Welcome to our November edition of Housing Finance Snapshot - a newsletter providing banking, finance, property security updates and opinion for those based within the affordable housing and local government sectors.
Impact of likely limits (cap) to be placed on Rent Increases in 2023/24
The Government is currently consulting on what the limit should be for rent increases next year – be that 3, 5 or 11%, with an earmark on 5% being most likely, although trade bodies are saying 7% is the preferred limit, so as to limit the Government’s benefits bill. The Consultation was to run until 12 October and sought views also on whether to set a limit for 2023/24 with another consultation being set up to discuss rent policy beyond 2025. This date has clearly passed and it is now anticipated that this will be announced as part of the Autumn Statement due to be delivered on 17 November. Such a limitation on rent increases immediately reduces anticipated income for registered providers (RPs) and local authorities (LAs) (said to likely be in the region of a reduction of £1.3bn), affects their gearing ratios and reduces funds available for planned services, staff pay, cost of repairs and maintenance, cost of new build, decarbonisation, retrofit and fire safety works, dealing with disrepair cases and preparing for more stringent regulation.
There is then the currently unanswered question of whether such reduction will just be for 2023/24 or extend to future years, creating an ongoing reduction in rental income (if imposed for the next 5 years, said to likely be a reduction totalling £7.4bn). This is alongside an anticipated rise in arrears of rent for RPs where their residents are struggling with the cost of living, energy and rising food costs. The Government may however consider an exemption for those operating in supported housing and proposes to apply the limit on rent increases to existing social housing tenancies rather than new tenancies which will come under the CPI plus 1% formula.
This has caused RPs to identify viability issues, work out what their contingencies are and what changes to budgets and services will need to be implemented and how quickly that can be achieved. RPs are being warned that with reduced financial headroom their capacity to cope with further financial shocks, that some will need to make difficult decisions to maintain financial resilience whilst continuing to deliver essential services. An effective risk management framework remains crucial.
The Sector Risk Profile – key themes for Treasury and Finance teams
The Regulator of Social Housing (RSH) has recently published its annual Sector Risk Profile (SRS) setting out its view of the most significant sources of risk to RPs. In terms of Treasury risk management and mitigation, here are some key takeaways:
RPs have taken advantage of previous low interest and have fixed 80% of their debt, but a significant number of RPs have at least 25% of debt at variable rates vulnerable to rate increases. The failure of RPs to manage interest rate exposure can lead to reduced capacity to deliver new developments and capital investment in existing stock, the cost of which is rapidly rising. Water tight treasury management and governance processes need to be in place to effectively monitor existing loan covenants to mitigate the risk of breaches and RPs are encouraged to communicate early with lenders regarding threats to covenant compliance. Boards and Treasury teams “must ensure risks from existing debt are managed, stress testing changes in underlying assumptions to understand and mitigate against unforeseen requirements for financing or interest costs.”
Greater reliance on debt is forecast to deliver investment in existing stock and to deliver new homes, which heightens exposure to interest rates. Declining credit ratings may also increase the cost of capital and potentially reduce investor appetite. Poor operating performance from RPs could see reduced investor appetite that leads to riskier financing products.
Business plans from June 2022 projected £47bn of new debt in the next 5 years, increasing debt facilities from £116bn in 2021/2022 to £12bn by 2026/2027. In light of the changing market, RPs will need to maintain a flexible Treasury strategy to factor in changes to the cost, availability and conditions of debt. Understanding inflationary costs will be key to shape future funding requirements and this will vary between RPs considerably. Treasury teams and Boards “should ensure that decisions around which debt funding option is right for their business stems from their activity, rather than the other way around.”
Alternative funding models
Equity investment in the sector by way of lease arrangements or direct equity investment has been a fast paced sector trend in recent years. It will be interesting to observe whether this investment stream will be impacted by potential ratings and governance downgrades. Whilst this has injected growth into the sector, this funding can be more expensive and the RSH comment that, in order to mitigate risks and avoid potential conflicts with investors over strategic direction “boards must understand how governance and risk flow within wider corporate structures and remain appropriately independent.”
A detailed appraisal of all key sector risks identified by the RSH can be seen in our Company Secretary Snapshot and below for updates on what we are seeing and ideas to help you prepare for and deal with these challenges.
FCA consultation on sustainability disclosure requirements and investment labels
There has been a lot in the press recently about ‘greenwashing’ with it being a hot topic at Cop27, where the UN chief demanded zero tolerance for companies that are making net zero pledges but continuing to invest in fossil fuels. Sustainable finance is a growing area generally and has been embraced by many RPs to tie in with their own net-zero commitments, so understanding how to avoid claims of ‘greenwashing’ is critical for RPs raising green finance.
In October 2022 the Financial Conduct Authority (FCA) published a consultation aimed at tackling ‘greenwashing’ by introducing sustainability disclosure requirements and investment labels. Whilst a previous discussion paper had indicated that these rules would apply to FCA-regulated asset owners (such as pension and insurance funds) the consultation is currently only targeting retail investor products. In line with Government’s ‘Roadmap to Sustainable Investing’ published in October 2021 it, sets out plans to introduce sustainability disclosure requirements and investment labels, building from the UK’s economy-wide implementation of disclosure requirements aligned with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD).
The consultation also includes a general ‘anti-greenwashing’ rule, reiterating requirements for all regulated firms that sustainability-related claims must be clear, fair and not misleading. Pension and insurance funds and others that invest in the social housing sector will be subject to this anti-greenwashing rule which is anticipated to come into force in July 2023, but should be taken into consideration as an overarching consideration by all RPs, particularly those seeking sustainable funding or publishing a sustainable financing framework.
Please contact one of our specialist Housing Finance team lawyers: Louise Leaver, Deborah Rowntree or David Moore if you have any questions around sustainable finance, or would like support with your sustainable finance framework.
Re-shuffle of priorities for Registered Providers’ finance and business plans
The reaction of markets, rating agencies and the Regulator to the mini budget and the rapid turnabout of its terms signify, in the words of Jeremy Hunt, that “there are hard decisions ahead”. We have seen the threat by Greater London Authority to withdraw development funding from underperforming RPs and some are suggesting a likely reduction in development plans by a third of RPs. Funding will cost more with income from sales of stock or shared ownership potentially reducing.
Following the UK’s downgrade by the credit ratings authority Moody’s on 21 October 2022 to negative from stable with Standard & Poors rating report standard at AA with negative outlook, 8 RPs including 4 of the G15 RPs have had their rating outlooks changed to negative.
We are also now seeing commentary in the sector that the property market is going to fall in the short term and this is likely to lead to valuations falling.
What solutions can RPs look to adopt to combat the tsunami of economic challenges? Having stress tested business plans in light of the pandemic, the Ukrainian conflict and a yet unknown rent cap, carefully formulated funding plans based on projections at the start of the financial year are being remodelled as the sector takes a sharp intake of breath at the seismic shocks of recent weeks. The escalating costs pressures are being felt by RPs and their tenants acutely as the sector grapples with decision making about priority expenditure. In this climate of decreasing financial headroom, a good place to start as a basis for decision making and strategic prioritisation is with understanding your assets, existing facilities and counterparties. The foundations upon which all decisions are made rest in the quality of data that is available to RPs, the assets that it holds and positive collaboration with its counterparties and professional advisors.
You will be wanting to:
- Make the most of existing stock based on reliable and accessible data.
- Establish a strategic Optimal Charging Programme tailored to the current economic environment with a focus on recovering hidden value in existing security especially where we could see valuations falling. RPs are increasingly considering securing shorter term funding for smaller amounts as activity in the capital markets slows due to the rising cost of borrowing for longer term debt. Whatever the funding approach taken, reviewing and maximising the value of your existing security is critical to cater for funding flexibility – see below for more detail on how to capitalise on your existing security.
- Enhance your stock condition and ESG data. It would be wise to consider how often the condition of your stock is surveyed – and what is the breadth of your condition survey to assess the extent of disrepair.
- Meet the likely increasing certification requirements of lenders. We anticipate that there might be a fresh look at certification requirements for these types of issues by lenders and a focus on which contracts bind RPs from a lender’s perspective. Will we be seeing a call out for a review of the sector standard certificate of title (introduced in 2018) or will simple updates to officer’s certificates and valuation scope deal with these issues satisfactorily for lenders?
- Seek opportunities in a distressed market – mergers and acquisition opportunities, acquisition of private stock sought to be offloaded by developers.
- Understand your existing facilities – it is increasingly important to understand the detail in your loan agreements and how they may interact with each other. What are the cross-default provisions? Who do you have to notify following a regulatory downgrade? What information can lenders request in relation to your stock? What happens if you are not in compliance with all laws and regulations e.g. the new Smoke and Carbon Monoxide Alarm (Amendment) Regulations? What consents might be required for a merger?
- Seek to restructure interest rate risk profiles – we have seen an increase in clients putting in place ISDA documentation to provide an additional tool in combating rising rates.
- Move funds held to take advantage of rising interest rates in line with your investment policy.
If you would like to have a general chat and find out more about our loan matrix and health-check on your existing funding documentation, please do speak to one of our specialist Housing Finance team lawyers: Louise Leaver, Deborah Rowntree or David Moore.
Capitalising on your existing security in an economic downturn – security mechanisms
Where do security considerations sit in this volatile landscape? How can RPs capitalise on their assets to tackle the perfect storm of costs increases and the challenge of meet priority delivery objectives?
The need for funding to meet rising expenditure is not likely to abate and as interest cover becomes ever tighter, security monitoring as part of a flexible security strategy are crucial risk mitigation tools. As many RPs are adjusting downwards their development pipeline targets in the short to medium term, this signals there will be potentially less new property security available to support funding requirements; another curveball to consider.
By taking a close look at your existing security this presents an opportunity to unlock value in existing RP stock with a view mitigating liquidity risk in a deteriorating macroeconomic environment and also being well placed to take advantage of funding opportunities when the markets get moving again. Now is an opportune time to take stock of your security position and consider the following security mechanisms as part of a forward looking 'Optimal Charging' security strategy:
- Get ahead of the game - carry out a strategic review and valuation assessment of your existing security
- Review your ex-LSVT stock currently charged at EUV-SH valuation and consider uplifting to market value
- Carry out a RAG analysis of security charged to your Security Trust at EUV-SH as unallocated and carry out due diligence to perfect your security for allocation at maximum value
- Take a fresh look at those difficult schemes which have been pushed to one side in busy times to potentially unlock value
- Overhaul and perfect your property lists to ensure all the correct security information is included so these are ready to go at the press of a button, therefore reducing transactional risks
- Review your Security Trust Deed to check the requirements for de-allocating and moving security around within facilities
- Collate documentation required by funders to secure MMC assets and anticipate increasing certification requirements centring on the impact on the fabric and use of buildings going into charge, building safety changes to ESW1, extension of Right to Buy, future homes standard (low carbon), retrofit works, energy plant and district heating systems, wayleaves and telecommunication costs etc
- Look at part charge schemes and prepare the uncharged parts of titles for speedy securitisation.
Now is a great time to speak to your lawyers about the opportunities above with a view to extracting maximum value from your existing assets to meet challenges ahead. It is surprising what additional value you might find! Please do speak to our Housing Finance team specialising in “Optimal Charging” – Jessica Church, Wendy Wilks, Richard Stirk and Julie Cowan-Clark.
See you at the next conference
Members of our team will be attending these upcoming conferences and we look forward to seeing many of our clients and contacts there
Social Housing Annual Conference, 1 December 2022, London
NHF Housing Finance Conference and Exhibition 2023, 15 March 2023, Liverpool
In the news
Legal directory results reflect our market knowledge
The recent results from both the Legal 500 and Chambers directories, continue to recognise Bevan Brittan as a social housing market leader.
In the 2023 directories we went from strength-to strength with the Louise Leaver appearing in the ‘Hall of Fame’, together with recognition for Julie Cowan-Clarke and Richard Stirk as ’Leading Individuals’ and Jessica Church as a ‘Next Generation Partner’ in Legal 500. Chambers also reflected our skillset with new addition of Jessica Church being identified for Social Housing Finance.
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