Housing associations (HAs) have grown and changed considerably over the last few decades. Many were originally set up as small-scale organisations that managed a few dozen properties in simpler times, when their purpose was clear and arguably more manageable. Fast forward to today and some HAs have developed into enormous and complex groups capable of harnessing vast amounts of private finance, as well as receiving billions of pounds in grant funding from the Government.
The importance of HAs has grown as the status of local authorities as major housebuilders has subsided over the last few decades. HAs now find themselves responsible for hundreds of thousands of individuals living in their homes. This relationship has, at times, proven difficult to manage, and critics suggest that this exponential growth has caused some HAs to stray from their core purpose: supporting tenants.
This debate has been recurring more and more frequently in recent years as several HAs have announced plans to merge with one another. Where some boards may see a larger organisation as more stable and therefore better able to serve its customers, there are those who claim that bigger organisations are run more like corporates that prioritise investors over tenants. This is perhaps the fundamental dichotomy that HAs must evaluate when looking to merge, but there are many more factors that should be considered.
What is driving mergers?
Given the challenging economic context, it is unsurprising that we are seeing more HA mergers. Rising inflation and increased cost of materials have compounded financial constraints on HAs, who are already dealing with the monumental cost of decarbonising their housing stock.
The financial challenge was identified by the Regulator of Social Housing (RSH) in its most recent quarterly survey, which found that the sector’s interest cover has fallen to a record low of 102%. The RSH has also downgraded swathes of HAs over the last few months, citing intensified economic pressures.
If we look at the recent history of mergers in the sector, there are two distinct types, according to Ray Tierney, Relationship Director at Lloyds Banking Group’s Social Housing team. He explains that there have been a number of examples of mergers taking place where one HA is in financial difficulty and is helped out by another organisation with a stronger balance sheet. These situations are commonly referred to as “rescue mergers.”
On the other hand, there are “mergers of equals,” which tend to be driven by the expectation of economies of scale.
Ray says: “An example would be the merger between Peabody and Catalyst. These were two strong associations, both G15, with strong management teams, that can both raise debt independently.”
The benefit of these types of mergers is increased resilience against external financial headwinds. Ray says: “It’s about having the ability to manage complexity, and you would say the larger the management team, the more resource they would have to manage that.”
The merger activity that has occurred over the last decade largely consists of mergers sparked by the 2015 rent freeze and those driven by the combination of the net zero agenda, fire safety issues, damp and mould problems and inflation.
However, the justification for these mergers has gradually evolved. As Ray explains: “Previously the reasoning behind mergers was more about being able to develop more homes. But now the conversations are a little bit more about how mergers will allow the organisation to invest more in existing stock.”
This is indicative of how much pressure the sector has come under in recent years. Whereas HAs used to take extreme measure by merging in order hit development targets, they are now doing so in response to widespread issues of safety and quality concerns.
What do funders want to see?
From a funder’s point of view, there are a number of details that need to be firmly in place before a proposed merger can be supported.
As Grant Vaughan, Partner at Newbridge Advisors, explains: “From a treasury perspective, we want to know if there are going to be any material blockers or concerns. With one HA effectively inheriting the loan book of another, we want to ensure that the covenants structures aren’t particularly onerous and won’t cause any issues for our clients once they’ve merged.”
Ray is keen to stress the importance of the board structure that will be formed as a result of the merger.
He says: “I think the management team has always been vital. The ability for the management team to manage through complexity is very, very important. From our point of view we need to understand how the team is able to work together effectively.”
Arun Poobalasingam, Head of Relationship Management and Business Development at THFC, notes that the more, better quality information a HA can provide, the smoother the consent approval process. THFC has come up with its own 12-point checklist that forms the basis of its information requirements when dealing with mergers:
THFC’s 12-point merger checklist
- The detailed business case for the merger when produced
- The combined long term business plan, accompanying board narrative, and financial forecasts (in FFR format), as well as individual FFRs
- Confirmation of the proposed executive and board teams of the combined group, or, if to remain separate, details of the proposed governance structure
- Sight of stress tests undertaken on the group consolidated plan
- Details of the currently available liquidity across the combined group and a note as to how this is expected to change (if at all) upon merging
- Confirmation of the most restrictive covenants that will apply
- Fire safety: full details of high/mid-rise properties (split 11-18m and 18m+) in the portfolio, and the extent, cost and timing of any remedial works required
- Stock condition: details on the stock of both parties, the range of archetypes, age, condition surveys, level of investment, and compliance checks
- Details of the impact (if any) on pension schemes across the merger entities
- Details of the group decarbonisation plans and how these are factored into the merger case
- Details of advisors and professionals performing due diligence
- Indications regarding funder concentration issues
When mergers collapse
The breadth and depth of information mentioned above can help get a merger over the line, but sometimes plans to merge fall by the wayside for one reason or another.
“What is interesting is to look at why some mergers don’t complete,” Ray says. Often, he says, merger talks collapse due to the amount of complexity involved. Sometimes, the parties cannot justify the move due to potential impacts on their service provision.
Last year saw a three-way merger proposed between Flagship, bpha and Futures, which would have created a new 60,000 home organisation. However, it was announced in October 2022 that the plans were being scrapped due to “unprecedented” changes in the economic environment. This demonstrates the challenge of undertaking a merger that can take many months to complete, in which time the economic picture can shift beyond recognition.
“One thing that we are very mindful of is announcing a merger and then the parties involved announcing that it is no longer happening,” says Grant.
He explains that announcing merger plans can have a material impact on things like bond spreads. Grant gives the example of talks between Sanctuary and Southern from 2021, which would have created the largest HA in the country.
“When that was announced, suddenly Sanctuary bond spreads widened quite a lot and Southern’s tightened. When it was announced that it was off the table again this was reflected in the spreads. So there was a lot of market movements that didn’t need to happen. It’s really about managing your external communications,” he says.
Opposition to mergers
With each merger that is announced, there are typically concerns expressed from some quarters about the implications of the move for tenants. In recent years, there has rightly been a sea change in the sector aimed at placing tenants at the heart of decision making. Supported by legislation such as the Social Housing Bill, landlords are required to put more effort in understanding the condition of their stock and challenges faced by their tenants.
Some fear that with each merger, HAs are growing to a scale that will inevitably impact the quality of service for their customers. In fact, a recent survey by audit and consulting firm RSM found that 64% of respondents do not believe that mergers improve services for residents. This, Grant argues, is even more reason for HAs to have adequate systems in place pre-merger.
He says: “Nobody can know what’s going on in every single property of course, but it just becomes a lot more important that you have the right processes and policies in place to be able to monitor the homes and ensure you’ve got the right quality homes, and obviously customer satisfaction remains high.”
According to data from the RSH, the number of Registered Providers fell from 1,570 to 1,424 between 2016 and 2020, largely driven by merger activity. Since this report was published, the sector has seen several more mergers, and many expect this trend to continue as HAs look to strengthen while they battle the economic headwinds.
As Ray says: “The sector is much more comfortable with mergers since the 2016 rent settlement and they have more awareness of the challenges they are taking on.”