Category: Market Insight

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

No longer one size fits all

As we move further into 2019, one of the big picture trends we are seeing in the UK social housing sector is a real diversification of funding strategies and sources. Pre-2008, with one or two exceptions, banks had a near monopoly on lending to housing associations via long term facilities and embedded or stand-alone swaps. The period between the global financial crisis and 2018 (again with notable exceptions in US and other currency PPs and a handful of retail bonds) saw the banks retrench to mainly 5-year funding and the UK institutional market (in the shape of public bonds and private placements) dominating the market for long dated funding, almost entirely in secured, fixed rate format.

As sector business models and strategies continue to diversify, we are perhaps starting to see a break down of the old “one size fits all” funding mechanisms and the development of a much wider range of funding solutions and sources for HAs which are more bespoke to the needs of the business. Examples include;

1. Increased use of unsecured bridging facilities from banks in order to secure liquidity and reduce timing/execution risk of capital markets issuance in potentially volatile markets
2. Issuance of Floating Rate Notes rather than the usual fixed rate format as many borrowers have become over fixed in recent years
3. Use of local authority lending for development, revolving and longer-term facilities
4. Increased use of unsecured funding from both UK and non-UK investors in order to increase flexibility and as loan security becomes a constraint within certain organisations
5. More direct funding into joint ventures and non-recourse commercial entities within groups in order to reduce reliance on on-lending or investment from the regulated entity
6. Greater willingness to access non-UK investor markets in order to retain pricing leverage and arbitrage pricing basis between GBP and other funding markets (e.g. US, Euro, Korea)
7. New group funding vehicles such as THFC’s bLEND and MORhomes

There has been a fairly consistent narrative in recent years that housing associations are getting a “raw deal” from sterling investors. When you look at pricing levels for sometimes weaker rated utility companies, for example, it is difficult to argue against this. Nonetheless, we would argue that the housing sector has perhaps played into the hands of UK investors by effectively signalling to them that they are the lender of first and last resort. This is in marked contrast to many issuers in the utilities sector, which play off sterling investors against the USPP and other non-GBP markets in order to tightly manage their funding costs.

This is borne out by some recent examples such as National Grid Electricity Transmission (A3/A-/A) which recently issued its first new sterling bond transaction since 2012 (excluding the liability management exercises undertaken as part of the Cadent de-merger in 2016) and only the second in the last 10yrs. The 16-year deal priced at G+120bps, significantly tighter than recent similarly rated housing deals. More recently, Bromford issued 20-year USPP the pricing of which we understand compared favorably both to its own secondary sterling bonds and recent issues by large HAs in the sterling market.

We see the challenge to established market orthodoxies as a healthy development for the social housing sector. As ever, changes to tried and tested funding mechanisms need to be fully understood from a risk management perspective and boards need to be comfortable with any associated treasury risks. For example, improving pricing dynamics by accessing a non-UK investor base may (where investors do not have natural sterling appetite) bring with it a degree of FX risk – whether contingent on pre-payment or outright, where the borrower swaps back into GBP. While these risks are manageable, they do need to be properly understood and capable of being monitored and managed from an operational perspective. This may preclude smaller organisations with less sophisticated and lower resourced treasuries which may opt for more vanilla funding structures.

MORhomes was of course predicated on its ability to address a number of sector challenges around pricing, ease of market access and structure. It is fair to say that we were always somewhat sceptical as to whether it could deliver on its stated objectives around pricing (other perhaps than for the very weakest credits) but had no evidential basis to support this. However, the spread on its debut issue of 190bps now provides a clear benchmark for HA borrowers weighing up their options, including own name approaches and the more competitively priced THFC aggregation vehicles. It is certainly clear given what we are seeing in the market that for larger and/or stronger credits, MORhomes (taking assumed additional enhancement/vehicle costs into account) is probably somewhere in the region of 40-60bps more expensive than what these borrowers might achieve in their own right. Even at the smaller/weaker end of the credit spectrum, it is likely that many borrowers would be able to achieve comparable or better pricing in their own name, although some may see non-pricing benefits in terms of structure and/or speed of execution (at least in respect of future transactions).

More generally, we fully expect this divergence trend to continue, bringing with it significant benefits for housing associations seeking both to minimise their cost of funding and to tailor debt structures to the specific needs of their businesses.

Originally published at the Social Housing Magazine on the 21st February 2019.

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Introduction

As a borrower it’s helpful to understand the thought process of a lender, and which issues feed into their risk assessment of a specific borrower or project.

Not all lenders are identical in their approach – their relationship managers, analysts and credit sanctioners are human after all and their collective views will combine with the institutional culture to drive the overall approach of the lender. Each lending entity whether an institutional investor or a traditional bank will have its own Higher Education (“HE”) credit policy and that may be influenced by many factors such as:

• Its existing exposure to the sector
• Current risk assessment of the sector / and the individual borrowing counterparty
• Competition for its funding resources (can the lender achieve higher returns in other sectors with similar risk parameters)
• Market intelligence, or the performance experience of its own portfolio of investments in HE

Some of the core credit principles remain as fundamental as ever and lenders remain focused on:

• An institution’s strategy, financial performance and balance sheet strength, both historic and forecast
• Reputation, quality, external measures such as league table positioning, National Student Survey results etc
• Quality of management and governance

These aspects whilst critically important are generally well understood and most borrowers will have rehearsed their stories to present a positive credit proposition to lenders. However, it is the external landscape that we believe some lenders are currently considering more closely.

Over the last few months there has been plenty of Higher Education press coverage, most of which has been negative in tone. Whether some of this commentary is justified or purely scaremongering is a decision for the lender to either take note of or ignore. Without doubt though, there is a strong political influence becoming evident across issues such as:

• The “Value for Money” debate, student contact time, and Vice Chancellor remuneration
• Theresa May announcing a freeze for 2018-19 on UK/EU Undergraduate (UG) fees, and whether these signals the start of a more aggressive policy on UG fee levels
• Whether government might introduce a lower cap on fees for lower cost humanities subjects or at least limit the extent to which the Student Loan Company will fund these subjects
• The sustainability of the current student loan mechanism and a widely publicised figure of UGs graduating with up to £50,000 of student debt, more students predicted not to fully repay their loans, interest rates of 6%+ on post Sept 2012 student loans.
• Concern over recruitment prospects with demographics showing fewer 18-year olds and EU applications declining, the first dip in applications since 2012.
• The impact of Brexit, and the uncertainties of a “No deal” scenario on EU staff and students’ status, and EU research funding accepting that many commentators feel that common sense will prevail with a transition period on these issues
• USS Pension deficit and the affordability of higher contributions
• A revised regulatory position with the passing of the Higher Education and Research Act and the introduction of the Office for Students

Perhaps these points will give further credence to students considering alternatives to the traditional University route post-compulsory education. There seems to be a growing awareness that progression to University is but one of the options available now. It remains true however that the quality of our HE  provision in the UK is still strong overall and that many students benefit from a University experience.

UniversitiesUK published their latest Facts and Figures document recently

• Overall Student Satisfaction 84%
• Recruitment levels from 18-year olds in lower participation areas at record levels
• Employment rates and median salaries continue to be higher for graduates
• England and Scotland saw an increase in Full Time student recruitment in 2015-16

However, the initial indicators for 2016-17 show there are signs that that these growth trends may be reversing.

During August there was plenty of commentary that HE Institutions were nervous about recruitment, citing the toughest ever student recruitment season. Figures from UCAS, the admissions clearing house, have shown a sharp fall in the number of applications for undergraduate study from UK-based students for the first time since 2012, as the shrinking demographic pool of secondary school leavers has combined with fewer applications from mature and part-time students.

In previous years, applications from EU and non-EU students have been an area of growth. But the Brexit referendum and its associated uncertainty has seen a marked decline in EU applications, despite strenuous efforts by the government and the higher education sector to reassure prospective students that they won’t be affected by any fall-out from the UK leaving the EU.

This represents the first drop in volumes of EU applications over the past decade – a period which has otherwise been marked by steady and substantial growth in EU student applications to British institutions (in sharp contrast to the apparent trend for 2017/18, applications from EU students increased by 7.4% between 2014 and 2015 and then again by another 6% from 2015 and 2016, but EU applications are down 5% for 2017 compared to 2016).

The latest UCAS figures that show the number of people who had applied to UK universities for the coming academic year by the 30 June deadline was 649,700 – compared with 674,890 in 2016.

There have been reductions in applicants from all four countries in the UK for 2017 and the trend reversal can be seen below:

Lenders will be scrutinising these recruitment indicators and the actual performance of individual institutions that they are considering investing into. Lenders will always consider investment opportunities on a case by case basis, historically they may have drawn comfort from the perceived level of government support for the sector and the fact that demand out stripped supply with student numbers historically demonstrating an ever-increasing trend (other than 2012 when the £9,000 tuition fee regime was introduced but even then, application numbers recovered very quickly to pre-2012 levels).

The latest HEFCE Financial health of the higher education sector: 2016-17 to 2019-20 forecasts publication issued in October 2017 commented:

“Our analysis of the sector’s financial results for 2015-16 showed a sound financial position overall. However, there was an increasingly significant variation in the financial performance of individual HEIs, and a widening gap between the lowest- and highest-performing institutions.”

“Sector borrowing [in English Universities] is projected to rise from £8.9 billion at the end of 2015-16 to £11.7 billion by the end of 2019-20. Relative to total income, sector borrowing levels are projected to reach 36.8 per cent by the end of 2018-19, before falling to 35.1 per cent by the end of 2019-20.

“Borrowing levels are expected to exceed liquidity levels in all forecast years, by £577 million at 31 July 2017, increasing significantly to £5 billion at 31 July 2020. While this does not raise an immediate viability concern, the current trajectory of increasing borrowing and reducing liquidity is unsustainable in the long term”

Lenders are looking much more closely at the prospects for individual institutions. It is too early to draw any clear conclusions regarding lender appetite, but we expect lenders to become more selective in the investments that they support and to reflect the potentially higher credit risk in the margins that they charge as well as greater differentiation between the terms provided to different institutions. This, coupled with the anticipated rise in interest rates will put more cost pressures on some Universities.

How can Centrus assist?

Centrus can:

• Review existing debt and derivative portfolios to ensure your institution has the optimal funding and interest rate risk management structure, providing advice on restructuring if appropriate
• Undertake feasibility studies to ascertain debt capacity, reporting on market appetite and pricing as well as consideration of funding options across different providers of debt in the banking, private placement and public bond markets
• Support the feasibility and structuring of financing in relation to specific projects under consideration on a recourse, limited recourse or non-recourse basis
• Working with institutions to present their credit profile, organising a funding process and facilitating the execution of a debt transaction either in the bank or the institutional market
• Determine accounting impacts, such as hedge accounting costs for a range of options.

For more information, please contact Robert St John, Director – Centrus