and that prudent housing association boards should be looking differently at debt.
We have already seen bond spreads widen since the 2015 Summer Budget. Long-term bond yields for some housing associations suggest that long-term debt investors are beginning to see the sector as a low investment grade credit risk. Current deregulation plans should enable housing associations to take more strategic commercial risk. Arguably this is a welcome opportunity, given the pressure that structural change has put on the sector’s ability to generate sufficient surpluses. But this increased commercial risk is not typically credit positive. In fact rating agencies have made clear that structural change in the sector is likely to be credit negative.
What will lenders do? Pricing increases are likely, both in general and in particular for housing associations perceived to be taking more commercial risk. More intrusively, lenders - both banks and capital markets - may seek greater controls over the association’s operating activities (for instance, consents to undertake certain non-core commercial activities) as well as building wider lender discretion into funding agreements (such as revaluing housing stock or requesting revised business plans). Some lenders have spoken about having board representation, a move which could dramatically change the governance dynamic for housing associations.
Ostensibly, a deregulated sector will bring a more “commercial” approach to lending. The flip side, however, is that many housing associations will not wish to take on this increased risk. Even those that branch out into more commercial enterprises to boost revenues will be doing so to support their core social housing offering, not to become the “next big thing” in healthcare, private rented housing or student accommodation. At their core, housing associations will continue to be providers of social housing, and lenders who specialise in funding the sector will continue to position housing associations in this way within their institutions. Increased lending restrictions may aim simply to preserve the status quo, a counterbalance to structural change in the sector so that lenders can continue to offer funding to the sector on the basis that it represents a broadly quasi-public sector credit risk.
The challenge for housing associations in negotiating or renegotiating funding terms is how to optimise terms requested in order to give funders what they need to be able to lend at a price and on terms broadly commensurate with a social housing credit risk, while also ensuring that any future additional lending restrictions do not constrain the business, strategically or operationally.
For several years, housing associations wanting to raise debt have shown they prefer the capital markets route. This appears to be partly because of strong bond and private placement investor appetite for the sector, and partly due to housing associations prioritising pricing and tenor, locking in substantial quantities of debt at the lowest price for as long as possible.
However, the challenge with cheap, long-term debt is that it is inflexible: it can be tricky to amend terms and practically impossible to repay early without incurring substantial charges.
With the uncertain external environment, housing associations looking to raise debt will need to re-evaluate their financing objectives and consider prioritising flexible funding solutions, even if these come with a higher price tag, a shorter maturity, or both. This may lead to a resurgence of banks as the sector’s dominant debt capital providers.
That said, every housing association is different and there will be no one-size-fits all solution for funding in the sector, especially as associations look to diversify strategically and operationally. More than ever before, housing associations engaging with debt markets - whether to discuss existing facilities or new issues - will need to develop clear and considered financing and negotiating strategies and prioritise flexibility to position themselves for an uncertain future.
To discuss how KPMG is supporting housing associations in navigating the current funding landscape, please contact Marc Finer in our Capital Advisory Group.