Navigating the funding markets: what do investors see as the risks?
2022 will be another key year in the UK’s attempt to solve the housing crisis. As with all sectors, housebuilding has sustained a heavy blow as a result of disruption caused by the Covid-19 pandemic and resultant economic fallout. While UK Government support schemes have helped businesses navigate the choppy economic waters of 2020/21, the desperate need for more homes has not abated.
In its 2019 manifesto, the government set out a commitment to produce 300,000 new homes each year by the mid-2020s. Progress towards this target was initially sluggish but soon figures were heading in the right direction, reaching 243,000 in 2019/20 before the pandemic reduced output to 216,000 in 2020/21.
Depending on how you define the ‘mid-2020s’ the housebuilding industry has just a few years in which to kick into overdrive and meet those lofty targets. But volume alone will not solve the housing crisis – we need the right type of homes. One report commissioned by the National Housing Federation (NHF) and homeless charity Crisis suggested as many as 340,000 new homes are needed in England each year, of which 145,000 should be for affordable tenures.
Housing associations will be vital to this effort. But the £12.2bn Affordable Homes Programme will only go so far, and sourcing cash from debt capital markets will become increasingly important.
For some time now housing associations have enjoyed the ability to draw on private capital at low rates to help meet their development ambitions. But with so much uncertainty, what does this mean for social landlords and their funding options?
GEOPOLITICAL IMPACT ON FINANCIAL MARKETS
Vladimir Putin’s decision to invade Ukraine is first and foremost a humanitarian crisis. But one of the many wider impacts is that it has also wreaked havoc on the global financial markets. The widespread economic sanctions are being felt throughout the markets and this has implications for any organisation that looks to the capital markets for funding, including housing associations.
As Fiona Dickinson, investment director at abrdn, explains: “We have seen very little issuance since Russia invaded so it is clear we have moved to a ‘risk off’ environment”.
The invasion led to the effective closure of the markets temporarily and has caused a build up of postponed issuance in the Sterling and Dollar bond markets, expected to include social housing issuers too. While investors do have cash to place, and appetite for housing associations is not apparently diminished, many issuers are choosing to wait given the uncertainty around pricing.
These latest geopolitical developments in Eastern Europe, which are changing by the minute, present another moving part for associations to grasp on top of existing domestic financial challenges.
RISING INFLATION
Before the Ukraine crisis the Bank of England had warned that inflation could rise above 7% in 2022, driving up day to day living costs as well as increasing costs for businesses. Housing associations are not insulated from these costs and finance teams will be planning and stress testing as a result.
For social landlords looking to access the debt capital markets, costs will rise. As Chris Evans, a director at Newbridge Advisors explains, the sector has grown accustomed to a low rate environment with budgeted cost of funding reflective, generally around the 3% mark. But he notes this figure will begin to get tested with the market currently pricing in a further two rate hikes in March and May.
“With the Bank of England flexing its monetary policy, base rates have increased, which typically has a read across to the cost of funding for all fixed rate borrowers in the UK,” he says.
Will Stevenson, deputy treasurer at THFC adds: “A rising interest rate environment will increase the sector’s borrowing costs, but with many associations having taken advantage of locking in historically low long-term rates, the extent to which this will actually impact business plans is likely to be deferred, and of course there is uncertainty about how far rates will rise.”
But it is not just the cost of borrowing that will hurt social landlords; inflation will also impact the cost of materials. Despite price inflation of materials and shortages of labour easing since last year, supply chain disruption still exists. This will have a direct impact on housing associations’ development programmes – something which credit ratings agencies are monitoring.
Maylis Chapellier, analyst at Moody’s, says: “For inflation, we are looking at how that will impact development plans. Most housing associations have ambitious targets in terms of being able to build new houses to help tackle the housing crisis.”
Rising labour and materials costs, as well as inflation, were all highlighted in Moody’s annual summary report for the sector. Published in December 2021, the report warns that these pressures are weighing on “already thinner margins arising from a greater reliance on lower-margin market sales”.
RATINGS DOWNGRADES
With these cost pressures, there will always be a threat to housing associations’ individual credit ratings. In their sector-wide analysis, the ratings agencies have identified the UK social housing sector as stable, but even so, individual housing associations will need to work hard to maintain their current good credit profiles.
Mr Evans of Newbridge sees ratings pressure as a key risk to the sector in the coming months. He says: “The vast majority of housing associations are still in that single ‘A’ category, but, the sector is having to navigate various headwinds and, at some point, we will start to see housing associations downgraded into ‘BBB’ territory. That is still considered investment grade and, there will still be appetite to lend, but the cost of funding versus those rated ‘A’ is going to increase.”
S&P Global Ratings said 84% of its 43 UK housing associations have a stable outlook but that follows downgrades of eight registered providers in the last year. The agency highlights a “sharper focus on asset quality and consumer standards” as the main risk to sector.
The ratings agencies all highlight the competing pressures of developing new homes as well as investing in decarbonising existing stock.
“Housing associations are facing conflicting messages from government,” Ms Chappellier at Moody’s notes. “On the one hand, they are required to build more homes but on the other hand they are being encouraged to retrofit their entire stock. Our view is that there will be a tradeoff between retrofitting and building.”
Fiona Dickinson, Investment Director at abrdn, also highlights this tradeoff. “The biggest riskis an association getting the balance right between fire, health and safety capital expenditure and ongoing development. I would be cautious about the risk balance for those associations that are maybe too determined to achieve their business plan development numbers and not swaying from that.”
THFC and Buro Happold’s Retrofitting Social Housing: a Funding Roadmap looked at the ways housing associations can meet the challenge of retrofitting. One part of the solution would be for the Government to provide guaranteed debt to fund initial retrofit investment.
COMMUNICATING WITH INVESTORS
Over the past few years, more and more housing associations have been entering the debt capital markets in search of extra funding and to refinance existing bank debt. The path has become well-trodden with investors repeatedly acknowledging the sector as a sound option for Environmental, Social and Governance (ESG) investments.
But the rise in housing associations seeking capital markets debt also poses a challenge: with more options for investors, landlords must work harder to stand out.
As Mr Evans puts it: “Investors will become more selective. They do not invest in every housing association that comes to the market. As a result, the quality and frequency of information provided is carrying greater influence on future investment.”
He notes that, with such a range of options in front of them, investors can afford to be more demanding about who they invest in. To address this Mr Evans highlights the importance of staying in touch with investors even after a bond issuance and constantly demonstrating the value that housing associations represent as an investment.
One way housing associations are seeking to do this is through enhanced reporting and achieving certifications that help investors understand their value.
“There is a greater level of professionalism around housing associations when they look to borrow now,” says Ms Chappellier. “They are labelling their bonds now and doing the right advertising, so for professional investors it has become easier [to invest].”
Part of the ‘professionalisation’ of the social housing investment sector can be attributed to the Sustainability Reporting Standard for Social Housing, which was introduced in November 2020. The standard, of which THFC is an early adopter, has helped unify the way in which social housing providers demonstrate their ESG credentials.
Will Stevenson at THFC said: “The UK government is pursuing a strategy of directing private capital into net zero transition projects to minimize the level of public subsidy needed.
“The SRS represents a solid basis for ESG disclosure which in turn encourages private investment in social housing decarbonisation.”
The convergence of decarbonisation, fire safety remediation and wider economic pressures has left housing associations in a tough spot. But it is important to view the sector from a wider investment perspective. Social housing in the UK is well regulated, government-backed and produces positive social outcomes. For investors, these features make for an appealing and secure destination for their cash and this should remain the case, according to the ratings agencies.
However, the shift from a comfortable low rate environment should not be taken lightly and housing associations should put in the work now to ensure they are maintaining good relationships with investors and gathering and reporting quality data which will continue to render them an attractive investment.
