• rebuilding social housing mast

    As the funding landscape for social housing continues to evolve, Grant Vaughan from Lloyds Bank Debt Capital Markets and Sarah Anderson from Lloyds Bank’s Sales & Trading Social Housing team, discuss the alternative options available to UK housing associations and the risks the sector needs to manage.


    Grant: Since the financial crisis, bank lending has changed. The social housing sector has historically been very reliant on the banking market for funding – receiving long-term loans with a tenure of 30-35 years at low spreads over Libor. We’re now in a completely different financial landscape and associations can only currently rely on the bank market for funding on a much shorter-term basis; maybe five or seven years – 10 at a stretch. Pricing is also significantly higher.

    Sarah: Housing associations are finding themselves in a changing risk environment. There’s pressure on the income alongside funding, including changes to grant funding and to the way these businesses calculate and collect their incomes. Their risk management strategy now has to take account of these fundamental shifts.


    Grant: The effect of the restrictions to bank funding has been for housing associations to utilise the bond markets as a credible financing alternative. These associations have very long-dated assets and the best way to fund those assets and their development is with long-dated capital. The bond markets, particularly in sterling, may offer our clients this duration.


    On the one hand, you’ve got the associations, and on the other, you’ve got the sterling investor base made up of pension funds, insurance companies and asset managers – all looking for long-dated assets to match off against their long-dated liabilities. What we’re doing in Lloyds Bank Commercial Banking is combining the specialism of the Social Housing team with the expertise of the Debt Capital Markets team to essentially match the two parties together.


    It’s a potentially valuable alternative source of funding. Various associations are now considering a potential strategy of taking out their core funding need through the bond markets and using the bank markets for short-term financing needs. Ultimately, once sufficient critical mass has been built up, we would expect this debt to be termed out in the capital markets.


    Sarah: Of course, this has a major impact on their interest rate exposure. They’re moving away from bank debt, which is a floating rate debt, to bond issues, which are fixed. We’re working alongside these housing associations to help them manage their positions both pre- and post-bond issuance, taking into consideration their current hedging position as well as the changing risk environment they’re operating in and where they should want to end up.


    There’s a lot of education involved for the sector and the responsibility is on us to work with them to structure the deal that meets their needs, but to also ensure that they fully understand the implications of the interest rate payments afterwards. Traditionally, their exposure has been a balance between fixed and floating and inflation trades. By issuing bonds, they’re moving much more towards a fixed position.


    We work with them to create solutions to get that balance back. By reviewing their historical positions we can present them with a range of options using a combination of gilt locks reissuance and swaps to manage their interest rate risk effectively.


    It can be beneficial for a housing association to have a combination of derivatives – a mix of fixed, floating and   inflation-linked interest rate payments. Their income is highly inflation-linked, so having inflation-linked debt can make sense. We have sophisticated models to generate a range of viable hedging positions for clients and work with them to manage taking their business from where it currently is towards that optimal position.


    Grant: I’d agree that education is important. Some of the earlier deals, for example, Affinity Sutton and London & Quadrant, were large associations, with personnel versed in the demands of bond issuance. What we’re seeing now, as associations realise the market’s potential, is smaller issuers emerging.


    And the benefits extend further – as a general observation, the deals demand fewer and less onerous covenants than bank facilities, and they’re cost-effective, particularly in comparison to the potential five-year funding that’s available.


    Sarah: I also think our market and sector experience, combined with working closely with the housing associations to understand their individual business and how it operates, means that we’re able to create a risk management solution that really underpins these benefits.


    Grant: There are benefits for investors too. These bonds tend to attract very high ratings, driven in part by the implicit government support that the agencies assume in their rating methodologies. Secondly, to date there have been no losses as a result of default in the sector. Another benefit is that the majority of social housing bonds are secured on underlying assets. There is also a social aspect, whereby investors are seen to be supporting social housing in the UK.


    Looking to the future, I think firstly that the activity we’ve seen from the larger associations will continue. It is also clear that demand exists for smaller bonds from smaller issuers, which will lead to a new wave of capital markets issuance.


    Without the bond market, the sector would find it difficult to be able to sustainably fund their growth ambitions. The market expects that grant funding, which previously formed a large part of our client’s business strategies, will likely be extremely limited from 2015. Bank funding to the terms previously considered is not currently a realistic option. Therefore without the capital markets, housing associations would find it challenging to develop. As the smaller issuers wake up to the bond markets, there’s a universe of potential out there.


    Sarah: The move towards alternative financial instruments such as bonds bring their own considerations and a greater focus on the assessment and management of risk exposures. Every organisation will have a different risk profile that requires a tailored response, but the recognition, analysis and mitigation of risk should be at the heart of the sector’s new financing agenda.

12/3/2020 8:12:12 AM