M&G Investments case study
With more than 20 years’ experience and £6.9 billion* worth of investments undertaken, M&G is an acknowledged leader in social housing finance.
In 2012 to 2013, M&G Investments worked with the Welsh Assembly to create a borrowing facility for 17 Welsh housing associations so that they could fund ambitious new homebuilding targets and other essential initiatives.
The most significant challenge was that many of the housing associations were not large enough to borrow the minimum amount usually available through institutional finance, which in some cases necessitated a higher-than-usual level of engagement on governance matters.
The problem of size was solved by creating a pool of capital made up of two parts: a £156 million 'club deal' loan from M&G and, secondly, a Welsh Government grant. M&G’s investment was underpinned by the same detailed level of credit analysis and engagement, including ESG considerations, on each of the 17 borrowers, irrespective of size.
The pool enabled each housing association to choose the tenor, or length, of their loan, benefit from economies of scale (which made legal and other fees more affordable) and select a repayment profile that suited their long-term plans.
One of the borrowers was United Welsh Housing Association (UW), a not-for-profit organisation providing housing and related services across nearly 5,000 properties, spanning 11 local authorities in the South Wales region.
UW focuses on supporting individuals and families in very diverse circumstances. This includes working with other support providers to supply homes for people with additional needs, such as those with learning disabilities, the homeless, young people leaving care, women suffering domestic abuse, those recovering from substance misuse and people with mental health problems.
UW’s goal in borrowing from the club deal loan was to fund the cashflow requirements of a 500-property development programme. One development benefiting from the provision of the loan is ‘The Beeches’ scheme in Caerphilly. This comprises 25 homes for rent and 20 homes for sale, at low cost, and centres on the regeneration of the Caerphilly Miners District Hospital. It is a joint venture with the Caerphilly Miners Centre and residential construction and social housing experts, Lovell.
As UW and the other 16 housing associations took apportioned loans from the capital pool, they triggered interest payments to M&G’s clients that were long-term, stable and secured against portfolios of existing homes – thereby providing a strong match for their liabilities.
* Source M&G, market value as at October 2015
Many of M&G’s investments in this sector are private transactions that are long term and illiquid in nature. They require detailed, often time-consuming analysis of a housing association’s creditworthiness.
A substantial proportion of this involves assessing whether the tenants can, given long-term fluctuations in employment and welfare patterns, afford rental payments that rise with inflation.
Many of these considerations are also driven by the fact that borrowers offer portfolios of existing homes as security to lenders, which renders the quality of homes and the way in which the housing associations engage with their tenants, material.
The value of the homes posted as collateral can change significantly over the long term. Socioeconomic factors like wealth distribution and employment patterns (from local to national levels) can influence demand for social housing.
ESG analytical considerations include the following:
- the percentage of stock meeting the legal decent homes standard
- the plan to reduce numbers of non-decent homes
- the quality of the repairs service provided to tenants
- the plan to prevent decent homes becoming non-decent
- bespoke quality standards that exceed the legal minimum
- contingency for retrospective imposition of 'green' standards on legacy housing stock
- homebuilding plans relative to the waiting list for new homes
- the number of a housing association's tenants receiving state welfare payments
- activities by the housing association to assist tenants claim welfare
- provision of debt advice and other financial guidance to tenants
- quality of the housing association’s management team
- levels of corporate governance – both absolute and relative to the sector
- quality of reporting and disclosure
Environmental risks can also play an important role. Regulation continues to increase the minimum green building requirements for existing and new stock, requiring ever more capital. This can affect creditworthiness, but can also boost the long-term value of collateral and improve its energy efficiency, making a tenant’s rental payments more affordable.
Detailed credit analysis can uncover significant issues that can only be addressed by thorough engagement. Recent examples encountered by M&G’s analysts and fund managers include housing associations with high levels of tenant dissatisfaction, caused by a poor repairs service, despite the management team reporting strong financials.
Engagement focuses on quality of management and levels of corporate governance, mindful that each registered provider is a not-for-profit entity, without the benefit of shareholder oversight and possibly without extensive experience in capital raising (or even debt repayment schedules).
Engagement starts as part of the initial analysis and continues through the life of the loan, a period that can last for decades.
Here, engagement can bring two benefits.
The first is that it can improve the risk and return profile for the investor (and their underlying clients or members, such as pensioners in payment).
Such engagement can include avoiding poor cost management, maintaining formal reporting and monitoring desired and mutually agreed improvements in performance.
The second benefit is that engagement can address the quality of life of many thousands of tenants through:
- maintaining and / or improving the quality of homes posted as collateral
- advice on financial management
- support for maintaining decent homes standards
- improving, fostering or maintaining good tenant relations
Active engagement can help address any quality issues with management teams, which can emerge in select cases. In such instances, the investor must quickly identify where support is required and which initiatives can maintain or enhance a borrower’s creditworthiness.
This can act not only as an early-warning signal for any developing problems but also to encourage best practice on management and disclosure.
An investor judges the success of a bond, loan or other similar investment if it is repaid within the terms and conditions of the agreement, without exposing the investor to undue or unexpected risks.
The impact of ESG in the investment process should be judged within these boundaries: namely, has integration and engagement assisted the ability of the housing association to repay its debt and manage or reduce risks to the investor?
This includes the following considerations:
- The housing association retains sufficient levels of governance so that it can meet its borrowing obligations. This includes
- the quality of the homes (and the quantity of decent homes) posted as security against borrowing
- successful engagement by the housing association with its tenants
- Governance levels facilitate the housing association to meet home building targets for families
- Material ESG risks that have been identified during or after initial credit analysis have been addressed through appropriate levels of engagement