The name is bond

As cold Thursdays in the grimmest stretch of the year go, 29 January 2015 was more exciting than most for Philip Day. The executive director for finance at Richmond Housing Partnership (RHP) was glued to his computer screen, watching the price of the bond he was trying to raise in the UK capital markets move as investors bid for the chance to lend to the 10,000-home housing association. ‘There was quite a bit of adrenaline on the go,’ recalls Mr Day.

RHP was seeking to secure a £175m, 30-year bond – £140m of it to be raised that Thursday, with £35m reserved for a future date. The cost of borrowing the funds would fall into two parts: the price of government bonds – known as gilts – that day; and investor demand for the RHP bond, which would determine the final ‘spread’, the additional amount that RHP, as the borrower, must pay on top of the gilt price. Together the two components form the ‘all-in price’ or ‘coupon’, equivalent to the interest rate paid on a bank loan.

On the first count, the south-west London association was in luck: the yield on 30-year UK gilts hit a historic low of around 2.1% that very day.

Fortune was smiling on the second count too: investor appetite was keen. After just two hours, bids totalled more than £560m. With demand thus outweighing supply, Mr Day says he watched an initial spread of 1.25% tumble to 1.17%, resulting in an all-in cost of 3.3% when bidding closed at the day’s end.

The deal marks a record low price for housing association, own-name, public, long-term bonds. RHP’s bond is significantly cheaper than the 3.63%, including a 1.4% spread, achieved by Paragon Community Housing on 14 January and prices paid by several other landlords, including Wheatley (with a spread of 1.6%), Herefordshire Housing (1.38%) and Riverside (1.35%) in November last year.

“The housing association sector does tend to default to issuing 30 years, plus or minus, debt when other sectors would probably be more flexible in issuing debt across different maturities.”

Phil Jenkins of consultancy Centrus Advisors

Such variation has amplified speculation that the sector is potentially failing to secure the best price for bond financing, in an era when banks are reluctant to lend for long periods and the capital markets are an increasing source of debt for the sector. Is the concern justified – and what can borrowers do ensure they achieve the best possible price?

It’s a valid question, given the sector’s appetite for bonds. ‘The capital markets have been increasingly important over the past two to three years,’ says Will Perry, assistant director of commercial and new entrants at the Homes and Communities Agency. The regulator notes that capital market funding, including private placements (see box), contributed 73% of new funding to associations in the final quarter of 2014.

Furthermore, housing associations accounted for 45% of all ‘long-term’ UK corporate bonds (of 20 years or more) issued in 2014, and 80% of those issued so far this year, says Adrian Bell, head of debt markets UK at advisory firm Canaccord Genuity.

More expensive?

Mr Bell argues that since there is a limited number of ‘around 20 to 25’ investors prepared to ‘invest long’, an imbalance of supply and demand is inflating the cost for the sector of raising capital market debt. ‘There’s this focus on borrowing very long, when long is the most rarefied part of the market,’ he says. ‘If [as a sector] you’re a big borrower in the market, investors will inevitably push prices up because they will see more of you coming.’ In other words, why accept a low price, when you know another housing association is likely to come along prepared to pay more?

There is no dispute that social landlords overwhelmingly use bonds for long-term finance. But not everyone agrees that this makes bond finance more expensive.

‘It’s a fair point that the housing association sector does tend to default to issuing 30 years, plus or minus, debt when other sectors would probably be more flexible in issuing debt across different maturities,’ says Phil Jenkins of consultancy Centrus Advisors, who calls suggestions that associations are overpaying ‘spurious’.

‘On the flip side, there are few other sectors [borrowing] in the 30-year space, so to some extent, housing associations have had a captive audience of demand for the longer dates,’ he adds. ‘With little issuance from utilities companies or the infrastructure sector, housing associations have enjoyed consistent demand for their debt issued at very long maturities.’

Though balance between supply and demand on any given day will inevitably influence prices – they are called the capital markets, after all – in fact this is just one element of what determines a bond’s cost.

Two key factors in bond pricing are a deal’s maturity (the length of time before the funds must be repaid) and the borrower’s credit rating. Investors demand a premium for allowing their cash to be tied up for lengthier periods, plus underlying gilt prices rise with maturity. Therefore, the longer a landlord wants to borrow for, the more costly it will be – regardless of the extent to which housing organisations may be crowding the long end of the market.

Conversely, the better the credit rating an organisation holds, the lower the spread it is likely to pay. This perhaps accounts in part for 5,800-home Herefordshire Housing, rated A2 by Moody’s, paying a spread of 1.38% last November, three basis points higher than Riverside’s spread of 1.35%. Riverside is rated two notches higher at AA3. The lower spread represents a saving of a few million pounds over the bond’s term.

Additionally, Riverside’s bond raised £250m, compared with Herefordshire’s £120m. As one institutional investor active in the housing sector, who did not wish to be named, puts it: ‘The best pricing will be for the deals of £250m plus’.

“‘The last thing you want is to go into a meeting where the elephant in the room, even if it’s a very small elephant, is not discussed.”

A bond investor

Another key factor is timing, which partly explains the attractiveness of RHP’s spread compared with those achieved by associations at the end of 2014. ‘The record low gilt yield [price] pretty much on the day we issued was key,’ admits Mr Day. But he adds that judgement played a part, as well as luck: ‘We were keeping an eye on timing [and the gilt price] because we weren’t under any pressure to issue the bond at a particular time.’

Yet there’s more to timing an issue right than waiting for a favourable gilt price, adds Mr Jenkins. ‘Towards the end of last year, there was a particular set of circumstances where a number of investors chose to close their books [not lend any more] for the year earlier than normal, coming on the back of a fair amount of supply from the housing sector. As a result, there was a smaller number of investors in the space and spreads were widened accordingly, even for [highly rated borrowers].

‘At the start of the New Year, that situation changed. There was enormous appetite from investors and that led to the pricing dynamic changing and spreads tightened significantly with [all-in costs falling below] the 4% level for the first time.’

Investors generally have a set amount they want to borrow for the year, and last year they had filled their order books before the end of December – this is why they stopped borrowing, but started again in January.

Fundamental to all of the above, however, is the quality of the business seeking investment and how well housing executives and their advisers communicate this to investors. ‘People just want to understand the business they’re potentially investing in, to see clarity in the business model and understand what the issues are,’ says one investor.

‘It’s about seeing the white of people’s eyes,’ he adds, explaining that funders will quickly recognise, and sense risk, in turn correlated to higher prices, when a landlord is holding back information. ‘The last thing you want is to go into a meeting where the elephant in the room, even if it’s a very small elephant, is not discussed.’

Investor pitch

“The issuers who get the best price are those who have successfully set up investor relations strategies and are in continual dialogue with investors.”

A bond analyst

Mr Day believes that the skill with which RHP presented its business to investors was crucial to securing its record-breaking spread. ‘You are going in there [to meet investors] to try and differentiate yourself from the others that have gone before you,’ he says.

Key to RHP’s pitch, he adds, was the organisation’s strong financial profile, an experienced management team that includes ‘a range of experience from within and without the sector’ and a clear and outward-looking vision to be a top UK service provider.

Nor should landlords seeking a good price restrict their interactions with investors to the period in which they are trying to raise a bond. ‘The issuers who get the best price are those who have successfully set up investor relations strategies and are in continual dialogue with investors,’ argues one UK bond analyst. ‘By having ongoing discussions with big investors, you will find out when they are most keen to invest, what maturities they want and how much they can invest.’

Still, argues Mr Bell, the sector should consider ‘more imaginative’ bond-raising activities – varying maturities and currencies, for example - in order to drive down costs. Short-term deals are always cheaper because there is less risk for investors, as their money is not tied up for so long. More investors are prepared to invest ‘short’ and this increased demand drives down the cost.

Places for People (PfP) issued a 10-year private placement Eurobond last year. The all-in price was 3.11%, lower than RHP’s record-breaking deal for its 30-year bond, even though PfP was only raising €40m – or £29m, a much smaller sum. The price of gilts, which underpins the cost of going to the capital markets for housing associations, is also lower the shorter the maturity. At the time of writing, five-year gilts were priced at 1.23%, 10-year gilts were 1.79%, while 30-year gilts were 2.48%.

As Mr Bell points out, ‘If you begin to create a range of deals, all of which are slightly different, you can begin to exercise real choice and [for investors] it becomes a much more interesting market to devote resources to.’