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Market Update

Covenant trends in the U.K. social housing sector

March 22, 2024


Housing associations embrace EBITDA-only interest cover ratios for enhanced financial flexibility, paving the way for covenant relief and optimised debt management.

Say goodbye to MRI

Over the past two years, registered providers (RPs) have redefined financial covenants to unlock capacity within loan facility agreements and ease pressures from cost escalation and investments in existing social housing stock. No tool provided more financial flexibility than shifting Interest Cover Ratio (ICR) methodologies away from EBITDA-MRI (deducting major repairs from operating surplus) and towards EBITDA-only calculations on a temporary carveout or permanent basis.

EBITDA-MRI was initially promoted to monitor underlying operating cash flow and address the capitalisation of maintenance costs following the introduction of component accounting. Although it may still serve as a helpful internal golden rules metric, it fails to distinguish between routine maintenance and capital investment and is punitive as a loan covenant. EBITDA-only better aligns financial tests with RPs' long-term business goals, enabling greater spend on important areas such as EPC and fire safety.

Chatham continues to work with clients to place permanent debt covenants that provide useful operating flexibility. In many cases, this means restructuring or replacing legacy facilities in favour of new banking relationships with beneficial covenants.

Opportunities ahead

Covenant pressure is likely to continue into 2024-2025, forcing RPs to reprofile investment in existing homes and seek covenant relief. Over the next financial year, we expect housing associations to replace temporary carveouts or legacy definitions with market-aligned terms, optimising treasury portfolios and aligning stakeholder interests with financial performance.

The chart below shows the increase in ICR for a sample of 100 RPs when moving from EBITDA-MRI to EBITDA-only (based on RSH Global Accounts data, anonymised and randomised). In the sample, the average ICR increased by c.1.00x, while average ICR increased c.1.20x across 200 RPs using the same data.

Source: Regulator of Social Housing, Chatham Financial

Even at higher test levels, RPs benefit from EBITDA-only calculations. The lighter blue line in the chart below overlays the EBITDA-only coverage level at which the RP’s interest cover capacity is the same as that generated with a 1.10x EBITDA-MRI. Most often, the breakeven is comfortably above market-facing EBITDA-only levels, which average c.1.35x. This translates to incremental debt capacity, covenant cushion, and increased cost flexibility.

Source: Regulator of Social Housing, Chatham Financial

In practice, ICR amendments are more complex than deducting (or not deducting) capitalised major repairs. Methodologies vary by lender and include or exclude combinations of fixed-asset sales, impairment, gift aid receipts, repairs, EPC spending, fire safety, and non-cash charges from operating surplus to arrive at test EBITDA. Further, ICR is increasingly based on interest payable net of interest receivable but differs in consideration of capitalised interest. Each of these components factor into the relative value of test levels across RPs’ bank debt portfolios.

Interest rates

Optimising covenant portfolios may also coincide with opportunities to restructure legacy fixed-rate loans for interest savings and reduce interest payable in the ICR. RPs can issue intermediate to longer-term debt to take advantage of the flat interest rate curve and term-out expiring short-tenor facilities placed during the recent period of elevated rates.

Longer-dated embedded fixed-rate swaps from banks are increasingly uncompetitive, leaving RPs exposed to higher levels of floating-rate interest costs and, therefore, more volatile interest cover. RPs can instead use standalone hedging instruments or capital markets debt to preserve fixed- to floating-rate ratios and extend the average life of debt portfolios, which mitigates refinancing risk and improves liquidity.

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This material has been created by Chatham Financial Europe, Ltd. and is intended for a non-U.S. audience. Chatham Financial Europe, Ltd. is authorised and regulated by the Financial Conduct Authority of the United Kingdom with reference number 197251.