Credit where credit's due
With more housing associations approaching the capital markets for funding, credit ratings agencies hold the key to the sector’s financial future. Gavriel Hollander asks Standard & Poor’s to unlock its secrets
When novelist Tom Wolfe coined the epithet ‘masters of the universe’ to describe the Wall Street money men who hold our financial fate in their hands, it’s unlikely that he had an image of Liesl Saldanha is his mind’s eye.
Nevertheless, as the director responsible for all public finance ratings at Standard & Poor’s - one of the world’s two major credit ratings agencies - there is many a housing association finance director who might view her judgements as the word of God.
Getting a good credit rating is essential for any landlord that wants to access the bond market, and with long-term bank lending looking to have gone the way of all flesh, those ratings seem ever more important. But the softly-spoken and guarded Ms Saldanha is quick to dismiss the notion that the agencies wield too much power over the sector.
‘It’s important that people do understand that ratings are our opinions and they need to take care when they use those opinions. What we do is try to make the rationale for those opinions as clear as possible so they understand what the rating speaks to. It allows them [investors] to take their own decisions at the end of the day.’
Ms Saldanha reverts to what quickly becomes a mantra.
‘The rating speaks to the ability to service and repay debt,’ she says, for the first of at least half a dozen times during the course of our 45-minute interview.
The meeting with S&P could not have been better timed. Just last month, Moody’s Investor Services made headline news even away from the business pages by putting UK sovereign debt on a negative outlook, suggesting a higher risk that the government’s credit rating could go the way of some of those of some Eurozone states. Moody’s followed up by doing the same for the entire social housing sector.
As more and more social landlords explore the possibility of a foray into the capital markets in their never-ending quest for new sources of funding, the news suggests that now could be a perilous moment to take the plunge.
Perhaps reassuringly for someone in her position, Ms Saldanha is reluctant to speculate, however.
‘S&P has the UK on a stable outlook at the moment and that’s what we would be looking at,’ she says, expertly flat-batting a question about the impact of her rival agency’s recent change of outlook - and whether S&P is likely to follow suit.
‘It’s our opinion on credit quality and that is our opinion for the UK.’
But what if that was to change? It’s clearly something that must be recognised as a possibility at the very least, given the ongoing volatility of the financial markets.
‘We review all the time the ongoing support that the government gives the sector,’ Ms Saldanha elaborates. ‘If we see any change in the government’s ability to service the sector we take that into account. But just because an outlook changes doesn’t mean we question the government’s ability to help the sector.’
Presumed government support and a strong regulatory framework are the reasons why those housing associations that have gone to the bond market to raise money for development are deemed more credit-worthy than a number of countries - Greece, Italy and Spain, to name the most obvious examples. London & Quadrant’s AA rating is two levels above Spain’s and 11 better than Greece’s rating.
This credit-worthiness is vital. With banks no longer lending on a long-term, or 30-year, basis to housing associations, it is these credit ratings that help landlords borrow money over long periods of time at low interest rates. Indeed, recently, all-in rates of around 5 per cent for 30-year loans represent historic lows.
In other words, for those landlords that need long-term development finance, it’s been a question of making hay while the sun shines. But there are clouds gathering on the horizon. The recent £250 million bond issue from Circle will be repaid at closer to 5.25 per cent interest, while Radian’s much smaller issue was priced at a touch over 6 per cent.
Putting a price on debt
The price of debt is dependent on two factors: the underlying cost of government borrowing - known as the gilt rate - and the margin investors demand over and above this, known as the spread. That spread has widened significantly in recent months. Circle achieved a spread of 198 basis point (1.98 per cent), while Radian, due to particular intricacies around how the bond was issued, had to settle for a spread of 275 basis points. These compare with the 99 basis points achieved by The Housing Finance Corporation on a £76.6 million ‘tap’ issue in January 2011.
Surely, these changes are, at least in part, a result of a change in credit opinion across the sector? Neither Circle nor Radian are rated by
S&P, but, speaking in general, Ms Saldanha disagrees that ratings dictate investor confidence or the price they’re willing to pay.
‘The spread does not always speak to credit risk alone, it speaks to a combination [of things],’ she explains, with the slight weariness of a maths teacher walking a none-too-bright pupil through a particularly complex simultaneous equation. ‘Just because the spreads widen does not mean that credit risk has increased. Sometimes liquidity plays a huge part in why the spreads have widened; it’s not just to do with credit risk.’
And while only a few years ago, the idea of that long-term debt coming from anywhere but traditional lenders was far-fetched, it’s a very different climate now.
‘Traditionally this has been a bank-funded sector and that’s why there are very few ratings,’ continues Ms Saldanha. ‘It [bank debt] was long-term and was cheap so why would you go elsewhere? Then you had 2007 and what followed and you had banks pulling back.
‘Now, with [international banking regulations] Basel 2, banks will have to keep a lot more capital on their balance sheet, the mechanics of lending to the sector changed so more associations want to look at their options.’
Looking at the wider picture, a follow-up question about whether the coalition’s public spending cuts are not, in reality, driven purely at keeping ratings agencies happy is met with a sharp glance at the attendant press officer who, unsurprisingly, demurs.
Nevertheless, the agencies faced a grilling this month at a Treasury select committee when MPs accused them of not doing enough to warn of the 2008 financial crisis.
Providing a service
So, if ratings are simply opinions, albeit meticulously well-informed ones, why are they deemed to be so important? And why should housing associations pay upwards of £50,000 just to get one?
The simple answer is that without a rating, most investors wouldn’t take a second look at a bond issuer, particularly from a sector that is still relatively wet behind the ears when it comes to the capital markets.
‘Yes, it is expensive,’ says Steve Binks, finance director at 62,000-home Places for People. ‘But in the long term we believe it’s worth what we pay because it gives investors comfort that we are at a particular level of risk.’
In addition, Ms Saldanha insists that S&P also provides a service to the issuer itself. ‘Where we add value is to explain how we arrive at our ratings,’ she continues. ‘Sometimes entities may be [rated] at the same level for different reasons.
‘We try to make it as transparent as possible so the market understands what we take into account to assign our ratings.’
Among the housing associations that S&P rates, there is very little apparent differentiation. To date, it has rated four bond-issuing housing associations along with the bond aggregator THFC. Sanctuary Housing Association and Sovereign Housing Association are both rated at the fourth highest AA- level, while Home Group, Places for People and THFC are one notch below on A+.
But these differences could grow as an increasing number of associations come to the table.
‘With a sample size that is larger we probably will see more differentiation but it’s not certain,’ Ms Saldanha says.
She adds that the Homes and Communities Agency’s affordable homes programme, which will see housing associations charge up to 80 per cent of market rents for affordable housing, could be the catalyst for changes to ratings, with previously secure cashflows potentially coming under threat.
‘The model itself does not pose a risk,’ she says when asked about the effect of the new regime on credit worthiness. ‘It depends on an association’s response to the model and how quickly they move properties on to it [80 per cent market rent].’
‘Associations are telling us that very few homes will move [initially] so it will be a gradual transition.’
The language might be all about yield curves and credit spreads, but Ms Saldanha emphasises more traditional elements when she and her colleagues rate an association.
‘It all depends on good management and governance,’ she says.
And even if pricing of bonds keeps heading in an upward direction, she thinks it is unlikely to stop the march to the market.
‘If they want to diversify their funding sources, then they will do it,’ she concludes. ‘As long as organisations understand the implications of their decisions they will be fine.’
The rating game: how S&P assesses the sector
- Home Group: A+; first rated June 2009
- London & Quadrant: AA-; first rated August 2009
- Places for People: A+; first rated October 2009
- Sanctuary Housing Association: AA-; first rated June 2009
- Sovereign Housing Association: AA-; first rated August 2009
And for comparison…
- Spain: A
- Greece: SD (selective default - the second lowest rating)