Shared Ownership or Right to Buy?

The passing of the Conservative leadership baton (or rather the poisoned Brexit chalice) from Theresa May to Boris Johnson has perhaps brought with it a shift in emphasis back towards the traditional ideological safe ground of support for home ownership over rent. This was evident at the recent Conservative Party Conference, when the latest Housing Minister, Robert Jenrick, announced that housing association tenants will be given the right to buy 10% of their homes – on an automatic basis for new homes and under voluntary arrangements in relation to existing housing stock, the so called “Shared Ownership Right to Buy”.

The announcement unleashed the sort of response usually reserved for somewhat “on the hoof” policy statements which one can’t help but imagine must be dreamed up late one evening before the conference by special advisors writing ministerial speeches and seeking a punchy headline. It is also worth noting that the voluntary right-to-buy scheme explored by the Cameron administration has not really gained traction.

Commentators have highlighted the demand-side weaknesses of the idea, including:

1) Why would rational people voluntarily take on full repair and other leaseholder obligations for the upside of a 10% share in house price appreciation (see recent cases of leaseholder exposures to fire retrofitting costs)?

2) The cost of servicing the 10% mortgage – along with the rent on a shared ownership basis (2.75% on value?) – could easily exceed the 10% saving the resident would make on their (sub-market) rent – how many people is this likely to be relevant to?

3) The market for shared-ownership mortgages is already relatively thin – why would lenders bother for just 10% shares vs the usual minimum of 25% (although they could come under political pressure to support a Government Initiative)?

4) For people who can access and service a shared ownership property, why wouldn’t they just do so in the market?

Putting to one side the question of whether this presents an attractive proposition to housing association residents, it throws up complexities in relation to the debt funding model traditionally utilised by HAs. These include:

a. Lenders have, to varying degrees, pushed back on the inclusion of material amounts of shared ownership within security portfolios, partly because of uncertainty over underlying security value and the process of realisation under a default and partly as a result of the administrative burden associated with monitoring and removing from charge as staircasing increases.

b. The typical approach taken by bank lenders has been to cap the amount of shared ownership that borrowers can include within a security portfolio for a given loan. Institutional investors have been somewhat more relaxed but have still often sought to limit levels.

c. Again, ignoring the question of uptake, which we consider would be limited, in the event of this policy being implemented, all new build property would be subject to Shared Ownership Right to Buy which lenders would see as being an inherently less stable form of security than traditional social or affordable rented. This would likely lead to greater scrutiny of forecasts and stress tests around different stair-casing scenarios (as lenders seek to quantify a new business risk for HAs) as well as changing the way in which HAs might manage interest rate and refinancing risk. If borrowers considered there to be an inherent risk of higher stair-casing then this would likely reduce their appetite for large volumes of long-term fixed rate debt with expensive spens/modified spens type breakage costs, which appears potentially a move towards a riskier funding profile.

d. In return for more leeway on the inclusion of property exposed to stair-casing, banks may look to tighten up interest cover covenants and raise asset cover thresholds, particularly where shared ownership stock exceeds certain levels, or to shorten tenors on new funding even further.

e. Where HAs sought to enter into voluntary arrangements in respect of existing stock, which was already charged under previously arranged loan agreements, it is possible that this would trigger renegotiation of these loan agreements. Depending upon the commercial terms of these agreements, HAs may be exposed to a worsening of economic terms as well as covenants.

In summary, the proposed policy, which we believe to be limited in its appeal to HA residents, would create a number of uncertainties in relation to the existing debt financing model for HAs.

While we don’t believe it to be material in terms of the market’s willingness to extend credit to the housing sector, we do believe that it has the potential to increase actual and perceived risk on the part of lenders and therefore to increase pricing and tighten security and financial covenants, the combination of which could lead to reduced borrowing capacity and output. This does not mean that there is no merit to any form of the policy, but it does mean that it should be considered carefully and in a way, which is sensitive to the range of existing funding bases out there in the market.

Visit the Residential & Real Estate page to find out the wide range of services that Centrus provides to Housing Associations across the UK and Ireland.

For other perspectives on this same policy, visit other articles such as: Shared ownership Right to Buy: a gimmick that will not help tenants or landlords

This article was originally published by the Social Housing Magazine on the 16/10/2019.

Centrus Housing Conference 2019

In early July, Centrus gathered over 100+ housing sector clients and professionals for a half-day conference in Central London to discuss the theme: “Housing sector: a new financial landscape?”

The day started with a panel of presenters focussed on the current and future financial landscape, specific to the housing sector and venturing beyond. Delegates were addressed by Anne Costain, Director of Finance, IT and Procurement at Radian Housing, followed by Lisa Pinney, Executive Director of Resources at POBL.

“Radian and Pobl are leading providers of affordable housing in England & Wales respectively. Both have achieved significant organic growth but they also have in common group structures and legacy funding challenges arising from combination with other housing associations. Anne and Lisa shared their experiences, where both organisations are on a journey towards improving their treasury portfolios, supported with corporate finance advice provided by Centrus.”

Paul Stevens, Managing Director – Centrus

The next session of our event debated the role of Equity and Profit and what the risks and opportunities are arising from commercial activities. The Centrus team was joined by Will Perry, Assistant Director at the Regulator of Social Housing, alongside Christophe Parisot, EMEA Head of Public Finance at Fitch Ratings.

“The session highlighted the contrast in views from the different stakeholders with Jon adding insight into the various guises of equity and how these could offer a range of interesting options to the sector. Will pointed out that there has not been any substantive successes from the for-profit providers yet and Christophe setting out the challenges from a rating perspective. Christophe also gave some insightful commentary around how the sector should be able to weather the credit impact of a potential (or eventual) Brexit.”

Barry Greyling, Director – Centrus

Our third panel brought the risk management subject into focus and the Centrus view on the financial markets, data management and reporting solutions. We heard Conor O’Flynn, Managing Director of Centrus Analytics, discuss the ideal 80/20 ratio of time spent in transactional versus strategic activities and how housing associations should look to start their unique journey to achieving an 80/20 balance between managing drivers and managing transactions.

Our final debate raised the question: what could funding solutions look like in the future, in the context of current and emerging trends?

“These are exciting times, with a positive investor landscape for housing associations to enter the institutional funding market. We are seeing an increased number of investors entering the sector from a variety of funding structures. This creates a wider range of funding options for borrowers to choose from.”

Maria Goroh, Director – Centrus

Dominic Brindley from NatWest discussed the sector evolution and the emerging challenges around ESG bonds and, the prospect of the transition between LIBOR-SONIA and Michael Carr, Director at National Australia Bank, and Amelia Henning, Director at Barings brought insight into how the sectors evolution and changing risk profile is viewed by new and expanding lenders.

“The last panel session highlighted the strong demand for housing debt from investors but also sounded a cautious note around lender perceptions of increased commercialisation. Other highlights included a discussion on the potential appetite of some investors for SONIA linked debt and how regulatory headwinds in the pension sector may provide ESG compliant bond pricing benefits for the housing sector. For providers looking to access debt the current environment is highly attractive, but the panel outlined the growing complexity and diversity of options facing borrowers with a recommendation that approaches to the market should be appropriately considered and structured.”

John Tattersall, Director – Centrus

The Centrus Housing team is very pleased with the success of our first conference and hope it provided valuable insight to all attending.

To find out more please contact Paul Stevens, Managing Director – Centrus

Following the launch of the recent White Paper UK Social Housing – Building a sector standard approach to ESG reporting, we hosted the first in a series of webinars designed to discuss and develop the ESG reporting standards.

This webinar explained the drivers behind developing a standardised set of ESG criteria, and explored how it could benefit both housing associations and investors.

The detailed criteria can be found here.

Chair: Luke Cross, Social Housing, Editor, Social Housing

Speakers: Phil Jenkins (Manager Director, Centrus), Gareth Francis (Director of Treasury and Corporate Finance, Clarion Housing Group), Anthony Marriott (Head of Treasury/Finance, Peabody), Mark Davie (Director – Fixed income, M&G), Marcos Navarro (Director, Housing Finance, Commercial & Private Banking, NatWest), Sarah Forster (CEO, The Good Economy).

In speaking of social housing borrowers looking at overseas investors, if considering institutional investor funding, international markets should be taken into consideration by larger borrowers with the relevant treasury resources to manage more complex processes, on-going monitoring, and appropriate risk management. Accessing new investors engenders increased competition and access to wider capital pools for borrowers.

Due to increased sector awareness abroad stemming from investor education on the sector we’ve seen an increasing number of transactions involving non-UK investors. Unsurprisingly, large pools of capital potentially interested in Social Housing are based in other developed financial markets such as US, Europe, Nordics, Japan, Hong Kong, and Korea. Each of these markets has its own specific characteristics and preferred formats in which institutions (largely insurance companies, pension funds and asset managers) prefer to invest.

Attractions of the US market

The largest international capital market is the US; this private market is well established and deep dating back to the 1990s. The US private placement market is also the largest alternative funding market for UK Housing Associations. Over the last couple of years HA borrowings from the USPP market amounted to over a couple of billion £this continues to grow. US Investors are attracted by regulation, stability, the strong ratings of Housing Associations, and to a lesser extent the secured nature of obligations. With the USPP markets scale, low exposure to the UK HA sector, and capacity it provides a good alternative to the domestic UK market where some native institutions have very high exposures; M&G alone have almost £5bn of housing association debt across public and private paper. Sanctuary was one of the first HAs to issue an USPP and has borrowed over $400m from US investors with the most recent unsecured issue in March last year.

Other UK housing associations accessing the USPP market in recent years include Vivid, Newlon, Network Homes, Octavia, Stonewater and Bromford. Large borrowers such as Peabody, Circle (now Clarion), Orbit, and Places for People have also previously accessed the US market.

The main attractions of the USPP market are a large investor base along with interest in the sector, competitive pricing, large ticket sizes, and options for bilateral or “club” deals. The UK market has primarily evolved around just bilateral deals. USPP documentation is similar to a UK Note Purchase Agreement (“NPA”) apart from US representations and cross currency swap break language which is required by most US investors. Issuers receive GBP funding and most investors execute the swap on their side but require a swap break cost indemnity in the event of optional prepayment by the borrower. Borrowers may choose to fund in USD and swap the currency themselves. However, in most cases, UK borrowers across different sectors will prefer the US investors to hold the swap. Covenants tend to include asset cover with interest cover and sometimes a gearing covenant. The exact suite will depend upon the credit quality and size of the borrower. US investors are willing to provide unsecured funding as well and more amenable to this format than their institutional counterparts in the UK. We have seen some borrowers accessing the market with secured and unsecured tranches and the premium for unsecured tends to range between 30-50bps depending upon market conditions and credit quality. The USPP market tends to prefer medium-dated maturities ranging from 15 to 25 years with a maximum term of 35 years.

From a relative value perspective, the competitiveness of US investors depends on spread levels for similarly rated domestic issuers in the US, general credit perception, appetite, and the cross-currency basis swap. The impact of cross currency basis has deteriorated since early 2018 due to movements in the GBP/USD exchange rate, however we still see UK issuers entering the US market as credit perception and general appetite still provides scope for investors to provide tight spreads.

Asia and Europe

Beyond the US market there has been interest in the UK housing sector from other region driven mainly by the highly rated nature of the sector (for Asia) and the Environment, Social and Governance (“ESG”) investment angle (for Europe and Nordics). These markets have a less established track record but we are seeing rising appetite from investors based in Korea, Japan, Hong Kong, Europe and Norway. Korean insurers provide GBP funding and, in most cases don’t require swap break cost language. Preferred documentation tends to be as listed MTN but loan/PP formats can also be used. Less value is assigned to security as Asian investors value a wider spread over security. We’ve seen pricing competitive or in line with UK markets at ticket sizes of c. £100-150m per name from Korean investors. Japanese investors are less active and require the issuer to do the swap. They can, however, be very competitive for unsecured funding provided the issuer does the swap (Notting Hill and Places for People have accessed the Japanese market in the past in smaller sizes of c.£50m per transaction). Asian investors provide shorter tenors; up to 20 years for Korea and 12-15 for Japan. Lastly, the Hong Kong market is similar to the Japanese in terms of demand and number of transactions.

We are seeing some investor demand from Europe (mainly Germany and Benelux) and Norway. Unlike the US, European investors typically don’t do cross currency swaps themselves and require issuers to swap. There have not been many transactions in Euros with Places for People accessing the Euro market to date, however we expect issuance in Euros to pick up as we see increased interest from investors in the sector driven by ESG targets.

With the UK housing association market becoming a more internationally recognised asset class and borrowers increasingly sophisticated in accessing these markets, we expect activity with international investors to grow, providing healthy competition for domestic institutions.

Originally published at the Social Housing Magazine on the 9th May 2019

Introduction

Given the consolidation in the housing association sector in recent years, we often point out that the largest HAs are bigger than their FTSE 100 property equivalents on most measures. The next tier of HAs below that are also now very large corporate entities. One consequence of this is that we are seeing a steady move towards a re-setting of the relationship between these borrowers and their banking groups in the context of a clear strategy.

As legacy bank liabilities steadily amortise, are restructured through mergers, or are replaced with more sustainable market level funding, banking portfolios are looking more like those of other property-owning businesses. HAs have more willingness to restructure their banking relationships and address legacy lenders’ concerns when the result is tailored to support the needs of the HA as borrower. As legacy issues reduce and new lenders come into play, banks are better placed to provide responsive and flexible support through balance sheet, underwriting and ancillary services and take their rightful role as “enablers”.

One good example of this progress and shift in relationships is the increasing provision of “bridge to bond” facilities from HA relationship banks.

Bridging Loans in an HA Context

For HAs, bridging facilities typically provide committed liquidity until they can issue into the public bond markets. As well as providing greater flexibility, bridging facilities also provide an opportunity for HAs to expand the relationship with their key lenders.

In this context, bridging loans are often very short term (2-3 years) with the potential for some or all of that period being unsecured. Mandatory repayment clauses force prepayment and cancellation upon DCM issuance and fee structures incentivise refinancing – the facilities are really meant to be bridges after all rather than “emergency liquidity”. In other sectors the term can be shorter still but given the vagaries of property investment timetables we see it as worthwhile HAs pushing for the longer end of this range.

Key benefits of Bridging Loans

• Efficient Liquidity Provision – a period of being unsecured means that committed liquidity can be provided at short notice and low cost, with underwriting often sitting separately from core relationship lending teams.
• Mitigate Execution Risk – the provision of committed liquidity affords some flexibility to the issuer and allows them to enter the market on their own terms rather than being a forced issuer.
• Leveraging Existing Bank Relationships – by involving a borrower’s core relationship banks, concessions can be gained in legacy facilities as part of the overall relationship package.

Centrus’ Recent Experience

We have recently seen a number of bridges taken by HAs for a variety of reasons and with some interesting nuances in the structures.

One client focussed on the bridge mainly as a vehicle for mitigating execution risk: the purpose of the bond was to refinance existing facilities and the security to be released was required as collateral for the new bond. By arranging the bridge it allowed the issuer to prepay an existing lender, release the security and subsequently allocate as collateral to the bond in a timely manner without risking execution.

A simultaneous bond issuance, prepayment and security release is of course possible, but removing complexity from the primary issuance (alongside the flexibility to issue to the issuer’s own timeline) was seen as a prudent approach that reduced risk in the context of an already complex set of transactions.

Interestingly, this bridge was also dual-tranched with the second tranche coming online once the first bond had been issued: this provided further flexibility for the issuer whilst retaining an efficient fee structure. The RFP process also involved a request for concessions on existing facilities, reinforcing the idea that mature banking relationships should be mutually beneficial – the stick and the carrot both have their places!

Another recent example which undoubtedly highlighted banks’ ability to be responsive and supportive occurred towards the end of 2018: a three week process – from RFP to execution – focussed minds and led to an excellent result for the borrower.

With three banks on board to split the substantial bridge requirement the decision had to be made between a syndicated facility or bilateral agreements. Syndicated bank facilities are more of a norm with large corporates and utilities and, in our view, a move to more mature banking relationships in the HA sector might in part involve a renewed appetite for large syndicated liquidity facilities. Some of the banks had a preference for a syndicated approach where they felt they would have more visibility of the overall transaction, given the low pricing of the bridge funding.

A syndicated facility simplifies documentation, but the entire process could be held hostage by the slowest moving bank. A series of bilateral facilities, on the other hand, would require three separate agreements to be negotiated and documented within the three-week timeframe but would allow execution of just part of the requirement if, for example, only two of the three agreements were finalised.

In this case the decision was made to pursue three bilateral agreements and it paid off: two agreements were swiftly executed with the third also finalised within a very narrow timeframe. Good relationships and open communication helped considerably.

Bridging the divide

Our view is that building better managed relationships with top tier banks via additional ancillary business (DCM, acquisition finance, liquidity facilities, hedging etc.) is a win-win: the banks like the deeper relationships and the erosion of legacy portfolio value naturally makes them more enthusiastic. The quid pro quo is that for HAs with ambitious development programmes, legacy debt has sometimes been a block to progress.

This article has focussed on bridging loans, which give flexibility for HAs looking to enter the public bond market (or indeed other capital markets). On one level they are simply another example of how banks’ direct balance sheet support is now focussed on the short term, but if used effectively they enable borrowers to align funding with the needs of the business. Bridges need to be tailored rather than “taken off the shelf”, but they can help to manage risks around funding investment programmes and thus be a good example of using banking relationships to support the wider business.

For more information, please contact Lawrence Gill, Director – Centrus