Social Housing Briefing - Bonds: Shaken or Stirred?
Funding, as we all know, is in short supply, difficult to access with tighter covenants and short term lending the new norm. As part of the response to this challenge, last year saw several social landlords north and south of the border raise long term finance on the UK bond market.
But what are Bonds, how are they accessed, where is the funding sourced, what are the risks, do they have to be syndicated, what are the exit arrangements, and are they right for your organisation?
As specialists in the Bond market to both the public and private sectors, we have produced this briefing in response to these questions commonly raised by the social housing sector in the last year.
What Is a Bond?
It’s simply an IOU. It’s a promise by a borrower ( called an issuer) to repay money to a lender (called an investor or bondholder) usually with interest. In other words, a Bond is a way of raising finance. Bonds are also called securities or notes and have pre-set maturity dates when the debt has to be repaid. Bonds have a trading value, that is, they can be sold by the bondholder, to other investors in the capital markets.
Where is the funding sourced?
The issuer is usually a large organisation (but can be a group of smaller organisations like a group of RSLs) and the Bondholder usually institutional investors like UK pension funds or insurance companies. Eurobonds are also common .This simply means that the issuer borrows from a foreign lender in foreign currency rather than accessing domestic money.
How is Bond finance accessed?
The creation of a Bond from the issuer’s point of view is complex and in legal and financial terms is a highly specialised area of law and regulation. The creation of a Bond from inception to issue can takes several months with individually negotiated terms and conditions and requires a high level of due diligence before the Bond is launched. But access to Bond finance need not be so complex and can appear very much like traditional bank funding. The Housing Finance Corporation’s (THFC) bond is one recent example of 8 housing associations accessing bond funding through the THFC club bond. From an RSL’s perspective, THFC (and M&G and others’) documentation looks very like a bank’s loan and security package.
What are the risks?
Risks include the following :
- The due diligence and process costs for an issuer can be high
- The interest rate is not known until the Bond has been issued
- Pricing can fluctuate with market uncertainties like the the current changes to Welfare Reform
- Inexperience of the investors such as with a retail bond ( where the public buy bonds ) requires greater disclosure of risks which attracts a higher pricing
- Terms and Conditions of a Group Bond are pre-set and non negotiable
- Asset cover and security release cost ratios will be higher than for bank debt
- Proceeds must be drawn in full on closing and repaid in one amount on maturity
Do Bonds have to be arranged through a lending club?
As a minimum borrowing fund of approximately £150million is required to make a Bond “worthwhile” for most Scottish social landlords the syndication route through the issue of a Club Bond is almost certainly the preferred route for the Housing sector north of the Border.
What are the exit arrangements?
Bonds are repaid on maturity or prior to term. Syndication does not need to have the perceived drawbacks of interdependency but could have the advantages of cost sharing and wider partnering arrangements.
Are Bonds right for your oganisation?
This depends. This Briefing is only a short overview to the Bond market. As with any funding arrangement there are general and specific risks which your organisation needs to consider. We would emphasise that this area is a specialist sector. You need discuss whether Bonds are right for your housing organisation with such a specialist in the Sector.
At Morton Fraser we combine social housing expertise with a specialist funding capability which includes experience in the issue of public and private sector Bonds.
If you would like to discuss any of the issues raised by this Briefing or any aspect of social housing law or finance we would be pleased to hear from you. Please contact either Andrew Meakin or Kate Dewar.
