Key themes for housing associations in 2024

What happened in 2023

2023 proved to be a challenging year for the sector, with many HAs having to balance stakeholder obligations and financial performance. This resulted in a slowdown in new development for many, coupled with the reprofiling of investment in existing homes.

A high-inflationary environment combined with rent caps and non-deferrable capex led to weaker performance for most HAs. We saw a series of downgrades and revisions to outlooks from the ratings agencies on the back of this deterioration in ratios, particularly in the second half of the year. This affected both ends of the credit spectrum. There are now an increasing number of HAs occupying the A-/A3 and BBB+/Baa1 ratings bands, which will require more careful management by issuers given investor sensitivities in the lower half of investment grade.

Covenant pressure increased as both topline revenues and the cost base came under pressure, accelerating the shift to the EBITDA-only covenant tests to allow HAs to spend on important areas such as EPC and fire safety. Banks have accommodated this change throughout the year, particularly for new names.

Most housing associations entered 2023 with reasonably high levels of fixed-rate debt. This fell significantly over the year due to a combination of difficult issuance conditions in the capital markets, high-fixed rates, and board reluctance to lock in to fixed-rate debt at what was perceived as the top of the rates cycle. Chatham saw more HAs operating with hedge ratios in the 50–80.00% range in 2023, down from 70–100.00% in prior years.

Heavier reliance on bank debt also shortened portfolio weighted average life, as lenders focused on the three-to-seven year maturity band (with some exceptions). Preference for shorter-tenor fixed-rate bank debt — where available — added to pressures on tenor. Chatham does not see this as a pressing concern for the sector yet, but given the general preference for longer-dated fixed-rate debt, we expect the tension between tenor, rate risk, and refinance risk to be a key talking point through 2024.

What we expect to see in the coming year

Return to capital markets

Investor appetite for housing association credits remains high while supply remains depressed relative to recent years.

In the public market, we have seen good secondary demand for HA names, which were a beneficiary of strong investor demand through December, reflecting trends in the wider sterling corporate bond market. While benchmarks gave up some of their gains at the beginning of 2024 and yields rose, spreads remained compressed for many of the larger, more liquid HA names. This is a good indication of investor support and is driving very positive issuance dynamics at the start of the new year.

In the private market, activity picked up through the second half of 2023, despite the more challenging conditions in primary. Options to spread maturities and adjust tranche sizing helped to reduce execution risk (versus public), which was a key consideration given weaker investor demand and coverage ratios on a number of public deals in the sterling market between July and September. These will remain important themes in 2024 where the ability to be opportunistic and capitalise on attractive issuance windows will add value — for example, with existing investors, up-to-date documentation, and security ready to charge. A pickup on the broader USPP market, which we have seen since November, will also help broaden the pool of demand. Upsizing of recent USPP deals is a very positive sign for investor appetite. Cross-currency pricing is currently favourable for U.K. issuers, allowing offshore accounts to drive greater competition on new deals.

Tenor was one area where investors and issuers struggled to find a comfortable middle ground in 2023. With higher all-in yields on offer and a continued appetite for long-dated credit to liability matching, investor demand for tenor was strong. Issuers, on the other hand, were reluctant to add long-term interest costs to the business plan and preferred 10–15 year notes, accepting the trade-off of refinance risk. This was considerably shorter than where most investors were happy to participate. In the wider sterling investment grade space, issuers achieved much better bid-to-cover ratios on longer tranches of 15 years and above versus shorter seven-to-15 year maturities. Recent success of shorter-dated transactions, including on the retained side of the market and the recent AHGS deal, has helped resolve this. In 2024, we expect HAs to have more tenor flexibility.

Primary markets have been very busy across GBP, USD, and EUR in January. "First-movers", such as Sovereign Network, have been able to take advantage of this and issued at attractive all-in levels. Due to the volume of issuance in the past two weeks, we have seen new issue concessions/premia widen, but this is more than compensated for by lower benchmark yields and tighter spreads. With a clear economic calendar in the coming weeks, heightened political uncertainty around the Middle East and elections in the U.K. and U.S. later this year, we are likely to see many issuers in this sector and others move sooner rather than later. Indeed, the “wall” of pent-up refinancing demand, especially within the commercial real estate and corporate sectors, may lead to periods of temporary oversupply in the market — impacting investor demand and pricing for HA debt.

In 2024, ESG will continue to be important. The sector has made considerable progress in the reporting, alignment, and standardization (to ICMA or LMA) in the past two years, which we expect to continue in the new year. ESG frameworks and Second Party Opinions (SPOs) have become standard in the primary market; however, private investors and banks place less pressure on formal accreditation. Many smaller issuers find the cost-benefit prohibitive given high costs to certify the good work HAs are already doing. We have yet to see a requirement for official frameworks and SPOs in the banking market, where ESG KPIs are still agreed on a bilateral basis, but this may be an area where issuers can capitalise on the work to support capital markets issuance.

Affordable homes guarantee scheme

ARA Venn issued a new 10-year GBP 350M bond under the Affordable Homes Guarantee Scheme at the end of November. This was considerably shorter than previous issues under the programme (2051, 2052, and 2053) and will help to build out the credit curve and give issuers a new pricing point to consider. Priced at G+55 bps for an all-in yield of 4.818% (before costs), we saw compression of five-to-10 basis points from initial price talk of G+60–65 bps. This compares with spreads of 35–40 bps on the 2053s at the time of issue, suggesting investors were looking for some concession for the shorter-tenor. This spread differential has remained steady since issue.

It was announced during the Autumn Statement that the government is increasing the scheme from £3B to £6B and broadening its scope, which will help more organisations access low-cost, government guaranteed funding. Alongside the recent shorter-dated issuance, we expect this will be an active funding route for HAs to approach the capital markets in 2024.

Gilt and swap markets

After rising throughout the year to the end of October, we saw large declines in both gilt and swap rates in November and December. At the low point, the long gilt (30-year) was trading at 4.00% while five-year swaps traded at 3.30% before fees. A shift in rate expectations was the main driver of falls, with participants expecting the Fed to move away from its "table mountain" policy of higher for longer to a "deep cut" policy of normalization through 2024 as inflation pressures subsided.

Bearish comments from the Fed, European Central Bank (ECB), and the Bank of England (BoE) have taken the heat out of the rates rally since the start of the year. Gilt yields and swap rates have moved back up over the last three weeks, although remain below October levels.

Upcoming inflation prints will be key dates for the markets, as seen with the latest December numbers in the U.K. Headline CPI came in at 4.00%, up from 3.90% in the 12 months ending in November. This marked the first rise in inflation since February of last year and contrasted with the slowing price trend throughout the second half of 2023. Core CPI, a key indicator for the Monetary Policy Committee, has shown resistance and remained unchanged from the November reading at 5.10%. While there has been a rapid decline in goods CPI from its peak at 14.80% in October 2022 to 1.90% in December 2023, services CPI continued to sit at elevated levels of 6.40%.

Current consensus is pricing in the first rate cut in June or September with at least three more by year-end.

Hedging

Standalone hedging

There has been an increase in the cost of hedging using embedded derivatives (fixed-rate loans). Banks have actively nudged housing associations towards loan-linked or standalone derivatives. There is a clear price differential, with most banks who actively lend to the sector having no appetite to offer further fixed-rate loans and impose caps on the levels of embedded fixing available. This has restricted fixed-rate loan products to smaller HAs that fit into the banks’ SME lending books. It has also presented some treasury and financial governance challenges for boards of HAs with limited or no previous experience of standalone derivatives.

Active management of hedging portfolios and pay-float swaps

One benefit of a move towards standalones will be additional flexibility for HAs, the ability to have more actively adjust hedging portfolios, and to take advantage of pricing opportunities. For some, this may mean separating the hedging and financing decision to focus on the market that can offer the deepest pool of capital at the best tenor and tightest pricing, using hedging to adjust back to the right level of rates exposure.

Some housing associations have explored opportunities to enter into receive-fixed pay-floating (bid-side) swaps, as a way of rebalancing fixed-to-floating ratios. This has also been explored as a way of synthetically creating a longer floating-rate note on the back of a bond issuance. With the larger issues benefiting from economies of scale and capable of doing a benchmark issue, using a receive-fixed swap allows these issuers to swap back the fixed-rate debt to floating.

Bid side swaps enable HAs to be more flexible with their hedging portfolios and raise floating-rate debt at medium-to-long tenors, where floating-rate note markets typically do not have much appetite. The use of bid-side swaps is something seen more commonly in commercial real estate markets. However, we expect to see these used more frequently by registered providers looking to rebalance their hedging.

Increased competition between hedge providers and shorter-dated hedging

With more housing associations entering the standalone hedging space, we expect borrowers to see an increased availability of hedging options with existing lenders competing to drive tighter pricing. We may also see third party hedge providers being used — this is where a hedge counterparty is not a lender, but can offer pricing on standalone hedging.

Increased competition will allow HAs to be in a better position to negotiate credit charges and apply pressure to lenders to sharpen pricing. Chatham sees this in the broader corporates market where standalone hedging is more commonly used, and this is a theme that may transcend beyond corporates and general real estate borrowers into the registered provider space.

For borrowers that are security constrained, we could also start to see more unsecured ISDAs being negotiated. Chatham is aware of a few lenders that are currently offering this with attractive credit charges on unsecured swap transactions. Whilst increased competition is one way we expect to see borrowers managing hedging costs, another theme that is likely to appear in the coming year is a push towards shorter-hedging tenors. Shorter-dated hedging can offer lower credit charges, and depending on the shape of the curve, borrowers can match the hedging to “sweet spots” in the swap curve where rates are more attractive at any given time.

Accounting treatment

Moving away from embedded fixing increases the complexity of accounting treatment. Many housing associations will apply hedge accounting to reduce volatility from net income. We expect that over the next year, accounting considerations will play a larger role when considering fundraising and restructuring exercises.

A greater focus on accounting volatility may also push some borrowers towards shorter-dated, more active hedging programmes. These can help balance the protection offered by hedging, while not unduly adding duration which can result in larger accounting and collateral volatility (whether hedged or not).

Operating environment

Rent setting will be a key issue for FY2025 with the removal of the 7.00% rent cap and uncertainty over the end of the 2020 Rent Standard. While removal of the cap should be a positive for profitability, we expect many HAs will find it difficult to pass through full CPI+1.00% increases at 7.70% next financial year in an environment where prevailing inflation has fallen to 3.00% or below. Shared Ownership Model Lease rent reform will also constrain future increases for this class of tenancy, with new lease uplifts capped at CPI+1.00%, although there may be some scope for landlords to use the full rent limit of 3.00% to offset this, as opposed to 2.75%.

Reforms to the Decent Homes Standard are also expected to increase costs for many RPs, placing additional margin pressure on business plans. These may overlap with other spend on net zero and EPC.

Upcoming customer regulation and grading has the potential to add costs into plans, although Chatham has yet to see any potential remedial works being scoped out in detail in FFR submissions.

The net effect of these changes will put continued pressure on profitability and margins. Rent increases reverting to formula may provide some relief in the short-term, but will cause continued uncertainty on medium-term profitability. Progress on each of these areas will be of interest to investors, ratings agencies, and banks. Managing the narrative will be important for HAs to present a consistent credit picture to each of these stakeholders.

Conclusion

Housing associations continue to innovate, and we see this trend continuing through 2024. Borrowers have access to a wider range of investors and funding instruments than they have in the past, including shelf facilities, standalone hedging products, and shorter-dated issuance. While the rates environment remains volatile, recent transactions have shown that the sector continues to occupy a sweet spot for investors with its high ratings, regulatory oversight, and stable business models.

Pressures on profitability through the remainder of this financial year and next are likely to put further pressure on margins and debt service metrics, and managing these will be of increased importance for HAs to present an attractive credit story.