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Bond of the Week: 6 December 2016

Places for People  4.25% 2023 - New Issue

    

Places for People  4.25% 2023

Places for People, the Housing Association, is selling a new issue on the ORB market. It is their second issue (the previous one matures on 27th December this year). However, it is important to note there are substantial differences between the new issue and the one that is about to mature. Firstly, here are the terms.

Issuer: Places for People Finance plc
Guarantors: Places for People Ventures Operations Limited
PFPL (Holdings) Limited (also known as Places for People Leisure)
Residential Management Group Limited
Touchstone Corporate Services Limited
Zero C Holdings Limited
Issue size: GBP (to be determined)
Coupon: 4.25% semi-annual, payable on 15th June and 15th Dec
Issue Price; 100
Maturity: 15th December 2023 (7 years)
Settlement date: 15th December 2016
Sole Lead: Investec Bank Ltd
Denominations: £2,000 + £100 increments
ISIN: XS1527331430
Listing: London Stock Exchange

Places for People Group is a leading Housing Association (with a senior unsecured debt rating of A3). They own and manage 152,783 properties providing social and affordable housing and are regulated by the HCA (the Homes and Communities Agency). However, Places for People also carry out various non regulated activities and it is this part of the organisation that is issuing this bond. The guarantees, as listed above, are from various operating companies but exclude any guarantee from the regulated part of the business. Therefore, you do not have the asset backing of the large stock of social housing – although there are some assets within operating companies listed above.

All previous issues for Places of People (or indeed other Housing Associations), whether secured or unsecured, have been issued from the group as a whole so will have included a claim, albeit not always a first claim, over all the assets of the Housing Association. This is the first attempt, that I am aware of, to separate out the activities of a Housing Association between those that are regulated and unregulated and arrange finance separately for each part.

What might be the coupon on this bond if it were to have been issued by the regulated body?
The recently-issued Places for People 2.875% 2026 institutionally-targeted bond, issued at G+225bp, now trades at c. 95.875, 3.35% ytm or G+195bp and the, slightly better credit, A2Dominion 4.75% 2022 retail bond, trades at c.109.75, 2.9% ytm or G+213bp. Given the new issue is priced at 330 over Gilts we might assume, therefore, that a bond from Places for People with a guarantee from the part of the business containing the housing stock would have a coupon of something like 3%. With the new issue ORB bond you are therefore being offered an extra 1.25% for not having this asset backing.

The first thing to note is that the non-regulated parts of Places for People are surprisingly large. They account for 53% of the Group turnover of £616.6 million. So in terms of turnover, collectively they are actually a bigger activity than affordable housing. This can lead us to one conclusion, as suggested to me by the Group Executive Director (Finance) Simran Soin. Given the proportional size of the unregulated activities, these activities must have been taken into account by the rating agency when they rated the existing issues and the rating agency cannot think they present a great risk or the Group (which encompasses the regulated and unregulated activities) would not be rated A3.

The four operating companies

Place for People Leisure.   This company manages (but does not own) leisure facilities on behalf of Local Authorities throughout the UK. They manage 110 sites and are one of the major operators in the country. The average length of a contract is 20 years – the shortest length is 9 years and the longest is 45 years. Turnover is £130 million and profit before tax is £6.7 million.

Residential Management Group (RMG).  RMG manages 76,402 leasehold properties in the private sector. Typically they will be brought in by developers to manage blocks of new build flats. I was told that they are consistently winning new contracts. Turnover is £31.9 and profit before tax is £3.8 million.

Touchstone.  Touchstone manages market rent and tenancy for 18,484 residential and commercial properties for institutional and corporate investors, for retailers with residential upper parts and for Buy to Let mortgage lenders. This means handling marketing and letting, inventories and deposit management, rent setting, collection and credit control. Turnover is £12.9 million and profit is £1.4 million

Zero C Holdings.   Zero C is a “sustainable” developer (my italics as what developer does not describe themselves as sustainable and I can never work out if it has any meaning at all. To me it is just virtue signalling.). They aim to build 200 homes per annum and have a pipeline of 1,500 homes, offices and commercial buildings. Each project is different so it is difficult to give a precise description of their activities. Generally they develop sites in partnership with others via joint ventures. Often the affordable homes part of any development will be sold on to the regulated part of Places for People. I was also told if market conditions change and private sales become more difficult, then they should have the ability to increase the share of the site that is sold as affordable housing to the regulated part of the business .

The Treasury Director also told me that they often formed joint ventures with estate owners and the gentry as they don’t like to sell their land outright. Examples given were the Duchy of Cornwall and a Scottish Earl whose name escapes me. Certainly there is a rather fetching picture, in their presentation, of a classically designed building built in Poundbury on behalf of Prince Charles.


Turnover is £39.3 million and profit before tax is £5.7 million.

Balance sheet for the holding company of these operating companies.  This shows Fixed Assets as £205 million and capital and reserves of £205.8 million. As part of PfP’s reorganisation, of which the issue of this bond is part, £200 million was injected into these businesses – although I do not know in what form this injection took place. However, it should be noted that these fixed assets are really investments in the operating subsidiaries and guarantors of the bond. On the balance sheets of these subsidiary businesses there will goodwill as these business were all purchased.  I have had a cursory look at the prospectus and it appears the total equity and reserves at the operating level are in the region of £25 million.

It is important to emphasise that the argument for buying this bond is not the asset backing but that the businesses throw off enough cash/ profit to comfortably finance the bond.  I was told these operating subsidiaries have been all consistently profitable over the last 5 years. Total profits for these four subsidiaries were last reported at £17.6 million. Initially PFP Holdings will only have net debt of £25 million so on a cash flow basis they will not be heavily indebted, although the debt level will increase as they make further investments from the proceeds of the bond issue.

Debt profile.  Currently the only debt within the structure is with Zero C. They have a £25 million revolver taken out in 2008 before Places for people bought the company.  It is intended to use the first £25 million of proceeds from the retail bond to pay off this debt. This retail bond will therefore be the only debt of the company. They would certainly like to raise an additional £25 million for future expenditure/ expansion and on top of that they would raise more but the absolute maximum would be £100 million which would give them £75 million of extra working capital.

It should be noted that there will be additional debt at the joint venture levels.  Nevertheless, any joint venture borrowings will be done on a non-recourse basis to the operations group. The debt will only have recourse to the specific scheme with no cross default.


Covenants. There is an interest rate cover covenant of 1.5: 1 and a negative pledge whereby they cannot offer security to another lender (i.e. a bank) and slot them in above the bond holders.  This second covenant is important.

To what extent, if any, can the new bond take comfort from being part of a large regulated housing association? This is really an impossible question to give an accurate answer to and even the management of PfP might find this difficult to answer.  We can only surmise. It all depends on the circumstances.

There can be no doubt that the regulator will be pleased to hive off some of the risk of the non-regulated business from the regulated social housing stock. The purpose of hiving off risk is so that if something were to go wrong in the more entrepreneurial part of the business there would be no obligation for the regulated business to come to the rescue.  Therefore you cannot simply argue that one side of the business will simply bail out the other side. Indeed PfP would probably need the permission from the regulator, HCA, to come to the rescue of any or all of the four guarantors.

On the other hand if it appeared the entrepreneurial operating businesses had a viable future and any troubles were of a temporary nature, you would think the regulator would not stand in the way of a modest cash injection.  Given that with no public subsidy for new social housing (when an HA lets a house at an affordable rent (80% of open market rent) the government does not make up the 20% short fall), they are in part relying on the profits from other activities in order to have money to expand their social housing assets. The regulator must be mindful of this.

Conclusion
 

In a market with a dearth of new issues and few safe investments with anything like a reasonable yield, the investor is being offered an additional 1.25% yield in return for the Housing Association offering a bond which is asset-lite. Instead of asset backing you have profitable businesses that should be comfortably able to service their debt on a cash flow basis. The businesses, as fee generators (Zero C is slightly different – sometimes they receive a margin, sometimes it is acting as the house developer), should be stable. They have good earning visibility for the future, either because in the case of PfP Leisure they have 20 year contracts  or for Touchstone and RMG they have inertia on their side.  But notwithstanding the conservative nature of the operating businesses, businesses  without assets are more exposed to “events” than those with.

Bar non-recourse borrowings in Zero C’s joint ventures, the bond will be the only debt of the guarantors and this position is protected by the negative pledge covenant. Bondholders will be the senior creditor but in a structure with few assets as opposed to the existing retail Housing Association bonds where the structures are heavily asset backed but the bond holders rank behind secured lenders and are structurally subordinated. And then there is the comfort of being part of a larger group with the access to capital but the problem that the regulator might veto any rescue of the un-regulated businesses.

The new issue is very much a question of on the one hand and on the other. However, given the present realities of the Sterling bond market, the new PfP seems a reasonable but unspectacular offering and I shall probably buy a few.

Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.

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