Creating the UK's largest housing association: Clarion prepares to unlock capacity

Bringing together Affinity Sutton and Circle Housing to create the UK’s biggest housing association meant getting 10 bank funders and £3.3bn of drawn debt ‘over the line’.

Mark Washer, group chief financial officer (CFO) at newly-formed Clarion Housing Group, said the banks were ‘critical’ to the process, which saw the groups finish ‘in as strong a positon as we went in’.

Clarion emerged in December 2016 with 125,000 homes in 176 council areas, and plans to build 50,000 homes over 10 years from 2019.

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Loan arrangements, covenants and documentation have been ‘harmonised’, with all bank debt moved into a single treasury vehicle.

It has meant the release and recharge of 31,000 properties used as security.

The merger traversed the 2015 summer budget and social housing rent reduction, as well as Circle’s regulatory downgrade to ‘non-compliant’ over its repairs failings, which re-erupted in December 2016, shortly after the merger completed.

The integration of Circle, including the collapse of the group, is targeted for completion by the middle of 2018, dovetailing with moving the repairs businesses into one single system.

The group has separated out its social and market activities with the creation of commercial arm Latimer.

This - along with plans to unlock internal capacity through stock rationalisation, ensuring the group is not ‘maxing out on debt’ - will lead to a ‘recalibration of the balance sheet’.

Clarion is also set to expand nationally while growing its strategic partnerships and land acquisitions.

Lender negotiations

Clarion was formed through the transfer of engagements of Circle parent, Circle Anglia, to Affinity Sutton Group, whose name was then changed to Clarion. It sees a combined turnover of £825m, a £229m surplus, and assets with an open market value of around £20bn.

Talks began with the banks in early June 2016, completing at the end of November.

Treasury simplification saw a move from two treasury vehicles to a single vehicle, Circle Anglia Treasury Ltd, for all bank facilities and ISDA arrangements. Bonds were left untouched. One large security pool was created to support all bank and swap arrangements, with the release and recharge of 31,000 Affinity properties, combining with another 31,000 Circle units already charged.

Mr Washer said: ‘We’ve come out of those negotiations with our [bank] relationships on a very positive footing, with some robust and healthy negotiations between us and the banks. It’s not necessarily the easiest thing to achieve with two parties coming together and the exposure that the banks have.

We came out in as strong a positon as we went in

‘We came out in as strong a positon as we went in,’ he added, pointing to the group’s £1.1bn of liquidity, which includes cash and available facilities.

‘It gives us the firepower and underlying financial strength that we know investors are very keen on us being able to demonstrate - and it gives us the capacity to gear up towards the 50,000 homes over a decade,’ he added.

The banks sought a ‘range of things’, while the group needed to work within the parameters set out in the business case. He added: ‘The clear position was to minimise the economic impact on the group, as every pound abank took out of this negotiation was a pound we can’t spend on housing, and that is what the group is all about.’

He drew comparisons between the group’s asset base and large corporates such as Land Securities and British Land, and said the treasury profile will ‘evolve over time’ in line with the development strategy,

But funding sources and structures in Latimer ‘will of course be very different’ for market rent and sale. The group is looking at a combination of banks, commercial paper and long-dated debt from the capital markets - with the latter having an increasing role in funding the housing association.

The CFO said they have left all derivatives in place - with a total notional value of £1.6bn, mostly rooted in Circle - as they wanted to ‘avoid unnecessary costs’. There are ‘no plans for any major upheaval’. Clarion is 89 per cent fixed, just above Affinity’s target range of 65-85 per cent.

Moody’s ‘downgraded’ Clarion from A1 to A2 rating, reflecting Affinity merging with a financially weaker Circle and a development programme resulting in higher debt and cash flow volatility and lower interest coverages. It said Affinity has a history of successful mergers, but pointed to challenges with execution and integration, adding that both organisations already had significant efficiency plans ‘in train’.

Mr Washer said they had already engaged with Moody’s and ‘fully expected them’ to respond that way.

Commercial and social

The 50,000-new home plan includes two thirds at social rent and shared ownership and the rest market products, but with most units ‘fully uncommitted’ and able to flex. Sales will not exceed 40 per cent of group turnover, excluding regeneration.

Plans for 5,000 homes per year on average compare with Affinity and Circle’s combined previous programmes of about 1,740 units per year from 2016.

The separation of commercial activity into Latimer aims to minimise risk to the social housing assets, but also offers funders a clearer sight of the business.

Latimer - led by former Circle CEO Mark Rogers - has been created from an existing development entity, and includes build for sale, market rent, care and support and other commercial ventures.

The group will inject its own equity into Latimer, with most funding then from third-party sources. Financing is expected to be on market terms on a non-recourse basis to the HA activities.

Mr Washer said: ‘In the future, Latimer becomes more than a straw man; it develops a balance sheet of its own.’

In the future, Latimer becomes more than a straw man; it develops a balance sheet of its own

Affinity’s financial ‘golden rules’ include a cap on investment sales at 20 per cent of reserves, and work in progress (WIP) to £600m. A ‘value at risk coverage’ rule ensures Latimer’s retained reserves, plus group equity investment, must cover the impairment to sales WIP that would result from a 35 per cent fall in market values by at least 1.5 times.

While commercial activity will increase, the group expects the RP surpluses to be well over 80 per cent on average in the next five years. A large part of this will be fixed asset sales. Interest on borrowings will still be ‘comfortably met by social housing lettings’ and the RP will maintain its ‘golden rule’ of 1.3x interest cover.

The plan is for a single HA, led by Neil McCall, former group operations director at Affinity.

Circle came into Clarion with nine registered providers, all legally separate, with their own boards, properties, accounts and funding. Clarion cited this when given an interim G2 governance rating by the social housing regulator.

The current process involves ‘transfer of engagements’ of the RPs into Circle Housing Circle 33, which will be known simply as Circle Housing. Wherry and Mercian transferred in September 2016, followed by South Anglia in December 2016. Roddons is next, with the rest to take place in 2017.

Care and support was an important element of Circle’s activities and ‘this continues now it is part of Clarion’. Prior to the merger, Prime Care - the domiciliary business - was sold to Apex. Clarion is now ‘looking at which integrated services it should provide for its combined customer base’.

Part of the group plan is to reduce joint operating costs per unit by 2020/21. Circle’s operating costs per unit were just below £5,000 in 2016, while Affinity’s were under £4,000. Affinity said it has a ‘track-record of successfully delivering similar levels of savings in previous mergers’. Savings will be made through office and staff rationalisation, significant savings in procurement, streamlining processes, and customer services such as ‘digital by default’.

Integration challenges include the existing efficiency programmes; those needed as part of the merger; and the two large-scale enterprise resource planning (ERP) programmes.

Affinity had planned to deliver £12m in savings by the end of 2020, while Circle planned £46m by full-year 2019. These are on top of the £38m merger savings anticipated in the new group, it said.

‘None of these things on their own is a simple task,’ said Mr Washer.

‘We believe we’ve identified a route though to make that work for the new group.’

Stock churn & partnerships

The base case business plan assumes zero grant for new development, so internal capacity will form a central part of funding the group.

Subject to market conditions, Clarion proposes to churn up to 1 per cent of its social stock each year, ‘accessing capacity’ of other HAs through strategic disposals and selling homes to those that ‘have resources but lack the capacity, skills and expertise to develop’.

Mr Washer said: ‘[It] is about not looking at the only source of funding for new development as being external borrowing, but a core part of that funding potentially coming from asset disposal. It means we are not looking at maxing out on debt.’

[Stock churn] means we are not looking at maxing out on debt

Another area for the group will be ‘developing a strategic approach to land acquisition’, he said.

‘Neither [Affinity nor Circle] have held significant land banks and you don’t get to developing 50,000 homes over a decade by pursuing the same strategy we have had in the past,’ said the CFO.

‘Part of that will be about looking to have more control over land-led development than in the past.’This includes working with local authorities - such as its bid with Morgan Sindall to partner on Haringey Council’s £2bn development vehicle - along with major developers.

Mr Washer said Affinity’s stock stretches across the country and that Clarion is a national provider.

‘Were certainly not looking at narrowing that development activity…we have to be looking at areas such as Manchester, Sheffield and Leeds. It’s important that we are active in all of these markets.’