Interview: ‘We didn’t know if we’d be in a credit crunch scenario’

Navigating the markets

Shortly after announcing the intention to go out to the bond markets in early March, the world began to change and the gravity of the COVID-19 crisis sent a series of quakes through global economies, equities and bond markets.

It became too risky to issue. A similarly well-rated housing association, Optivo, was further along with its process, having completed investor roadshows in early March.

Optivo waited it out for another four weeks before deciding to launch at the first opportunity on 31 March 2020.

Amid new issuer premiums for some corporates of between 50 and 100 basis points, Optivo paid closer to 30bps, with a spread of 230bps, as one of the first to enter the sterling markets following an effective shutdown in mid-March.

Sanctuary’s team was watching from the sidelines, and having continued to work with bookrunner banks – Lloyds, Barclays and HSBC – took the decision that evening to make its own move.

It held its virtual investor roadshow two days later and had priced by the end of the week at 170bps and an all-in cost of 2.375 per cent for 30-year money.

The virtual roadshow, while necessary, was a more “sterile” experience as it was not possible to engage with investors on a face-to-face level, says Mr Lunt, who likens the investor preparation for a public bond issue to “a finance directors’ Olympics’”.

“You feel a bit disappointed if you can’t go to the Olympics having done the training,” he says.

Despite the unconventional approach to the process, the deal still attracted £1.55bn of orders and the housing association increased the issue from £300m to £350m.

While taking an extra £50m comes with a cost of carry, Mr Lunt says it was attractive due to the long-term nature of the funding and extra support to be able to withstand the shock of the COVID-19 crisis.

The FD puts the level of investor appetite down to a combination of pension funds needing to place money, an appetite for 30-year money and Sanctuary’s credit profile, rated A2 stable by Moody’s and A+ stable by Standard & Poor’s.

He says the majority of the questions from investors were more focused on the response to the current crisis, despite the long-dated nature of the transaction, including implications for housing benefit and Universal Credit (UC), and the impact of the development delays on committed cash flows.

“We would have always been asked [those questions] but they were asking in the context of, ‘Can you turn off the tap pretty quickly from a cash perspective.’”

While Sanctuary was looking at an all-in cost of around 1.9 per cent in late February before the crisis hit in the UK, it finished at 2.375 per cent in April.

“I do think [spreads] will definitely come down. We were slightly tighter than Optivo and I think there will be another housing association that comes in tighter than us,” he adds.

That has been borne out, with The Guinness Partnership this week launching a £400m bond – including £150m retained – at a coupon of 2% and a spread of 145bps.

“It’s a market, supply and demand. I don’t think as a sector we should allow ourselves to get too comfortable with the [current] rates as low as they are over the long term.

“With our financial planning, we would not be doing our job properly if we always focused on the rate at the time – we’ve always got to make sure our models are sensitised to rate increases.”

Wider business

The bond proceeds will be used to top up the RCFs, which Mr Lunt drew down in line with Sanctuary’s "naturally conservative" approach. (At the 2019 year-end, the group already had £150m in cash).

The new funding can then be used primarily to invest in existing homes, in line with the new strategic plan but reflecting an “evolution of what the history of Sanctuary has always been”.

“We shape our financial envelope based on investing in the existing stock first, and we then look at allocating resources to new development activity while ensuring we stay within the parameters of our risk appetite,” he adds.

The FD adds that Sanctuary has a low exposure to fire safety remedial works, so the focus is more on the components of existing stock, tenant expectations and the environmental agenda as Sanctuary pursues the 2050 zero-carbon target.

And while Sanctuary heads into April with extensive liquidity, it may come out of this year with with more cash in the bank than expected.

Its development completions for 2020/21 were around 1,500 but are set to come down by half in light of the crisis and subsequent closure of sites, hiatus in construction and the time it takes to start up again. It’s five-year business plan going into the crisis was for 11,000 units over the next five years.

Mr Lunt says: “[It will depend] on where organisations are with the development pipeline, but actually we will have more cash as a result of the crisis than we will have lost cash.

“Housing associations are cash generative. It’s only when they start developing and reinvesting in stock that they become cash negative.

“This was going to be a really intense time because of our development and reinvestment programmes. The irony is, notwithstanding the impact on the income side, initially we will have more cash but we plan to continue with our long-term investment plans.”

However, the slowdown also comes as Sanctuary saw its regulatory rating for viability move down a notch from V1 to V2 this week, based on its planned increased investment in existing and new homes, and exposure to development, which the Regulator of Social Housing (RSH) said puts pressure on interest cover.

The group EBITDA interest cover was at 121% at March 2019, with group interest cover of 2.15x.

The RSH said while Sanctuary had an adequately funded business plan, the additional investment means Sanctuary would be reliant on income from a market sale programme to meet interest costs in the short-term, and face reduced capacity to respond to "adverse events".

Delivering services

Sanctuary is now working with developers and contractors across new build and repairs and maintenance (R&M).

On development, Mr Lunt says builders will be paid for March and April in line with milestone payments for the work that has been certified to date.

For R&M contractors, the approach is prompt payment and looking at shorter payment periods for some of the supply chain.

“We’re happy to take a bit of a hit on working capital but we can’t bail out the entire supply chain.”

Like others across the sector, Sanctuary has seen a significant rise in UC claims, from an average of 80 per week up to 400 per week.

And similar to others, there are no plans for a rent payment holiday or to review the 1% inflation-linked rise from 1 April 2020, following four years of rent reductions.

“It would be a difficult exercise to orchestrate.

“We should not be deciding the future model on the basis of the current circumstances. If there’s a level of support that’s needed, we are working closely with residents to provide advice on how to access Universal Credit and other benefits.”

Care support

Meanwhile, the Sanctuary Care business is under increasing pressure, managing over 100 care homes across the country and 6,300 staff.

“We are meeting daily to manage through this crisis and we are all, as a team, supporting each other, from the minutiae of whether we have got PPE, to the strategic decisions,” says the FD.

Securing PPE is an ongoing challenge, with some supplies not arriving as ordered. Where staff are shielding or self-isolating, the group is paying overtime to the rest of the workforce.

From a financial perspective, the group is also using the Service Sustainability Fund to recover some costs.

Mr Lunt adds: “The [care business] is running extremely busy at this point in time.

“They are used to infection control – it’s part of what they do – but they have not seen it on this scale in recent memory.”