Costs, covenants and carve-outs: housing associations’ path to reaching net zero by 2050

In the Midlands, Platform Housing Group is spending £12m on energy efficiency over the next two years, £64m over the next five years and £640m up to 2050.

Rosemary Farrar, chief financial officer at the 47,100-home landlord, says the planned spend is changing according to information on costs and has not been limited by other cost pressures.

She says energy efficiency is one of the top priorities for the board in terms of setting its budget for the year, and the group is speeding up its energy efficiency work.

“I know that 2050 is quite a long way away in terms of decarbonisation, but 2030 isn’t,” she says. “And so, we’re going as fast as we can within, I suppose, relatively achievable cash flow pace.”

Some HAs have been forced to make changes to their timescales or spending plans.

Adam Masters, assistant director, environment and sustainability at Stonewater, says the landlord is pushing back its net zero target compared with earlier ambitions. The group, whose 35,400 homes are spread across England, is spending £30m to £35m on energy efficiency in the next five years and £300m in the long term to 2050.

Mr Masters says: “Our longer-term net zero standard is likely to be 2045 rather than 2040 due to the increased cost of retrofit.”

22

Registered providers that have reported agreeing a waiver from their loan covenants in respect of energy efficiency or decarbonisation

£500m

L&Q’s planned spend to ensure its homes are at least EPC Band C by 2030

£442m

Karbon’s planned spend to reach net zero in 25,345 of its homes by 2050

However, others are not making any changes in their spending plans and timescales – for example Abri, which is spending £5m on retrofit pilot works and electric heating upgrades in its properties in the current financial year.

Longer term, the 40,300-home group will be spending £67m over the next five years to bring all of its stock up to a minimum of EPC Band C, and a further £400m to ensure its stock reaches net zero by 2050.

Rob Barker, head of asset projects and partnerships at Abri, says: “Abri’s current spend profile has been modelled in our long-term financial plan and despite the current economic climate, we have not made any changes to our timescales, or spending, in making our homes more energy efficient.”

HAs will continue to manage the impact of their covenants on future plans, but energy efficiency and major repairs and maintenance spending have already impacted their financial positions.

According to the RSH’s Global Accounts, aggregate EBITDA MRI interest cover dropped by 24 percentage points to 128 per cent in 2021-22, the lowest level reported since 2012 (see graph, above).

Furthermore, over the past few months, the RSH has downgraded the viability rating for around 50 HAs, from V1 to V2. Most of these were because of HAs increasing investment in their existing stock which, coupled with inflation and interest rates, reduces their capacity to respond to adverse events.

Some HAs say they are not actively worried about the financial effects of decarbonisation investment and highlight that they continue to monitor their finances closely.

Covenants

HAs must remain compliant with their covenants when spending on decarbonisation, and those with restrictive covenants are looking to negotiate these with their lenders to free up additional capacity.

The main covenant in this area is the EBITDA MRI interest cover ratio, which stands for Earnings Before Interest, Tax, Depreciation, Amortisation, Major Repairs Included. It is a key indicator for liquidity and investment capacity and seeks to measure the level of surplus that a registered provider generates compared to interest payable.

CHP’s Paul Edwards says the HA has been negotiating with banks to agree a new set of covenants, which will allow it to carve out spend on energy efficiency works in the next few years, so they do not get counted against its interest cover covenants. He says that CHP’s lenders have been open in agreeing the carve-outs to enable that spend to occur. Mr Edwards calls this a “sign of a strong relationship between the lenders and the housing association sector”.

He says: “We found the banks to be certainly amenable to recognising the pressure that energy efficiency and net zero has on housing associations and it doesn’t impact our underlying ongoing profitability.”

Elsewhere, Jane Castor, chief financial officer at Thirteen Group, says the 35,400-home landlord can accommodate energy efficiency spending for over 15 years within existing covenant arrangements. After this, the North East-based group will need to make trade-offs or revise its covenants.

Ms Castor says Thirteen has initiated conversations, which are still in the early stages, with lenders about the potential to move to an EBITDA-only covenant, freeing up capacity to deliver its decarbonisation ambitions.

“Indications are that a transition to EBITDA only across our entire portfolio will be achievable, and we are seeing our peers completing similar exercises with positive results,” Ms Castor says.

Similarly, Charlotte Carpenter says Karbon is seeking to open the conversation on its covenant suite shortly with its lenders. She says the HA still has some traditional banking covenants in place around EBITDA MRI, and as its stock data continues to evolve, it will be using this to start the conversation about covenant carve-outs related to net zero works. 

“All our lenders are very proactive in relation to these conversations and know Karbon well, so we expect these conversations to be successful and be supportive of our business model,” Ms Carpenter says.

However, other HAs say they already have strong interest cover and are unrestricted – or are restricted only in the pace of their work.

Rosemary Farrar says Platform “probably has better headroom and capacity than many” and is only restricted by covenants for the pace it wants to spend on energy efficiency works. She adds that she believes the covenants will not actually restrict the programme because it is also restricted by the supply chain and “practically what an organisation even at our size can do within a year”.

She says: “It’s to do with not pushing your foot on the accelerator and then putting your foot on the brake. It’s about balancing spending priorities properly. We’re very strict with our golden rules.”

Legal professionals in the sector say that funders are open to conversations around covenants and there has been a rise in those discussions of late.

Michael Nutman, associate at Anthony Collins, says: “We’ve seen a marked shift in the past 18 months for lenders to be very open and willing to discuss flexibility and financial covenants for the purposes of things like decarbonisation work.”

Ms Farrar says Platform has the capacity in its long-term plan to invest in existing stock and to do so at a “sensible” pace. This will put pressure on the HA’s margin, but Ms Farrar is not concerned about the impact on its credit profile. The HA is graded G1/V1 by the English regulator and has a credit rating of A+ with a stable outlook from S&P.

She says: “We told our investors we’re reducing our margin from 35 to 33 per cent because of that investment in our housing stock, but I don’t think that’s a particularly bad margin anyway.

“I just think it’s about telling the story, forward planning, being absolutely clear about what you can afford, and doing this at a pace that you can afford to do it. So, we’re not worried about our rating, no.”

HAs face a constant balancing act between covenant compliance and meeting conflicting priorities of investment in existing stock and building new homes, amid the challenging environment of inflation and a seven per cent social rent cap.

“I just think it’s about telling the story, forward planning, being absolutely clear about what you can afford, and doing this at a pace that you can afford to do it”

Ms Castor says that Thirteen Group has “agreed mitigations” it would implement if unable to successfully negotiate interest cover changes.

She says: “Assuming we are able to agree an EBITDA-only interest cover covenant across our portfolio, then we expect to be able to deliver on our plans for other business areas alongside decarbonisation targets. If we are unable to agree this, then we have a series of agreed mitigations we would implement [that would impact other business areas].”

CHP’s chief executive, Paul Edwards, told Social Housing in January that the group would likely cut back on net zero spending to prioritise damp and mould in the short term. However, he says the group is now “content that the balance of spend between routine and planned maintenance between short-term damp issues and long-term energy efficiency works is a balance that’s working well”.

Damp and mould cases being reported have started to “diminish quite quickly”, Mr Edwards says, and are “moving back to a business-as-usual position”.

He adds that CHP is also not going to cut development spending, as the need for affordable homes where it operates across Essex is “greater than ever”, although pressures remain.

“Across the board, this year is difficult because the inflationary pressures coupled with the rent cap mean that we’re having to work harder than any of the years that I’ve worked in this industry to have a budget that is sufficient to deliver our corporate objectives,” Mr Edwards says.

Although still some distance away – and with a small amount of government assistance in the form of the SHDF – meeting the 2030 and 2050 deadlines will be no easy feat for the sector.

Mr Edwards reflects: “It will be our biggest challenge as an industry, as a country, to get through the next 10, 15, 20 years of really making an impact in our carbon emissions and the energy efficiency and comfort of our homes.”

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