The non-profit-making sector of the UK economy is surprisingly large, and includes housing associations, universities, charities and parts of the National Health Service.
Like the commercial corporate sector — only in some cases, more so — non-profit entities are adjusting to new constraints on banks, and looking to institutional investors for long term capital.
Because of their close ties to the state, before the financial crisis housing associations and universities could borrow from UK or continental banks for 30 or 40 years at 15bp to 50bp over Libor. “Banks have realised that although these weren’t lossmaking loans, they were lending at lower rates than they could borrow at, and for longer terms,” says Priya Nair, managing director in debt capital markets at RBC Capital Markets. “So they put pressure on the housing associations over covenants or when they had to renew loans, and muscled them into changing the terms or repaying.”
The housing associations had the largest debt needs, as they own 2.6m homes and are building more.
“We are open for business with the housing association sector, which we view as very secure and stable,” says Grant Vaughan, associate director, corporate debt capital markets, Lloyds Bank in London.
Banks now typically only lend up to five or seven years, not 30. Spreads have risen to more than 100bp or 150bp over Libor.
“The headwinds the housing associations have faced have caused them to think about other options than just going to their relationship banks,” says Nair. “We have been advocating that the bank market is there for short dated and undrawn finance, up to five years, while drawn and long dated debt should come from the institutional market.”
There have been housing association bonds since at least the 1990s, but issuance soared in 2012 to £3.3bn, three times more than normal.
Larger associations like Sanctuary, Genesis and London & Quadrant were repeat issuers, but a new generation joined their ranks — names like Saxon Weald, Great Places, Raglan and Midland Heart. Some of these are large, others have only 6,000 homes.
A ready market
Far from suffering indigestion, investors have lapped up the deals, since they are desperate for sterling bonds to buy, as UK companies do much of their funding in euros and dollars.
Greater issuance has tempted more investors to take the trouble to understand the social housing sector, so that where deals used to go to a few handfuls of investors, now order books often contain 40 or 50. Spreads have tightened markedly.
“The range is about 80bp-140bp over Gilts now — about two years ago it was more like 160bp-170bp to 200bp-210bp,” says Nair.
Some believe investors are only now pricing the sector properly. “These are highly rated borrowers and they should trade tightly,” says one banker. “Low single-A utilities trade at 105bp or 110bp over Gilts, so for some of the best housing association credits which are high single-A or double-A from S&P to trade 15bp to 20bp through them feels quite reasonable.”
Banks like Lloyds Bank and RBC have encouraged investors to differentiate in pricing between the larger, stronger and better run housing associations and their weaker brethren.
Investors’ hunger for paper has also made them scrap taboos about only wanting deals of £250m or more. Public bonds down to £100m now attract plenty of investors, and private placements have appeared — sometimes the subject of fierce bidding wars.
In July, Canaccord managed to get in this way a spread of just 112bp over Gilts for Saffron Housing, a small debut issuer, on a £75m 35 year bond.
“At least five or six investors, which tend to be the larger, more sophisticated ones, are willing to buy deals that are small and unrated, off bond or loan documentation,” says Vaughan. “The demand from US investors is still there, but has not been so competitive with UK demand this year.”
Bankers warn associations against thinking they will save money by cutting out the banks. “Whatever the banks are making in fees is easily offset by saving only 2bp or 3bp of margin by getting the best bid from the investors,” says one.
Legal & General Investment Management is one of the most active PP investors, for its annuity fund. “We’re investing in them because they need long dated debt and they offer a relatively good track record with respect to their operating and default history,” says Georg Grodzki, head of credit research at L&G in London. “Liquidity is of secondary importance.”
Not set in stone
But the sector’s outlook is not cloudless. The failure of Cosmopolitan Housing Association in 2012 led to criticism of the regulator, the Homes and Communities Agency, though it orchestrated a takeover of Cosmopolitan by Sanctuary HA.
The episode showed the sector can resolve failures without harming investors. “The beauty of this sector is that no private sector lender to it has ever lost a penny,” says a banker.
More encouragingly for associations, the government gave them a present in June: the offer of £450m of grants and £3.5bn of loan guarantees for affordable housing providers, with up to £3bn more in reserve.
If the government’s collateral and other requirements are not too onerous, housing associations might be able to issue government-guaranteed bonds at perhaps 60bp over Gilts — a material spread saving, but not game-changing.
In the long term, Grodzki says, “The sector’s framework and structure is changing and risks are likely to increase, with government support being gradually withdrawn.”
One hypothetical scenario is that the government could become disenchanted with having 1,500 associations, not all well managed, and try to consolidate and commercialise them, introducing conventional profit-driven capital structures.
Investors will be on their guard. The precedent of building society demutualisation, which led ultimately to the failures of HBOS, Northern Rock, Alliance & Leicester and others, is not encouraging. The housing association sector’s record of a non-profit-driven commitment to social housing, combined with an unblemished credit history, has much to recommend it.
Hospital PFIs take private route
|The UK’s National Health Service is no monolith but a network that includes state bodies, independent public sector companies like the NHS Trusts that now run hospitals, and private doctors’ practices.
Financing new hospitals has been since the 1990s an important field for the private finance initiative (PFI). Private companies have built many hospitals and provided cleaning and maintenance services on 30 year concessions. From 1998 to 2008, bonds financing such projects were commonplace, often using guarantees from monoline bond insurers.
They vanished when most monolines blew themselves up with structured credit investments in the crisis. Since then, most health PFI deals have gone to banks, including Japanese banks, still willing to lend long term to such projects.
A few deals are getting done privately, such as the £237m Alder Hey Children’s Health Park in Liverpool, closed in March, with M&G IM and the EIB as lenders.
Universities head for bonds — on or off balance sheet
|Universities are an extremely rare species in Europe’s bond market ornithology, unlike in the US, where many colleges issue bonds.
In the first half of 2012 there was a sudden spate of 30 year bonds from US universities, prompted by exceptionally low interest rates. “They can be very opportunistic,” says Marcus Hiseman, head of European corporate debt capital markets at Morgan Stanley in London. “A lot of it comes from the endowment side. They know their assets are yielding more than the rate they can borrow at, so they put a little leverage on their funds, like Wellcome Trust did.”
The £550m 30 year bond for the Aaa/AAA rated UK medical research charity was priced in 2006 at 44bp over Gilts. It was a key pricing benchmark when, in another flash of glamour for the sterling market, the University of Cambridge issued its first bond in October 2012.
There have been half a dozen other private and public UK university bonds, most recently De Montfort University’s £110m issue in July 2012. The 30 year Aa1 rated bond was priced at around 260bp over Gilts.
But Cambridge’s £350m 40 year bond, led by HSBC, Morgan Stanley and Royal Bank of Scotland and paying just 3.75%, trumpeted the arrival of a new market.
Cambridge had been deliberating on the deal since 2007, to finance new research facilities. But the prompt for many universities like De Montfort has been falling grant support, forcing them to maximise revenue by attracting high-paying foreign students and corporate donors with modern facilities.
“The Cambridge deal was incredibly well received,” says Hiseman. “Most of the big sterling investors said this was a must-have. I have never seen them show their hands to the extent they did, putting a super-aggressive level on the table for us to begin with.”
Rated Aaa, Cambridge priced at 60bp over Gilts, achieving its goal of being classed with its US Ivy League peer group, and coming 2bp inside triple-A Johnson & Johnson, 12bp tighter than Transport for London and 20bp inside Wellcome Trust.
The University of Manchester followed in June 2013, with a £300m 40 year bond rated Aa1 at 80bp over Gilts, about 25bp outside Cambridge.
Several other universities have got ratings. “We’ll see more deals come through,” says Hiseman. “It takes a lot of time for organisations like universities to go through an approvals process. But it’s great for the economy — this is exactly how investors should be spending their money.”
Investing in university infrastructure, he argues, helps to foster centres of innovation around universities and creates benefits for the local economy.
Another strand of university financings is those done off-balance sheet, such as the project financings this year for the Universities of Edinburgh and Hertfordshire. The later had issued a PFI-style bond in 2002, but returned this year for another major campus development, financed with a £143.5m bond, placed by RBC Capital Markets with Legal & General IM, entirely in index-linked form.
These projects were structured PFI-style, through private consortia. The £62m Holyrood Student Accommodation deal for Edinburgh in July — and a £102m housing deal in Leeds a couple of weeks earlier — were notable for marking the return of monoline wraps.
Assured Guaranty, the only monoline still operating in Europe, still has pre-crisis guarantees on £8bn of European bonds, but since 2008 had only given one fresh guarantee, on an old hospital PFI bond previously wrapped by Ambac. The Leeds City Council housing refurbishment PFI bond, placed by Lloyds Bank, and RBC’s Edinburgh deal showed monolines could add value on new project financings.