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Market Update

Long-term challenges and opportunities for the housing association sector

June 29, 2023


Housing associations (HAs) have had a busy 2023 financial year in the funding market, initially in the listed and private capital markets, and later in the banking market.


As the sector pauses to take stock and update business plans and funding strategies, now seems an appropriate time to reflect on some of the longer-term successes of the sector and review the issues it faces on the journey ahead.

HAs have faced several major challenges in recent years, ranging from the government’s strategy on reducing rents to the impact of COVID on the provision of services. The sector has emerged stronger from these, supported by a focus on delivering social impact through efficient management, investment in the existing housing stock, and a commitment to new sustainable general needs and shared ownership housing.

In the process, it has been helped by an attractive interest rate environment together with a growing recognition amongst capital market investors of the generally high-credit quality of housing association borrowers. In mid-2022, this allowed many organisations to restructure inefficient legacy funding and raise an increasing volume of low-cost, long-dated debt to expand operations.

Source: RSH

The journey forward

The political environment

The political environment has now become less friendly for HAs. For years, the government has sought to encourage increased competition in the provision of general needs and shared ownership housing from local authorities and for profit operators. This has already applied pressure on margins, but the government has now adopted a more interventionist approach to shortfalls in service provision. This is a process which has yet to run its course.

In a period of increasing budgetary constraints, it has raised a real dilemma for HAs. The government is looking to achieve more for less; capping rents below the rate of inflation while tasking HAs with client management, health and safety, and zero carbon agendas that largely need to be paid for out of existing rents.

Mergers coupled with operational efficiencies have represented a logical response to this but herein lies a problem — the more centralized the services become, the greater the risk that they end up becoming more remote from the tenant. The time when an estate manager collected rents and responded to the needs of their tenants is long past, but if you are largely dependent on virtual contact how do you ensure issues are successfully identified and addressed, particularly for the more vulnerable?

This seems to be one of the largest challenges facing HAs — trying to deliver greater social impact while also operating within the demands of state policy.

    Solutions inevitably vary from association to association but require each to balance the needs of its tenants against supporting the existing estate and investing in the provision of new housing, all without undermining the viability of the business. Not an enviable choice.

    The economic environment

    The situation is not improved by the economic environment facing HAs in the short-to-medium term. Pressures on operating margins from sub-inflation rent rise and increasing demands for expenditure on the maintenance of existing assets have coincided with a significant rise in the cost of debt. This is demonstrated clearly below:

    Source: Bloomberg

    Source: Bloomberg

    Source: Bloomberg, Chatham Financial

    These challenges are reflected in a steady decline in the credit standing of HAs. This has been exacerbated by a decline in the rating of the sovereign but reflects a general decline in the credit metrics of many HAs.

    Source: S&P, Chatham Financial

    The trend has accelerated in recent months as both Moody’s and S&P have looked at the challenges ahead. It risks the reputation the sector has fought to establish in the capital markets over the last 10 years as a source of low-risk investment — a safe haven in an increasingly volatile market.

    There is a danger that under pressure to deliver even more for less, it ends up taking a step too far on the credit standing of the sector.

    One of the greatest challenges for an individual HA is how to insulate itself from this. Operational efficiency and the ability to identify the issues affecting their customers is one challenge for HAs. Financial efficiency is another.

    In the section below, we set out some thoughts on the latter.

    The issue facing HAs

    Managing the future cost of debt

    Since the start of 2022, the financial markets have been affected by two conflicting sentiments:

    • Fear – concerns over the level of inflation and how high interest rates need to go in the short-term to address this, and
    • Hope – that inflation will fall rapidly back from its current levels to 2.00%, followed by a return to pre-2020 interest rates.

    In recent months, this has induced a state of drift in the fixed-rate markets with yields largely range-bound despite significant intra-day volatility on the back of actual or expected economic figures.

        Source: Bloomberg

        In the process, it has become unclear how rapidly inflation or interest rates will fall from their current levels in the U.K. Below, we have set out the last Bank of England (BoE) forecast which provides a very reassuring picture. However, the BoE has consistently underestimated the impact of inflation — the exceptionally heavy levels of over-subscription on recent issues of index-linked gilts suggest investors may share this concern.

        Source: Bank of England

        HAs went into 2023 with debt books well prepared for a hostile interest rate environment, with a high level of fixed-rate debt, hedged for long maturities. Access to the capital markets formed an important element of this funding — providing low cost, lightly-covenanted debt fixed for long maturities.

        Unlike the period from 2017 to 2022, this debt now has positive mark-to-market valuations, even in the case of older legacy swaps. This provides HAs with the opportunity to develop a strategy for retiring old, expensive, and inefficient debt without putting pressure on both the Statement of Comprehensive Income, as well as cashflows.

        While there will be a need to top the level of fixed-rate debt going forward, it still leaves the challenge of raising new funding which many borrowers will require over the next two to three years.

        With the all-in cost of fixed-rate debt currently exceeding 5.00% for medium and long maturities and raising 20 to 30-year fixed-rate funding in the capital markets are unlikely to be attractive, there is a risk of repeating the problems created in 2010 – 2020 of substantial mark-to-market losses if interest rates fall back again.

        This means a more flexible approach to raising new debt may be required. This could be approached in two ways:

        (i) Short- and medium-term bank funding

          Raising shorter-dated debt from the banking market may be an attractive alternative to long-dated capital market funding. Margins generally remain tight while maturities have lengthened by comparison with their levels in 2010 – 2020; while the drawdown flexibility offered by an RCF may be attractive given increased uncertainty in relation to future expenditure programmes.

          However, banks are becoming less willing to offer embedded swaps and while traditional ISDAs (or even loan-linked ISDAs) provide an alternative solution for hedging rates, SONIA swap levels are significantly higher than gilt rates for shorter maturities.

          Source: Bloomberg

          (ii) Accessing the capital markets for short maturities

          The capital markets offer significant benefits over bank debt on loans of five – 10 years. This is the area of strongest demand in the sterling market and the all-in price of debt is likely to be lower for good quality borrowers, while the covenant and security structures are considerably more accommodating than for bank loans.

          While lacking the flexibility on drawdown and repayment of an RCF, shorter-dated bonds allow HAs to reach a wider investors group in the U.K. and offshore, thus expanding their potential source of funding beyond the constraints of the long-dated capital markets.

          Liquidity and rapid access to debt

          HAs started 2023 with high levels of liquidity.

          With new banking and capital market loans taking up to three to four months to negotiate and secure, it is important to maintain an adequate level of liquidity to meet any unexpected events and allow for the risk that the financial markets can close for periods of time — as happened with much of the capital markets during the second half of 2022.

          Speed of access also allows borrowers to pick their moment on new debt. What can appear an attractive opportunity may turn into expensive borrowing if it takes three months to execute the trade in a volatile and unpredictable market.

          For this reason, HAs need to have strategies for ensuring rapid access to debt:

          • Running at least one bank relationship where the borrower can be confident that the bank facility can be increased at short notice if required,
          • Maintaining close relationships with existing private placement providers to allow existing loans to be increased if required (we have moved from initial discussions with an existing investor to commitment within two weeks),
          • Creating and securing retained bonds on existing public issues which can be sold at short notice, and
          • For borrowers with significant debt portfolios, establishing a Medium-Term Note Programme. There are now 10 housing associations with these. While involving some additional cost versus a stand-alone public issue, it allows repeat access to the public market with very short lead times — of no more than two weeks if security is in place.

          While the RSH is looking for associations to maintain at least 18 months of surplus liquidity, faster and more flexible access to the debt market will undoubtedly reduce the need to carry excess liquidity during periods when the cost of committed debt facilities is high.

          Maintaining a strong credit rating

          As highlighted in section two, HAs have come under rating pressure between 2020 – 2023.

          For organisations looking to access the capital markets rating, agencies are key stakeholders in the business and need to be treated as seriously as a direct lender.

          Their ratings determine the level of risk capital institutional investors need to allocate to any loan and, therefore, directly impact the cost and availability of debt.

          This is a major issue for investors, particularly if they have a heavy weighting in HA bonds. A move from A- to BBB+ (or equivalent) across the sector will lead to a significant call on their capital. This explains their sensitivity to any risk of a downgrade to BBB/Baa territory and explains why many borrowers with A3 neg/A- neg ratings (particularly with a two-notch upgrade to their BCA) are paying on average 25–30 bps more than their higher-rated colleagues. This differential has become more apparent over the course of 2023.

          Source: Moody's, S&P, Fitch

          In this environment HAs need to integrate rating agency metrics into their business plans at an early stage and highlight to the board the implications of spending plans for the rating, while adopting a pro-active strategy for managing the rating agency relationship(s).

          We have taken the lead in helping HAs in this process, developing models to highlight vulnerability and advising on changes or approaches designed to address weaknesses. While rating agencies are influenced by key credit metrics, they also have considerable flexibility on how these are applied. Appearing to take notice and responding to their concerns often pays dividends.

          With borrowers restricted from making public forecasts on their business plans, rating agency reports are an important source of information for investors on the future development of the business. The rating agencies will generally risk adjust/haircut data appearing in the FFR so the published numbers will have a significant impact on their approach to the credit, and therefore, the trading of an HA’s bonds.

          Investor relations

          With 90 HA issuers in the bond market and an additional 150 or more with private placements, developing good relationships of trust with key funders is important, particularly in difficult financial markets.

          There is a need to stand out from the crowd and be user-friendly, and this comes from maintaining a predictable financial calendar of publications while providing regular financial information and social impact reports in a consistent format.

          This is an issue we have majored on in the past.

          Simplifying the covenant structure

          If protecting credit ratings and deepening investor relationships form one strand of treasury activity in an adverse market, simplifying financial covenants – where possible – forms another.

          Businesses can fail because of operational problems or a shortage of liquidity, but the biggest risk comes from an inadvertent breach of covenant. We are proud of our track record in simplifying the covenants attached to legacy debt portfolios and resisting and reversing the movement to EBITDA-MRI, which has created pain for the sector.

          Unexpected challenges can arise in any business, and minimising the constraints imposed by financial or operational covenants plays an important part in safeguarding its future resilience and viability.

          Public markets are a relatively covenant free zone for HA borrowers at present. Bank loans are at the opposite end of the spectrum, covenant-heavy with complex obligations. Given they allow for flexible drawing and repayment, using them as a source of reserve liquidity while core borrowing can be an attractive formula — particularly for larger borrowers.

          Utilising the for-profit RP model to diversify sources of funding

          In a market where the cost of funding and plan pressures are high, innovative models are being considered and utilised to ease financial pressures and help continue to deliver on corporate ambitions. One model is the use of for-profit RPs to bring in third party equity funding into the group structure. Over the last two years, we have seen an increase in appetite from existing capital markets investors to expand their investment in the sector through equity partnerships. Driven by their ESG mandates, these investors are looking for low stable returns – in most cases single-digit.

          The model involves setting up investment pods (FPRP) and selling an equity stake to an equity partner who would be able to sit alongside the HA. In theory, it would provide the HAs with control over strategy and tenure as well as a partner committed to the sector and delivering affordable housing. Although there are several FPRPs in the sector, the number under the ownership of a housing association is limited. However, this model is now being considered more broadly by the sector. Traditional housing associations will be able to leverage their understanding of the sector and management capabilities to operate and manage these investment pods.

          • Last year we saw Hyde partner with AXA to execute this model.
          • We also saw Savill Investment Management enter the affordable housing sector utilising this model.

          Chatham is currently aware of several investors who are looking to partner with HAs in this manner.

          The journey ahead

          HAs have been successful in reacting to opportunities and responding to adverse developments. They journeyed through the introduction of private finance and stock transfers while addressing the challenges of the 2008 — 2010 financial crisis; only to emerge stronger as a result, as a keystone in government policy on low-cost housing.

          But they also need to remain vigilant. One key to success has been the ability to marry a desire to deliver social impact in its myriad forms with the need to finance it, building on the sector’s reputation as a safe haven investment and being able to access continually available and relatively inexpensive funding.

          In the more difficult financial and political environment we currently face, there is a need to look carefully at how this advantage is maintained if they want to continue to prosper.

          About the author


          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.