Is now the time to consider unsecured borrowing?

As housing associations’ finances come under increasing pressure, how much will unsecured borrowing have a part to play? Gary Grigor of Devonshires and John Tattersall of Centrus Financial Advisors assess the situation

The housing sector has been hit by a number of challenges in recent months. What began as a cost inflation challenge quickly became a more acute operating margin challenge in the face of unspecified caps.

With borrowing costs now far higher than originally forecast, interest cover covenants are coming under increased pressure. 

The pan-sector response is still in development, but capex is likely to slow in the short term and efficiency savings will be needed.

Liquidity requirements are likely to fall too, as the temptation to reduce facilities and save carry costs to optimise interest cover performance appeals.

This strategy has risks, though, particularly where it takes time to put new facilities in place should requirements pick up again.

It is in this context that unsecured borrowing may have a strategic part to play.

Unsecured borrowing allows registered providers (RPs) to dispense with providing and maintaining a ring-fenced pool of property security either via a security trust mechanism and/or direct charging to the relevant funder.

Instead, the organisation must maintain a pool of unencumbered assets for the life of the facility. The upside of this is that the time, effort and expense associated with pledging a ring-fenced pool of property security under conventional funding arrangements is dispensed with, paving the way for a quicker and more decisive funding solution.

Unsecured borrowing can also be scaled up and down far quicker than conventional secured funding.

While an unencumbered pool of assets must be preserved at all times, there are not the same rigorous due diligence requirements to be satisfied.

Provided that the unencumbered assets stack up to meet the minimum threshold from a valuation perspective, then that, in itself, will be sufficient.

As a result, the composition of the unencumbered property pool can also dynamically fluctuate over time, facilitating easier asset management and offering protection should asset values fall, as potentially forecast next year.

The Pros and Cons

Pros

• Speed of execution: With no security charging process, facilities can be executed and available comparatively quickly. They can also be restructured and re-sized with greater ease. Unsecured facilities can offer strategic value where a debt capital markets programme is in train, but the timing is not quite right to launch.
• Flexibility: Release and substitution mechanics do not apply, so managing the unencumbered asset pool is generally straightforward – helpful where stock rationalisation is under way.
• Sweating the asset pool: Most portfolios have assets that wouldn’t otherwise be acceptable to a funder yet can still generate borrowing capacity via the unencumbered pool.

Cons

• Cost of carry: Margins and fees tend to be higher for unsecured facilities, albeit the differential to secured facilities has meaningfully narrowed in recent years, particularly on an undrawn basis (as low as five to 10 basis points per annum in some cases).
• Shorter tenor: To further offset the cost difference, most unsecured facilities tend to be structured on a three-year term, if with annual renewal/extension options sometimes available.
• Overall asset cover efficiency: Higher asset cover ratios tend to apply in sizing the unencumbered asset pool rather than would otherwise be expected on charged security.

We have advised on £540m of unsecured facilities in the past 12 months, and in several instances, facilities have been scaled up with the additional funding available in less than three weeks from the initial request.

Who should be thinking about it?

Funders will, of course, make decisions on a case-by-case basis, but in our experience, it is likely that an RP with the following would potentially benefit from this financing route:

• Reasonable scale: lenders have a strong preference to be one among many lenders, which favours larger treasury portfolios
• A strong credit profile – potentially supported by an external rating with a rating agency
• A diverse loan portfolio, which is looking to ‘right size’ liquidity, while baking in flexibility and the ability to scale dynamically if needed
• A big enough pool of residual unencumbered assets seeking to ‘sweat their assets’ more efficiently

The providers

While initially led by some of the newer entrants looking to make a footprint, most commercial funders will now entertain the prospect for the right RP.

In debt capital markets, some institutional investors have also demonstrated their ability and willingness to provide unsecured finance where suitably compensated in the spread, but experience informs us that this tends to be reserved for some of the larger RPs.

If debt capital markets funding is likely to be drawn, the cost differential can also be wider than seen on standby liquidity lines.

This is not to say there isn’t value in unsecured debt capital issuance, particularly where a portfolio contains challenging or quirky assets that would otherwise be challenging to leverage.

The increasingly challenging operating environment may dampen the appetite for unsecured lending among banking institutions, particularly should there be a general reduction in the sector’s credit standing.

However, for the time being we continue to see term sheets offering attractive unsecured funding from a broad range of lenders on a regular basis.

On that basis we consider this a viable solution that deserves due consideration in RP business plans across the country.

Gary Grigor, Partner at Devonshires, and John Tattersall, Senior Director at Centrus. Originally published in Social Housing Magazine, 2022.

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