Opportunities for housing associations in a high rate environment and why timing matters

Indicative pricing

Market update

Sterling bond market

• Negative market sentiment seems to have eased despite significant sell-off in the gilt market following the release of U.K. CPI figures.
• The gilt curve has been volatile, but the market rallied towards the end of last week, resulting in a 15 basis points decrease in yields.
• Sterling issuance has mainly concentrated on the three-to-five year range, but there are indications of investors seeking longer durations.

Housing association spreads

• Housing associations (HA) have tightened by one basis point, tightening across all tiers over the past fortnight.
• Spreads appear to have reached lows, with tightest credits trading at G+90 bps area – in line with the lowest levels we have seen historically.

New issues

• There have been no new own-name housing association issuance in the past fortnight.
• We expect a number of issuers to approach the market in the next two-to-three months.
• Given the current economic backdrop, this presents a challenge for pricing, with rates expected to peak in autumn and remain elevated through the middle of next year.
• Issuing sooner rather than later and taking advantage of excess demand for bonds may help drive value for those issuers that are ready to approach the market. Driving value this way and pushing for tighter spreads on new issues may be the best way to achieve pricing targets.
• Flexibility on duration and timing will also be important, particularly for borrowers targeting shorter maturities where small differences in tenor can translate into large differences in benchmark yields.

Opportunities in a high rate environment

• The present high rate market environment offers borrowers an opportunity that has not been available since pre-financial crisis times.
• HAs can benefit from the current monetary tightening cycle by utilizing the consequent rise in interest rates to restructure existing fixed arrangements, such as swaps sitting at the +5% level, or redeeming bonds with high coupons.
• The rate increase has caused a decline in the mark-to-market value of swaps and the redemption value of bonds, making them more affordable to terminate and creating the chance to restructure difficult legacy facilities.
• This may be useful for HAs facing difficulties in renegotiating covenants, such as the move to EBITDA only, where lenders are not willing to facilitate a shift.

Private placement opportunities

• There has been no new issuance that Chatham is aware of in the private placement (PP) market over the last fortnight.

Banking market

• While interest rates have shown some volatility in recent months, this has not yet translated into increased pricing/margins from banks in the sector.
• Margins remain near their historic lows, but concerns about the economic environment and sector credit quality may lead to lenders becoming less accommodating over time.
• Chatham has observed an increase in the cost of hedging through embedded fixing, prompting borrowers to implement standalone swaps. We have also seen more lenders impose caps on the levels of embedded fixing on offer for borrowers.

RSH quarterly survey

• The reports highlight that cash balances are at the lowest level in almost eight years.
• Cash available reduced by £0.7B over the quarterly and is expected to reduce by a further £3.6B over the next 12 months from the £5.1B March 2023 figure.
• This is partly due to cash reserves being used to fund development programmes.
• Some HAs have reported plans to reduce surplus cash in response to the rising cost of debt.
  • This is not surprising given the priority of the decent homes standard and focus on damp and mould repairs.
• The past 12 months until March 2023 saw the highest spend on capitalised expenditure on repairs and maintenance recorded at £2.7B.
• The sector has forecasted capitalised expenditure on repairs and maintenance from March 2023 until March 2024 to total £3.5B.

Economic news

• May U.K. PMI figures (S&P Global Construction) came in at 51.6, indicating a modest expansion compared to the previous month at 51.1.
  • According to the report, improved supply conditions, demand, and easing purchasing price inflation contributed to the growth in construction activity.
  • Although there are concerns over rising interest rates and the U.K. economy continues to hinder growth projections, the construction sector has a positive outlook for its growth prospects for the year.
  • It is worth noting that the index measures total industry activity, with commercial building performing the best. Residential building projects decreased for the sixth consecutive month, reaching the sharpest decline since May 2020.