Fitch Affirms 2 English Social Housing Registered Providers
The affirmations reflect Fitch's view that although these entities will see a significant reduction in turnover over the next four years compared with the previous business plans as a result of the rent cut announced in the summer budget, they should be able to compensate for this by cost reductions and efficiency savings as well as increases in other (commercial) activities in order to continue reporting a steady performance. The Stable Outlook reflects Fitch's view that developments over the past two years will not have a material negative impact on the sector despite the weakened operating environment and increased challenges faced by registered providers (RPs) in England.
KEY RATING DRIVERS
Sector Review
Fitch applies its public-sector entities criteria for the rating of RPs and adopts a bottom-up approach. The standalone assessment of each RP takes into account factors such as demand, operational efficiency, debt dynamics and management. It also incorporates public support factors, notably the strong predictability of the RPs' cash flow through government funding and capital grants. The one-notch uplift reflects the strong oversight of the regulator.
In November 2014 Fitch downgraded three RPs in the English social housing sector by one notch, reflecting a reassessment of RPs credit strength, which Fitch considered had weakened as the sector expanded its non-social housing activities and increased its debt. However, this was compensated by the high level of direct and indirect public funding that is now included in Fitch's assessment of the standalone profile rather than in the rating uplift. Increases in debt were factored into the downgrades. Further increasing debt is likely as a result of the rent cut. However, this will be gradual and should not affect the ratings at this stage.
In 2015 there have been various announcements affecting the sector, including publishing of the new Regulatory Framework by HCA, announcement of the offering for tenants of RPs the right to buy (RTB) their home at the same discounts available for council tenants, and the reduction of the social housing rents by 1% a year for four years starting in April 2016 (see details in 'Registered Providers: Regulatory Considerations' dated 12 March 2015, 'Fitch: New Right-to-Buy Could Add to Housing Provider Challenges' dated 16 April 2015 , 'Registered Providers: Rising Commercial Activities' dated 19 May 2015 and 'Fitch: Rent Cuts Negative for UK Social Housing Providers' dated 14 July 2015 at www.fitchratings.com).
As a result of the rent cut announcement, the RPs' business plans (BP), which had largely been updated in June, had to be revised to reflect this. The effect of this for some of the RPs Fitch rates is significant, and the rent loss primarily affects surpluses leading to diminished cross subsidy available for developing affordable homes over the next five years. It has also meant the headroom for interest cover and gearing covenants has narrowed. The value of some housing stock has also been reduced, affecting gearing calculations.
In many cases, initial actions have been taken to compensate for the rent cut, primarily focusing on cost reductions and operational and efficiency savings. Stress testing and multi-variable scenarios have been re-run for the revised BPs. Under most scenarios, headroom diminishes under the multi-variable combined stress testing. In order to mitigate these effects and to be able to comfortably meet their covenants, RPs have put forward corrective measures, including pre-emptive and responsive actions.
In terms of impacting development plans, considering there is uncertainty post FY20, some have decided to assume no development beyond this date. Other potential options if necessary are to convert larger loss making private developments into intermediate or private rent, or delaying the build of various phases of larger developments, as well as scaling back on non-core activity.
For the sector, both the 2014 global accounts and the latest quarterly accounts ending 30 June 2015 demonstrate that the sector as a whole remains financially robust. RPs performed strongly in FY14: turnover was GBP15.6bn, an increase of 5%; operating margin increased to 27%; and an aggregate surplus of GBP2.4bn was recorded, an increase of 22% compared with 2013. Sufficient finance is in place with GBP12.8bn of undrawn facilities. During FY14, GBP5.6bn of debt was raised, of which GBP2.5bn was through bank lending and GBP2.9bn was through the capital markets, GBP500m through private placements. Demand is expected to continue to increase. In 2014 there were 1.4 million households on local authority waiting lists, and fewer than 120,000 homes were built. However, although the sector has coped well with changes, risks remain in the volatility of the sector cash flows, in the expansion into non-social housing activities and in increased debt burden.
At the end of October the Office for National Statistics decided to reclassify English housing associations as public non-financial corporations included in the general government sector. The Department for Communities and Local Government responded by saying it would pursue deregulation of the housing sector and bring forward measures that seek to allow housing associations to become private sector bodies again as soon as possible. Fitch believes that the reclassification would not affect the agency's view of RPs' debt and would not bring the ratings closer to those of the sovereign. However, as strong regulation and oversight leads to a one-notch uplift, depending on the extent and nature of deregulation, this may affect the notching uplift. It is likely that further details on this will be announced in the Spending Review on 25 November. Fitch will monitor developments in this area and its potential impact on ratings and may comment further as any related policies take shape.
A2Dominion and Great Places
Both A2Dominion and Great Places have reported strong performance in FY15 and have shown through their revised BPs that they will be able to compensate for reduced rent income.
A2Dominion reported improved performance in FY15 with turnover of GBP297m and net group surplus of GBP44m. Surplus in the revised BP follows a similar trend to the June BP and operating margins range between 26%-30% to FY20. Interest cover is at a similar level and ranges between 2.2x-2.9x compared with 2.2x-3.3x in the June BP. Gearing is slightly higher and starts at 64% before reducing to 49% by FY20, compared with a range of 59%-44%. The borrowing requirement over the first five years remains in line with the June BP and total debt is not expected to exceed GBP1.6bn.
Great Places reported a stable turnover of GBP84m for FY15 and surplus of GBP11m. Surplus in the revised BP follows a similar trend to the original BP and the operating margin remains at 30%. The revised BP shows interest cover is at the original BP level by FY25 and the gearing ratio also improves. Existing facilities will last until FY21 and by FY20, while the debt stock is GBP50m better than the original BP, with outstanding debt unlikely to rise above GBP580m over five years from just over GBP470m at FYE15. Debt to turnover initially worsens but after FY19 improves significantly. The revised BP with a reduction in future development achieves a position of security stability which the original BP did not.
RATING SENSITIVITIES
The standalone ratings may be downgraded due to the following:
- Sustained weaker operating performance.
- Further announcements affecting the sector in the Spending Review on 25 November.
- The extension of RTB, which if implemented could create additional challenges for RPs in managing their asset cover.
- Widespread diversification into non-social housing activity and in private real estate market, through, in particular, increasing outright sales.
- Increased volatility in operating revenue as a result of higher exposure to development activities and a significant increase in gearing.
- The effects of continuing pressure on bank lending margins and risks associated with the finance market that could impact the sector.
The one-notch uplift may be affected by weaker oversight and regulation on behalf of the HCA, which may lead to a narrowing of the rating uplift.
The ratings may be upgraded due to an improvement in financial performance and other factors such as operational efficiency, debt dynamics and management, which directly affect their credit strength.
The rating actions are as follows:
A2Dominion Housing Group Limited
Long-term foreign and local currency Issuer Default Ratings (IDRs) affirmed at 'A+'
Short-term IDR affirmed at 'F1'
Long-term IDR Outlooks: Stable
A2D Funding plc and A2D Funding II plc's Long-term local currency unsecured bonds have also been affirmed at 'A+'
Great Places Housing Association Limited
Long-term foreign and local currency IDRs affirmed at 'A+'
Short-term IDR affirmed at 'F1'
Long-term IDR Outlooks: Stable
Long-term local currency secured bonds affirmed at 'A+'.
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