Building a relationship: How to invest in social and affordable housing

To date, Pension Insurance Corporation (PIC) has invested over £2.5bn in directly sourced debt investments, including almost £1bn in social and affordable housing across the UK.

PIC head of debt origination Allen Twyning says the insurer lends to registered providers of social housing, with these loans secured on a portfolio of homes.

But, he explains, PIC also gets involved with other transactions too - including a number of social housing private finance initiative (PFI) transactions, deals which typically involve a local authority putting a project finance structure around a portfolio of potentially quite dilapidated stock in order to bring it up to a much higher standard.

It has also been involved with some slightly less straightforward transactions that have been more unique in nature. One such deal was the £70m secured debt deal to fund retirement housing in the Church's Housing Assistance for the Retired Ministry (CHARM) scheme, provided by the Church of England Pensions Board.

This investment, in which PIC is the sole investor, is linked to CPI and secured against a portfolio of residential assets. PIC also invested in £93m of secured debt issued by the Welsh Housing Partnership - a partnership supported by the Welsh government and set up to deliver new affordable housing for four housing associations.

This deal was particularly innovative as £10m of the loan was deferred for four years.

 

Rationale

PIC says the key reason it does these sort of deals is to match its cash flows, something that has become particularly important under Solvency II.

Twyning explains: "Year by year we have liabilities to match and we have to go and find high quality credit assets to match those liabilities.

"Previously, we were doing these things because we felt they were a good diversifier and we saw value but now, with Solvency II, it has become exceptionally useful for us to work with borrowers and agree a cash flow profile that works for them and works for us."

Twyning cites the example of US dollar denominated corporate credit, which is typically issued in durations of up to 30 years.

"Once you get beyond 30 years you really are struggling to find suitable assets in the US dollar market," he says. "It's a little bit easier potentially in the sterling market but there isn't a huge amount of supply.

"So we've found these kind of directly sourced transactions particularly useful when going out beyond 30 to 40 years, where we can't find public bonds that are there to match our liabilities."

Origination

But while these deals are proving invaluable to help it match liabilities, finding such opportunities can prove challenging for an organisation that doesn't have access to the same large network as a bank.

Twyning says there are two main routes it uses to originate deals. First, he says, is the traditional bank-led private placement process, where a bank will take a borrower round to a handful of investors who are known to be active in the sector and then facilitate a bidding process. The other route is to use specialist intermediaries who will advise and arrange the debt - a route

Twyning believes can make a lot of sense in the fragmented housing association market.

Once a deal has been sourced, however, PIC says it then needs to do an in-depth credit assessment to ensure it will be a good quality investment.

Twyning explains: "The core of what we look to do is ask are these assets good quality, in demand and can they sustain long-term debt?

"You go through a process. Not every housing association you meet appears ready from a governance perspective to take on long-term debt or you may have concerns about asset quality or they may just be running with too much debt. Those are the ones that we don't get involved with."

Yet, even if a housing association does get into financial difficulty, it is unlikely lenders will take a loss as these difficulties tend to get dealt with by merging the troubled association with a larger, more healthy one.

Twyning says: "What we see as the most likely outcome is a negotiated position with the regulator where the assets and the corresponding liabilities would get moved to a healthier entity."

 

Competition

While PIC has been investing in the social housing sector for a number of years, there is increasing institutional interest for assets of this type.

Twyning says this demand tends to come in cycles and believes the key is for lenders to maintain price discipline - noting they are not compelled to keep lending if they don't think there's value in the market.

But he says there is also an increase in the number of associations wanting to come to the market to replace or add to short-dated bank facilities.

He says: "I think we have seen an increase in supply and an acceptance that capital markets are probably at least part of the solution, if not most of the solution in terms of long-term funding."

Twyning also notes that, while there may be more investors than in the past, there are still only a few that can write the larger deals - those with ticket sizes of £50m to £100m or more - and fewer still that can offer innovations around things like duration or the deferral of funding, where a proportion of the loan is provided at a point in the future.

He explains: "A lot of housing associations look at where interest rates are now and want to lock in but they don't necessarily want all the cash coming onto their balance sheet on day one as they may not have a current spending need or they may be earmarking it for a refinancing in a couple of years.

"What we find is you are able to negotiate superior terms if you can give them something that is more cost effective for them over the longer term, or makes more sense for their balance sheet."

Long-term

Twyning says that, while these sorts of investments can add significant value, they do require significant work.

He explains: "Unless you're doing it in decent ticket size, I don't think it makes economic sense to do so. So we look at £35m to £40m as a minimum investment size to justify the level of work."

He also says that these sorts of investments need to be seen as part of a long-term relationship - noting PIC is starting to see some borrowers come back to discuss incremental funding.

Twyning concludes: "I think if you are going to get involved, I think you've got to think about the longterm relationship and how that works and the level of involvement you may need to do, both up front but also as things change.

"Clearly these things evolve over time and borrowers may need to come to you to talk about consents or waivers to do things that are slightly outside of the loan documentation - it is not just about making an allocation, it is more of a dynamic ongoing commitment to be involved with the organisations you lend to."