In recent years, the housing association market has matured, moving from banks and aggregators prior to the financial crisis to own-name bonds post-crisis and an increasing number of bilateral private transactions in the last five years.
The following factors are driving the increase in bilateral transactions in the housing association market:
1. Housing associations are looking for long-term funding partners who understand their business and can provide long-term support.
2. Customized funding, covenants, and deferred drawdowns.
3. The ability to quickly supplement funding with a single or group of funders.
From the standpoint of investors, there has been a shift in how they choose the long-term assets to which they want to be exposed.
Insurers and pension funds are increasingly investing directly and selecting assets based on their individual liability mix, identifying points on the maturity curve to invest in, credit profile, borrower’s business model, deferred funding profile, and so on.
The more active approach funders take in sourcing their assets on the private credit side is driving this increased flexibility on the part of investors – and typically insurers.
That in turn is a function of long-term low interest rates forcing them to ‘reach for yield’ and compete for assets, along with longer liabilities (over 35 years) which are generally not available in public markets and visibility on the maturity of their existing assets, removing or at least reducing refinancing risk.
The current funding market for housing associations is favourable, enabling them to access structures previously not available in a variety of ticket sizes and at very competitive levels, compared with the more standard formats seen in the public markets.
With more investors entering the social housing funding market, the inflow of capital into the private credit space has meant increased competition.
While some investors with large existing exposures to housing associations are becoming more selective or require tighter covenants, newer players are differentiating themselves by providing longer deferral profiles, longer maturities, larger tickets, faster execution and flexibility around covenants.
For a number of years, the private debt market for housing associations was dominated by domestic institutions. More recently, foreign investors have begun to play a much greater role in terms of deal volumes. For these overseas investors, housing association exposure is part of their global strategy by country/region and sector. The lack of geographic proximity and familiarity means that they typically need more hand-holding, sector teach-ins and consultations with lawyers and the regulator before investing.
From a borrower’s perspective, there are several considerations when deciding between the domestic and overseas investor bases for a private market transaction. These typically include:
- Use of credit ratings
- Deferred profile
- Covenant package
- Secured vs unsecured borrowing
- Cross-currency swap indemnity language
Most home-based investors, most especially in the UK are typically more flexible when providing longer deferred drawdowns (up to three years) and longer tenors, sometimes beyond 35 years. They also like amortising or part-amortising structures that under insurers’ Solvency II regulation do not need external ratings and have natural appetite to fund in sterling.
Many investors seek to build a long-term relationship with the borrower, gradually increasing exposure over time. They like diversified geographical exposure and are increasingly aware of the risks associated with commercial activities and organisations with exposure to the housing market.
Overseas investor relationships tend to be more transactional in nature with periodic credit updates. Typically, US investors require or prefer issuers to be rated (a private rating letter often suffices), to be able to provide deferred drawdowns up to 12 months, to be price-competitive on medium tenors (15 to 25 years), generally require swap indemnity language and push for covenants in line with bank covenants.
Having said that, an increasing number of larger US investors have been more flexible recently on covenants; provided delayed draws up to three years; dropped swap indemnity language requirements; and started investing in larger ticket sizes bilaterally.
Many overseas investors are also more willing to provide unsecured funding than domestic investors, for whom secured lending is the widely accepted format. Being less established and wedded to a particular structure, non-UK investors sometimes assign less value to security and prefer to be paid extra spread.
On the flip side, given the regulated nature of the sector, political headwinds can change overseas investors’ long-term appetite dramatically, whereas local investors with larger exposures are typically more tolerant of sector-wide ups and downs.
In terms of negotiating changes to capital structure, we always urge borrowers to try to agree covenants that give them maximum flexibility to evolve their business.
Covenant negotiations with investors, whether domestic or overseas, can be a protracted process and depend on individual institutions and their priorities at that point in time.
Needless to say, the stronger the relationship and the better the investor’s understanding of the business, the easier these negotiations can be.
However the outcome can never be guaranteed regardless of the jurisdiction of the ultimate investor, which is why a robust negotiation of covenants that are capable of standing the test of time is so important at the outset. There is further flexibility and competition to be gained by diversifying the investor base, especially for larger associations where domestic investors are getting ‘full’ on some individual credit exposures.
Smaller and medium-sized associations have to take into account all of the above considerations when choosing long-term investment partners.
Process-wise, we find that a lot of clients like to engage bilaterally with the selected investor base when choosing the right investor, rather than widely syndicating their debt in the private market. We expect this trend to continue as individual investors become more active and take control in sourcing their assets.
Many investors also like this process as it gives them enough time to get to know, understand and analyse the borrower and potentially gain a larger exposure than would be the case through a syndicated process.
The funding environment is positive for housing associations with larger availability of capital pools and flexibility of funding structures.
But borrowers should carefully consider the implications when choosing long-term funding partners – and whether they are right for their business.
Written by: Maria Goroh, Director of investor coverage, Centrus