Focus: Investors look for HAs to manage risk

Social Housing asked three investors for their views on the sector. They include Canada Life Investments, which funds HA bonds and private placements; Legal & General, which provides bespoke long-term loans and private placements; and Aviva REaLM (Returns Enhancing and Liability Matching), which specialises in lease and leaseback.

Sector’s attraction

Aviva: The main attraction is the business environment of the sector which is a good match to the cash flows and liabilities of UK DB pension schemes. Particularly key is the strong link between underlying social housing rent and inflation. The announcement by the government to guarantee the link to CPI plus 1 per cent for 10 years as well as the statements on mandating of arrears have been encouraging for investors. Social housing is a sector with a strong demand/supply imbalance and an insufficient supply for the demand from occupiers.

L&G: Looking at the core business model, very simply, HAs provide a product (rented housing) where there is very strong, enduring demand, where income is reasonably predictable and where costs can be managed. The housing need is not only an incredibly pressing one today, but stretching far into the future. Social housing should therefore provide sustainable and long-term income flows which are attractive to investors. The existence of a regulator and the historic role it has taken provides further attraction to investors.

‘HAs are still coming to grips with how they meet overall objectives with lower grant’ - Alex Gipson, L&G

Canada Life: Social housing is a high-quality sector seeking long-dated funding which aligns well with the business that Canada Life Investments is looking to match. A key factor supporting our interest in social housing comes from the robust oversight and transparent regulation of the HCA. However, the sector does need to overcome some challenges, particularly with regards to welfare reform and reduced government funding.

What HAs need to show

Aviva: Our investments are mainly structured as a lease and leaseback. Our focus has also been on new build assets as well as stock transfers of modern stock. After confirming suitability of the assets, we would additionally conduct counterparty due diligence with the registered providers’ management team to assess the competency of the management team and their resources, understand the strategic direction of the business and the corporate structure and other key characteristics of the business, all to establish the suitability of funding via our structure.

L&G: Like all lending or investment decisions, there are a variety of criteria that we consider key, whether it is for a commercial entity or a regulated sector such as social housing. Most of these relate back to an understanding of an organisation’s business model and the ability of the management (in the case of HAs at both executive and board level) to deliver that model - that’s more important to us than size or geography.

Canada Life: We look for HAs with a conservative business mix, a good management team, and evidence that traditional rental business supports the financing needs of the company.

Key risks facing sector

Aviva: We perceive the risks to involve central government policy risks associated with the financial viability of the operators of social housing stock, which in transactions to-date have also been the counterparties to our financing solutions. To mitigate this, we have adopted an approach providing our investors with ultimate ownership of the properties under the head-lease in which it enters. We carry out extensive property due diligence focused on sustainability of the net operating income and an increasing margin for the HAs. We also undertake a covenant evaluation of the asset operator by commissioning an implicit credit rating, and limiting transactions to investment grade-only operators.

‘We look for HAs with a conservative business mix’ - Roger Dawes, Canada Life Investments

L&G: The continued roll-out of welfare reform remains a risk that needs to be managed by HAs. Outside of this, HAs are still coming to grips with how they meet their overall objectives in a continued era of lower grant support. Some will look to stretch existing cashflows further, some consider investing existing resources (both financial, people and infrastructure) into more commercial activities to generate a return to be reinvested in core objectives. Both are legitimate areas for consideration, but clearly not without risk. Ensuring those new risks are understood as part of the initial decision and roll-out (where appropriate) of those plans is key.

Canada Life: The key issues relate to the impact of welfare reform and the government’s roll-out of universal credit. However, we are also keeping a close eye on the extent to which HAs are involved in non-traditional, more commercial activities. We believe having good covenants in place is crucial for any investment.

Investment plans

Aviva: We have commitments from investors in excess of £300m and expect interest to grow. We also expect to sign deals with additional new HA counterparties over the course of Q1 2014.

L&G: We have invested around £3.5bn in UK infrastructure to date and are one of six insurers committed to investing £25bn by 2018.

Canada Life: While we do not have specific investment targets for HAs, we are looking to engage with HAs of all sizes who meet our key investment criteria: a conservative business mix, a good management team, andfinancing needs supported by traditional rental business.

Impact of commercial activities

Aviva: Affordable housing/general needs properties are the main focus. Increased foray of HAs into commercial activities (eg private sale/rent) has created increased operating income volatility which tends to have a negative impact on the credit assessment of the operator. We see our financing option as a preferable alternative solution for HAs over, say, market renting or sale as it provides additional capital receipts and keeps the assets in the public sector.

L&G: An investment by HAs in more commercial activities needs to generate the right returns to reflect additional risks, and we need to be comfortable - in the same way as both HAs’ executive/boards and the regulator - that those risks are understood and that the association has the ability to become a successful player in that new market. It comes back to the original ‘key criteria’ - is the overall business model fit for purpose and in the particular area of commercial activities is it being funded in an appropriate and sustainable way? Commercial operators run PRS and private sale activities through a sensible mix of equity and debt. HAs need to adopt a similar approach and provide either or both of the funding elements to ensure they are achieving appropriate returns.

Canada Life: This depends on how large a part of the business that commercial activities represent, or are planned to represent. We do view this as one of the key risks facing the sector.

Rating agencies and HCA judgments

Aviva: We engage with an independent external partner to assess the imputed credit rating of a counterparty, using both Moody’s and S&P methodologies, where one is not available. These ratings will in turn be used to inform our analysis when establishing the appropriate risk margin for the counterparty above a basket of available social housing bonds. The credit analysis also continues post-completion via an annual update creating an alignment of interest with the industry regulator who monitors the financial security of all RPs. We believe that this monitoring is a key strength of the sector.

‘We believe that [regulatory] monitoring is a key strength of the sector’ - Phil Ellis, Martin Zdrovkov, Aviva

L&G: We don’t seek to outsource our evaluation to these parties but once we have made our own assessment of a borrower, we would compare with those of the two parties, if available. Both rating agencies and the regulator have a different relationship with potential borrowers compared to an investor and a different level/form of interaction. As such they provide a slightly different perspective and effectively a second/third pair of eyes. The absence of an external rating does not however in any way restrict our ability to invest.

Canada Life: We will always consider the regulator’s assessment of any housing association that we are engaged with. Analysis from the ratings agencies, where available, can also be helpful to us when we are conducting our research into an investment. However, this would be just one input into the overall process.