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;
- 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
- Issuance of Floating Rate Notes rather than the usual fixed rate format as many borrowers have become over fixed in recent years
- Use of local authority lending for development, revolving and longer-term facilities
- 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
- 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
- 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)
- 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.