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T.H.A.T. Thought No. 31 – An Issue of Ratings

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On 26 September 2017, Moody’s announced that it would be reducing all Housing Association ratings by one notch, and from negative to stable outlooks (or in the case of Notting Hill remaining at negative outlook).

This followed its decision to reduce the rating of the United Kingdom on 22 September from Aa1 (negative) to Aa2 (stable) over concerns about the impact on the economy of the Government’s strategy for Brexit.

The reduction means that Moody’s ratings on Housing Associations have fallen by up to four notches over the last six years – while the rating for the UK has been reduced by two notches (Aaa to Aa2) and the value attached to government support has been reduced from two notches to one.

If our figures are correct, this has produced the following outcome:

Moodys_credit_rating_2017

Cumulatively the move suggests a major shift in the view Moody’s are taking over the credit of the sector.

Over the period, the agency has not upgraded any association, while five are now rated Baa1 or Baa2 implying underlying credit metrics that are barely investment grade.

So it is probably worth considering what impact this will have on the pricing and availability of funds; how justified it actually is, and what, if anything, borrowers should be doing about it? 
 

The impact of the downgrade.

The first thing to note is that the announcement has had no immediate impact on the trading of Housing Association bonds in the secondary market.

Secondly, it contrasts with the situation at both S&P and Fitch where:

• UK ratings by both agencies have fallen to the same extent as Moody’s (AAA to AA).
• The same one grade uplift exists for Government support (except in Wales which has a two grade uplift), and yet
• Housing Association ratings have generally only fallen by one grade over the period.

Against this background it may be tempting to ignore the downgrade and simply move on. However, this is to misread the cumulative impact it has on the price and availability of debt.

In JCRA’s view the approach taken by Moody’s has materially affected the attitude of investors to Housing Association debt:

• Discourages new investors from entering the market
• Increases the level of capital investors must allocate to the holdings of existing bonds
• Helps feed a view amongst some investors that ratings always overstate the credit, and
• Generally undermines the reputation and standing of the sector.

Associations are well advised, therefore, to consider action to counteract the impact of Moody’s actions if they wish to maintain or expand access to debt.
 

The financial performance of the Housing Association Sector

In this the housing associations are supported by the very robust performance that the sector has demonstrated over the period.

Housing Associations have come under considerable pressure from the Government over the last six years from Welfare Reform and in England, a reduction of grant followed by a reduction in rents.

Yet this has been accompanied by a steady improvement in the financial performance of the sector as is demonstrated in the figures produced by the HCA for English Associations:
 

HCA_English_Associations


These show significant improvements in operating margins and interest cover with only a minor increase in gearing and debt per unit.

Of course, it is possible to argue that some of the improvement arises from an increase in the risk taken by individual associations (particularly in London) because of a shift in development strategy towards open market sales.

Yet it is wrong to overestimate the impact of this. It may justify individual downgrades but the impact on the whole sector is limited. In general, the improvement comes from greater operational efficiency, improved governance and more professional management.

The figures only cover the period to 2016 and it is also possible to argue that the impact of rent reductions in 2016/17 will produce a weaker result.


The performance of individual associations

Yet the 2017 accounts for individual housing associations appear to tell a very different story.

This is clearly demonstrated in two of the Housing Associations that have held a rating from Moody’s since 2012.

While it is not possible to use the HCA accounts to measure performance against Moody’s ratios, this can be done using the accounts of individual associations.

In both of the cases set out below they demonstrate a stable or substantially improving trend on the basis of these analytics. 

 

Housing_Association_Rating


Responding to the downgrade

Given the sweeping nature of the pronouncement from Moody’s, JCRA thinks there is little benefit from arguing with the agency about individual ratings. This is largely born out in conversations our clients have conducted over the last week which suggest the analysts have no room for manoeuvre.

Instead, JCRA thinks that associations should look at some or all of the following actions:

• Present to existing and potential investors with a focus on two issues:

- the improvement in the underlying performance of the business over the last five to ten years, and where relevant

- the shift in the asset management strategy over the period, how this has benefited the bottom line and what steps have been taken in the process to minimise risk

• Obtain a second (or third) rating. 

- S&P and Fitch are both respected by investors, and

- have an approach to associations that is more sympathetic to the underlying business model

• Consider dropping Moody’s once the alternative rating(s) are in place. Investors have to take the lowest public rating in allocating capital to their investments – so a Moody’s rating that is two grades lower than others is expensive to maintain.


Conclusion

JCRA believes that the approach Moody’s has taken is fundamentally misguided. It does not appear to:

• Understand that Housing Associations become more rather than less valuable to any cash strapped Government:

- Sub market rents created by borrowing outside the PSBR

- An attractive potential source of revenue

   > early repayment of grant

   > sale of property at open market values

• Appreciate the improvements that have taken place in operating performance

• Give credit for the robust approach that many associations have taken to:

- market risk on the development programme, and

- the margins on the asset management programme across Open Market Sales, Shared Ownership, Staircasing and Asset Rationalisation 

Housing Associations need to take direct action to address these issues since otherwise there is a risk that the capital markets become a more expensive and more restrictive source of borrowing.

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