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Analysis & Comment:  

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Hightown Praetorian & Churches Housing Association 4.4% 2025 

Before I comment on the above, a short word on the last ORB new issue IPF 5 7/8%. It has been pulled because of lack of demand. I rather got the feeling it was going slowly but I was not expecting the bond to be cancelled. It doesn’t appear it was the coupon (although more always helps) nor that the company itself was out of favour; there had just been an equity buy recommendation and the stock had bounced. It seems that people were just not that interested or enthused which is a pity. Post the cancellation of the issue some of the related bonds on the secondary market have bounced as the prospective new issue supply will not be coming. Also the new Provident Financial 5 1/8% 2023, another lender in the euphemistically named home credit sector, has shot up in price, presumably on the back of no new issue for IPF.

Now on to Hightown Praetorian & Churches Housing Association which is a completely different type of issuer so there should not really be any read across from what has happened to IPF.

 

Issuer

Retail Charity Bond plc

Borrower

Hightown Praetorian & Churches Housing Association Limited

Underlying loan

Senior Unsecured, Unsubordinated

Subscription Period

31 March to noon 27 April 2015 (may close at short notice, subject to RNS announcement)

Settlement

30 April 2015

Maturity (expected)

30 April 2025 (10 years)

Maturity (final legal)

30 April 2027

Size

GBP [TBC]m

Coupon

4.40% p.a., semi-annually in arrears ACT/ACT

Listing

London Regulated Market and the London Stock Exchange Order book for Retail Bonds

Sales Restrictions

UK, Channel Islands and Isle of Man only, Reg S

Denoms

GBP 100 (minimum subscription GBP 500)

Lead Manager

Canaccord Genuity

ISIN

XS1200788369

SEDOL

TBC

ORB TIDM

HTOP


The bond is being issued on the Retail Charity Bond platform, previously used by Mencap. Hightown is using this platform both because it is a charity (like many HAs) and being relatively small needs only to raise between £20 to £25 million.  The charity platform caters for small issuance. The bigger Housing Associations (HAs), Places for People and A2 Dominion Housing Associations, came straight on to the ORB in their own names.

First some comparisons are set out below. We can see that Hightown is cheap on a relative basis to Gilts and on an absolute yield basis (the only one above 4%). Mencap is not bad value, but bear in mind the price has come down sharply from above 106 to 102.50 because of the new issue, and may well increase in price again once Hightown is out of the way. The question is, in credit terms should the new issue be trading at the yield premium it is being offered at?


Bond                                                   Rating              Life                  Yield                Spread to Gilts                        
High Town Praetorian 4.40%              Not rated         10 years           4.40%              282bp
A2 Dominion 4.75%                           A+                   7 ½ years         3.17%              175bp
A2 Dominion 4.50%                           A+                   11 ½ years       3.72%              213bp
Places for People 5%                           A2                   1 ¾ years         1.51%              112bp
Mencap 4.375%                                  Not rated         6 ¼ years         3.91%              264bp

Before we look at their capital strength here is a short word on their charitable status. Many Housing Associations (HAs) are registered charities but while some such as A2 Dominion will concentrate on providing housing units at sub market rates to the population as a whole, some will have a much stronger “social agenda”.  Hightown is one of these. They provide supported housing for those with learning difficulties and mental health problems. They also provide accommodation for the homeless, the young, women with young children and women fleeing domestic violence. When providing these services they work closely with, or rather on behalf of, the local authorities who are legally obliged to provide care in these areas. In a sense this is a fee based business where the cost of providing care will be very closely matched to fees paid by the local authorities. Margins, or profits (or as HAs, avoiding the dirty word profit, like to put it “surplus income”) will be low but so is the risk of a mismatch in income and costs. One final point is that although Hightown is a registered charity it is not regulated by the Charities Commission but by the Housing Associations’ regulator; presumably because one regulator is enough. We are regulated and I can tell you one regulator is more than enough.

Formed in 1967, Hightown operates in Bucks, Beds and Herts. Demand for social housing, I was told, is high in these counties because of high property prices (average of £275,000 per dwelling) and I was also told that high property prices underpin the capital value of Hightown Praetorian’s housing stock. They own and manage 4,400 units.

They have 860 clients in care and supported housing with 630 units and employ 450+ people. As an example they have four hostels for the homeless in St. Albans and have housing for young people in Hemel Hempstead, Watford and Hatfield. They also provide adult learning and short computer literacy courses and have a charity shop, largely staffed by their own clients to give some work experience. Geographical concentration gives them operational efficiencies: 30% of their housing stock is in Dacorum (an area of Herts just West of St. Albans) and 25% in St. Albans itself.

Now here are some hard-nosed figures; firstly on revenue. Rental revenue accounts for 72% of income, shared ownership and sales 26% and the rest comes from the charity shop. Free cash flow (I.e. profit) has been steadily rising: 2010 £4 mil, 2011 £5 ¾ mil, 2012 £5 1/2mil, 2013 £8 mil and 2014 £11 million. For their size I am told they are a significantly more profitable HA than the average. Their EBITDA margins place Hightown in the top quartile of HAs. A large part of the reason for this is that, unlike many HAs, as interest rates started to fall post the financial crisis they did not choose to lock in their funding and now have a large part of their borrowings funded by very low cost variable rates (average cost of their debt is 3%). This bond will now of course lock in some fixed rate funding. Another positive statistic is that they also have interest cover of 2.75X versus an HA average of 1.4X.

The assets of Hightown, other than £52million of reserves, are their housing stock. Of the 4,400 units, 83% are for general needs, sheltered and supported housing. 16% are for shared ownership. The average age of the properties is 22 years – so major repair and renovation bills should not be a problem. Also 83% of units are two bedroom or less so the bedroom tax should not be a major problem for their clients and 70% of units are low rise making management and maintenance easier and cheaper. Still on the subject of welfare reform they have worked out than only 6 clients will be affected by the benefits cap. Like all HAs, Hightown will have to adjust to Universal Credit whereby rather than being paid directly by the council, housing benefit will pass firstly through the (hopefully not too slippery) hands of their clients before finishing in the coffers of the HA itself. This, however, is an issue that affects the whole sector and to date there does not seem to have been much of a problem.
 

Demand for housing, and therefore the revenue side of the balance sheet, remains strong. The local authority produced waiting lists for social housing shows an increase from 25,000 in 2005 to 42,000 today in Herts and Bucks. Hightown’s plan is to grow by an approximate 300 units per annum (2/3rds through the acquisition of completed stock so avoiding development risk) . This will be largely financed out of free cash flow with some modest borrowing. It is good to see management costs per home have fallen from £500 in 2009/10 to £350 in 2013/14.
 

Currently Hightown has £225 million of borrowings from facilities of £280 million. The new bond will increase the percentage of fixed borrowings to 40%.

Finally here is a look at the all-important balance sheet. Net debt to assets (at cost) is a relatively low 53%. That is £46,000 per unit. Assets are not revalued and the open market value of their housing stock would be considerably higher given how house prices have moved. Total housing assets appear on their balance sheet at £390 million as at 31st March 2014. The Director of Financial Service, David Skinner, did not want to comment on what the current mark to market valuation might be but did not demur when it was suggested the valuation might be nearer double at £800 million.

Conclusion. It is very difficult to see a housing association being allowed to become insolvent unless there were very clear signs of grossly incompetent or corrupt management. Hightown appears to be particularly financially sound both in terms of profitability and their balance sheet (low gearing). Their advanced social agenda also ties them in much more clearly with the services that local councils are legally obliged to provide. This might not only lead to certain ethical funds targeting this bond, but also should confer some additional unspoken political protection. I think therefore the only reason this bond is offered cheap to the comparables is that it has no rating and the issue will be small. However, I don’t set much store by ratings and as long as there is a trading price (and there will be) I don’t think issue size is a major obstacle.  With a 10 year maturity and a 4.4% coupon there is some interest rate risk but I don’t see any sharp interest rate increases in the near future and when you see what is available elsewhere in the market, 4.4% seems positively generous. [Wellcome Trust a charity (admittedly rated AAA) issued a 4% 2059 year bond a year ago and it is now trading at 134.25 to yield 2.65% for 45 years. Now that represents a lot of interest rate risk]. I shall be buying this bond and I rate it a buy. Indeed if you want a safe element to your portfolio and would get some pleasure from supporting its well worth social agenda I would suggest it is a strong buy. I leave you with a question. Would you prefer to buy the Hightown at 4.4% for 10 years or for an equal 4.4% yield, following a strong new issue rally, the new Provident Financial 8 ½ year bond the proceeds of which will probably be on lent to the clients of Hightown at somewhere between 100-200%? Is it do the maths or consult your conscience?

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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