Anticipate the unexpected – opportunities and challenges in the current climate

Credit outlook deterioration with uncertain economic backdrop

 

Given the pressures facing the sector, in particular balancing investment in existing assets with new-build development and the volatile market backdrop from an inflationary and rates perspective, business plans are more challenged. There is less capacity and weaker margins, with the result being deteriorating credit ratings.

 

Many providers are reflecting on their credit rating trajectory, ensuring strategic decisions are made in the knowledge of its impact on ratings.

 

We are seeing more considered rating strategies, with some registered providers taking on additional ratings and others dropping them. In this context, it is also important to consider the impact of capital treatment changes on both bank and investor appetite.

 

 

Proactive engagement with rating agencies and understanding the levers at play to maintain, support or bolster ratings have never been more important.

 

Funding market selection and strategy

 

One of the green shoots for registered providers is the appetite from funders to continue to support the sector. Banks, in general, are looking at scaling up their exposure, providing greater duration, pragmatic structures and, to some extent, looser covenant protection.

 

Despite exceptionally compressed credit spreads, investors are desperate to deploy capital. Capital markets issuance over the past 12 months was rare, given the differential between the UK gilt market and UK swaps.

 

Value for money and cost effectiveness (balanced with a consideration of covenant package) have never been more important in funding selection.

 

Funding selection is on a case-by-case basis, depending on the registered provider’s strategy – whether that is future-proofing existing treasury portfolios through extending duration or seeking shorter-dated, more flexible, facilities.

 

Consideration needs to be given to interest rate exposure and any golden rules in this regard. There has been an increasing use of International Swaps and Derivatives Association agreements (ISDAs) to manage such risks, but this needs to fit with a registered provider’s strategy and risk appetite.

 

In the more volatile markets we have been experiencing, having a clear plan B (at least) is essential.

 

Bank market liquidity remains robust, and while some commentators have noted that bank liquidity is fading, we are seeing the opposite from discussions with funders. There will be a debt ceiling for the sector but, positively, we are seeing the vast majority of funders seeking to grow exposure.

 

On the capital markets side, while some own-named funding has returned with Flagship, LiveWest and Places for People executing transactions recently, the relative cost remains elevated, save for the Affordable Homes Guarantee Scheme.

 

Some registered providers are considering shelf facilities from US private placement investors, which, from a future execution perspective, limits price competition, but there is a cost to putting such facilities in place. In addition, floating rate funding is being offered, but be mindful of more punitive prepayment provisions.

Portfolio optimisation

 

A key consideration in an elevated rates environment is around the optimisation and rationalisation of existing portfolios.

 

This has primarily resulted in registered providers reflecting on target debt mix, composition of funding, considering opportunities to restructure facilities, using such restructuring to secure covenant improvements (both financial and non-financial) and optimising security efficiency.

 

We are seeing more flexibility from funders to act in partnership with registered providers versus a ‘computer-says-no’ approach.

 

A wealth of retrofit opportunities are being thrown at the sector. Analysing each of the relative pros and cons of these is key to ensuring registered providers are selecting the optimal solution, mindful of reporting requirements.

 

Hedging is a very pertinent theme in the market, given the increasing drawdown of variable rate facilities.

 

Exploring the available hedging strategies at play and considering how best to hedge current and future debt will be key – either through a standalone ISDA, a loan-linked ISDA or through embedded fixed rates.

 

Lender relationships

 

Lenders, in general, are being supportive of registered providers. That being said, there is more of a clear message around partnership working and having the opportunity to support and pitch in for ancillary business.

 

This is becoming more of an important theme, and while previously a more moot point, we are seeing banks evaluate total portfolio return in their lending decisions. Direct funding approaches are likely to impact on the desire of banks to support future funding.

 

There do remain lenders that have more onerous covenants in legacy facilities, with an unwillingness to change terms, especially where terms are economically disadvantageous compared with current facilities.

 

Again, this is a case-by-case decision, and in a market where funding costs are ever important, a key trade-off exists between capacity and cost.

 

For larger borrowers with significant relationship banks, ensuring a strategic tiering approach to relationships will help provide maximum transparency around total relationship return.

 

Growth and rationalisation opportunities

 

Collectively, we have been very busy supporting clients through merger activity as well as consolidation of portfolios. This is a theme that is set to continue, as signalled by recent announcements and given the challenges facing the sector. However, it is an opportunity for pre-emptive action.

 

We are seeing portfolio sales, acquisitions, stock swap discussions and more innovation around financing development.

 

This entails both on and off balance-sheet considerations, with ultimate ownership of the asset being less important for some providers. Again, consideration of such options should be on a case-by-case basis.

 

Getting your house in order

 

A strategic and considered approach to ensuring treasury and funding projects are delivering the nuances of your corporate strategy has never been more important.

 

Making sure cash and liquidity optimisation is targeted, ‘right-sizing’ to reflect corporate strategy needs, seeking to mitigate costs of carry where possible and optimising both covenants and security are strategic ‘quick-wins’ to ensure treasury is optimised.

 

Considering derivatives readiness, and conducting board training and education will also help support interest-rate risk management strategies. Additionally, considering the ratings impact of different strategic decisions will help ensure financial decisions are entered into in the considered knowledge of such impact.

 

While there are huge challenges impacting the sector, and predicting the future with a high degree of certainty is nigh on impossible, the funding markets remain buoyant, and there are opportunities for registered providers to support the future-proofing of their organisations in years to come.

 

Natalie Singh, partner, Trowers & Hamlins, and George Flynn, director, Savills Financial Consultants