COVID-19: the impact on the debt markets for housing providers

Banking market

In response to the evolving global crisis, a large number of central banks have enacted major monetary interventions alongside significant fiscal stimuli from their respective governments.

In the UK this has seen interest rates cut twice to 0.1 per cent and the Bank of England launch a renewed programme of ‘quantitative easing’ (QE) – buying debt of key sectors – with an initial £200bn to invest.

It remains to be seen whether housing association debt will be included in this new round of QE.

The interest rate cuts were largely priced in by the markets, but an interesting picture is drawn by chart 3.

This shows how the two main rates at which banks lend to each other – SONIA and LIBOR – have differed in their responses to recent developments.

The chart illustrates one of the key benefits of SONIA compared to LIBOR. While SONIA, by its nature, has largely followed the base rate cuts (albeit lagged a little), LIBOR has actually diverged from SONIA in recent weeks.

This is because LIBOR includes an element of bank credit risk, which understandably is heightened at the moment.

Over the past few weeks, the differential between SONIA and LIBOR has moved from around 10 basis points (bps) to more than 40 bps

This difference demonstrates the benefit of funding based on SONIA at the present time.

As you would expect, SFC is in regular contact with the key bank lenders to the housing association sector.

We understand that banks are experiencing increasing pressure on their cost of funding and we expect this to feed into a more expensive funding environment in the short term. We see the market as difficult but not closed.

Despite the turmoil, the message we are hearing continues to be ‘business as usual’ as far as possible, with all banks enacting their business continuity procedures early on in the crisis.

We have worked closely with clients to make sure funding discussions that were ongoing with banks are being progressed to conclusion, despite the market uncertainty.

This includes the closing of a £30m revolving credit facility (RCF) with one of our clients from one of the leading high street banks, which was signed off just last week.

An additional challenge to be overcome when considering funding through the banks at this time is the speed and practicality of charging new properties as security.

With no access to properties permitted, some valuations are likely to be challenging (but not impossible).

Utilising existing excess security is a good option if you are considering an approach to the banking market for further funding in the short term.

Capital markets: private

SFC is also in regular contact with the key institutional investors to the sector to maintain our understanding of their current capacity and appetite to strike deals.

The volatility in the market is causing issues for investors as they seek to protect their funds.

Government bond yields have reached all-time lows in recent weeks, but the unprecedented spending plans announced by various governments pushed yields higher, due to the sheer quantum of issuance those measures implied.

Since the announcements, yields have fallen back down but remain above their lowest levels of a few weeks ago (chart 2).

At present, this all means limited investor appetite and only very small windows of opportunity to price, and hold, a bid.

For those investors willing to look at opportunities beyond this present volatility, there is likely to be an associated uncertainty adjustment to credit spreads, which may be substantial.

We have, in the past week, seen the first housing association price a private deal (that we are aware of) since the impact of COVID-19.

Tuntum priced a £42.5m transaction with Macquarie Infrastructure Debt Investment Solutions, which included £10m of one-year deferred money and had an ultimate maturity of 2053. Although the spread has not been disclosed, it is likely to have been above two per cent.

On the private deals that SFC is currently managing, we are slowing or pausing the timetable, but continuing to progress as much of the transaction as possible (documentation, security etc) so that our borrowers can be ready at short notice when more favourable funding windows do open with private investors.

Capital markets: public

We have also taken a similar approach in the public market, where we supported Longhurst Group in successfully issuing its retained bonds in the early stages of the COVID-19 outbreak.

Since then, the public markets have remained relatively quiet for housing associations, with only a few small issuances until Optivo approached the market for its £250m, 15-year bond, for which it conducted a roadshow at the beginning of March.

The transaction was met by significant demand at indicative pricing of 250 bps over gilts (the cost of government debt).

It ultimately tightened to 230 bps and priced with a coupon of 2.86 per cent.

It is good news for our market to see a significant housing association deal price and with such a robust level of demand, but as with other corporate issuance seen in recent weeks this credit spread represents a significant level of “new issue premium” compared to a “normal” functioning market.

While gilt yields have remained at or around record lows (despite a slight jump in mid-March), secondary market credit spreads have widened across the board as markets price-in the perceived credit risk introduced by the crisis.

As illustrated by chart 4, housing association bond spreads have followed suit, widening from a 120 bps average in February to around 185 bps today.

As shown by Optivo, any issuer looking to hit the market at the moment would also likely face a wider new issue premium than usual.

That said, chart 4 also illustrates a relatively strong performance by housing association bonds relative to two other key comparable sectors: real estate and utilities.

The spread differential between housing associations and utilities has reduced from around 40 bps to 20 bps between February and today, while real estate spreads have moved out from a 20 bps differential to around 50 bps.

In addition to these three established funding routes, the Bank of England has also made short-term funding facilities available to support UK businesses through the COVID-19 crisis.

Most housing associations with credit ratings will qualify for the Covid Corporate Finance Facility, and for those unrated associations, the rating process is promised to be an expedited version of the normal approach.

However, this short-term facility has been specifically designed to support organisations with serious cash flow challenges through the COVID-19 pandemic, so may not be appropriate for most housing associations.

While the doors to both the public and private capital markets remain ajar, SFC is confident that the appetite for investment in UK housing associations remains very high, reflecting its continued sound fundamentals.

We expect a flurry of issuance in due course, as the markets get used to the new normal.

Housing associations keen to raise new funds should be ready to move quickly.

Alex Morgan, director, Savills Financial Consultants