Last year, I wrote about the risks for investors in housing association (HA) debt of the significant increase in housing development for outright sale that many HAs are undertaking.
This risk has recently come in to focus following the latest trading update from London & Quadrant (L&Q), one of the largest HAs in the UK with one of the most ambitious development plans. They are also one of the most prolific issuers of corporate bonds, with £2.3bn of public bonds outstanding, and maturities out to 2057. In what amounted to a profit warning, L&Q announced at the end of January that their expected surplus for the year ending March 2019 would be £150m lower than they had originally budgeted for (£190m vs £340m).
The majority of the blame was placed on weakness in the London housing market: “…the ongoing political and economic uncertainty continues to weigh on consumer sentiment, particularly in the London sales market where confidence remains a constraint and is contributing to downward pressure on pricing.” In simple terms, they are making less money from selling homes (both outright and via shared ownership schemes) than they thought they would. Indeed, L&Q’s net margin on all sales fell to 7% in the 3rd quarter, down from 16% in the same quarter of 2017.
It may well be that this is a short-lived phenomenon, and that post-Brexit consumer confidence returns with a bounce in sales and operating surplus. However, for us, these results re-affirm our view that the outlook for much of the sector is more uncertain than is reflected in current bond pricing. In general, we will continue to avoid those HA bond issuers with development plans that expose them to excessive outright sale risk.
That’s not to say that funding social housing isn’t a key focus for our Ethical range of funds. Indeed, we recently purchased a newly issued bond from Futures Housing Group, a smaller sized association (<10,000 homes) based in the East Midlands. Although it is increasing its development pipeline, the proportion earmarked for outright sale is very limited, with most of the development still focused on affordable housing. At a spread of close to 170bps over similar maturity gilts, the 2044 dated bond (rated A+ by S&P) offered a much more attractive risk/reward profile than many of the alternatives in the sector.