Standard & Poor’s (S&P) has downgraded Karbon Homes’ long-term issuer credit rating from A+ to A, reflecting its view that economic conditions in the North East will “further deteriorate” as a result of COVID-19 – with a limiting effect on the provider’s financial flexibility.
However the agency gave the rating a ‘stable’ outlook, stating that the estimated weakening of EBITDA margins and higher debt will be “counterbalanced by Karbon Homes’ reliance on more predictable revenue streams”.
The credit ratings agency forecast that the 27,000-home provider’s EBITDA margins will average about 30 per cent, while debt-to-EBITDA will average 11x from financial years 2020/21 through to 2022/23.
The ratings downgrade has also been applied to Karbon’s £150m bond issued in November 2018.
S&P referred positively to Karbon Homes’ consistent focus on low-income social housing, which “makes its streams more predictable and ensures low industry risk”.
The agency expects Karbon to scale down further its exposure to market sales, with revenues from first tranche and outright sales expected to average around four per cent in financial years 2021 to 2023, down from 10 per cent previously.
However, S&P expects that “the already-limited economic dynamism of the North East will deteriorate further as a result of the COVID-19 outbreak, and will continue limiting Karbon Homes’ ability to boost its operational and financial performance”.
It said that the association’s concentration in the region has also led to “steady increases in arrears, estimated to remain above six per cent” for the financial year ending 31 March 2020.
S&P chiefly attributes the increase in arrears over the past two years to a “threefold increase in Universal Credit claimants”, but it anticipates that arrears will remain relatively high as a result of the economic impact of COVID-19.
It added: “On the positive side, vacancy rates have remained very low, even compared with peers and despite slight increases caused by unexpected maintenance of the stock acquisition in May 2018.”
S&P said that following the anticipated economic recession in the UK caused by the coronavirus outbreak, it forecasts that Karbon’s S&P-adjusted EBITDA margin will reduce to 25 per cent for financial year 2021, down from the 30 per cent estimated for 2020.
“This temporary dip in the margin follows our expectation that a share of rents from self-paying tenants will come under pressure,” S&P said. “However, we expect that Karbon Homes’ flexibility to boost its performance will remain limited, despite being able to increase rents from 2021, EBITDA will be balanced by higher capitalised repairs and anticipated lower margins from non-traditional activities.”
S&P said that Karbon Homes has “moderate levels of debt”. Referring to its refinancing programme in 2018/19, which included issuing the £150m public bond, S&P said the group had effectively reduced the cost of debt, and had locked in fixed rates and cut the average interest expense.
It added: “We anticipate interest coverage to remain robust, even in FY2021, where lower EBITDA would reduce interest coverage to about 1.8x from 2.2x. Therefore, considering this temporary pressure, we expect adjusted EBITDA to average about 2.1x during FY2021-FY2023.”
Commenting on the downgrade, Scott Martin, executive director of resources at Karbon Homes, said that the provider’s 30-year business plan and strategy would not be impacted.
He said: “Despite the change in our rating we are pleased to have maintained an investment grade, and with very strong liquidity, Karbon remains in a robust financial position.
“Whilst we are naturally disappointed, we understand the external factors S&P has highlighted regarding the impact the coronavirus pandemic is having on the North East economy, our main area of operation.
“We have robust business continuity plans in place for events such as this and undertake regular stress-testing for a range of scenarios. Our dedicated teams have successfully maintained essential services to customers throughout this period whilst also continuing to provide vital advice and support.
“Our investors consider us an attractive prospect because of the strong demand for social housing in the North East and Yorkshire and we are well placed to support our communities in these challenging times.”
The downgrade comes after S&P last week affirmed the A+ ratings of two providers, Wheatley Group and Cross Keys Homes, with a ‘stable’ outlook for both.