Impact of the changes to Housing Benefit announced in the June 2010 Budget

Review of Potential Changes in the Social Housing Sector

Written evidence submitted by Council of Mortgage Lenders

The Impact of Housing Benefit Cuts and Regulation Changes on Debt Financing (12/08/2010)

The funding community to the social housing sector takes great comfort from the strong regulatory framework and implicit Government revenue support in the form of social housing grants and housing benefit. Funders and rating agencies base their credit, probability and loss in event of default analyses with reference to this framework and the sector’s strategic and moral importance to the United Kingdom Government.

Bond market investors and rating agencies in particular place a great importance on the sector having both a strong regulator with the ability to intervene and indirect subsidies in the form of housing benefit. Investors and rating agencies believe these two elements in particular have underpinned the default free history of the sector. Should housing benefit cease to constitute a high proportion of housing association rents or not be paid directly to RSLs and regulation weaken significantly or be removed entirely the ratings of the sector would likely fall significantly and debt pricing would increase significantly. The rating agencies note:

"Moody’s ratings in this sector continue to benefit from a strong regulatory framework and the embedded high probability of intervention from the government of the United Kingdom ( Aaa /stable), were housing associations to face severe financial distress. The latter is a major factor in our ratings. Although not anticipated, were government policies to be less involved with the sector in terms of oversight, funding and use of reserve powers to co-ordinate the rescue of stressed housing associations, the ratings could fall significantly" Moody’s, English Housing Associations; Tight regulation and Government funding provide balance to pressures from economic downturn, March 2009.

"the following factors could, without balanced implementation by government, be negative for the sector………Substantial cuts in housing benefits could increase volatility on rents………A significant weakening in the financial monitoring by, and intervention powers of, the regulator (currently carried out by the Tenant Services Authority-TSA), could weaken credit quality in a sector, which by design operates with low, not for profit margins……The high investment grade ratings largely reflect Moody’s view of a strong regulatory framework and high government support for the English social housing sector" Moody’s, English housing associations face pressure from funding cuts, potential changes in regulation July 9 th 2010

"In the case of deep cuts and weaker financial regulation, the ratings of almost all housing associations could come under negative pressure" Moody’s, English housing associations face pressure from funding cuts, potential changes in regulation July 9 th 2010

"Standard & Poor's believes that most providers benefit from strong ongoing government support through regulatory mandates. In our view, support is most evident in the various forms of regulatory oversight, including the potential of regulatory supervision in the U.K. " S&P, Social Housing Providers Benefit From Government Support And Demand For Affordable Housing, February 3rd 2010

At one extreme if financial regulation of the sector were to be scrapped entirely and housing benefit not be paid directly to housing associations we believe this would align the sector with the general property sector. If housing benefit were also significantly reduced one could argue that the credit of the sector could be viewed as similar to the sub-prime mortgage market in the USA due to the low income nature of tenants and lack of governmental support. Severe changes to either revenue support or the regulatory framework would likely push the credit of the sector closer to a property credit as opposed to the quasi sub-sovereign status it currently enjoys. We believe that in extremis this could move the ratings of the sector from high investment grade towards low investment grade ratings for well managed RSLs/RPs and sub-investment grade for smaller and less well managed RSLs.

Although it is difficult to find direct trading comparables we have given below the current trading spreads for some general property companies that have issued bonds in the sterling market:

Source: Bloomberg, RBC

In the current market bond trading spreads for property related credits are 100-150bps higher than for social housing debt in the bond market. We would assume that bank lenders would similarly price these two different types of debt with the same type of differential.

We understand that approximately £60bln of private finance has been invested in the social housing sector over the last twenty years (by banks and institutional investors). If margins on RSL debt were to be increased by 100-150bp over time as it is gradually refinanced and if it is assumed that another £60bln will be required from the private sector over the next 20 years the cost of changing the credit quality of the sector could easily rise to £1.2billion - £1.8billion per annum by 2030. It is clear that with already thin operating margins housing associations would not be able bear these increased debt costs without either significantly increasing rents or requiring greater Government subsidies and grants.

The regulatory framework and indirect government funding of the social housing sector in the UK not only allows RSL/RP bonds to trade at tighter spreads in good market conditions as can be seen by the above current trading spreads, it also means that trading spreads and debt pricing for the sector are less impacted by market shocks. Evidence of this ‘protective effect’ is seen in the trading spreads below, which show that during the credit crisis spreads for unregulated property companies widened significantly more than for bonds issued by regulated housing associations.

01/01/2008 01/07/2008 01/01/2009 01/07/2009 01/01/2010 01/07/2010

Spread to gilts (Basis Points)

Source: Bloomberg, RBC

The Sanctuary Housing Association bond shown above represents one of the largest and best managed housing association groups in the sector. To date smaller housing associations have enjoyed relatively similar debt pricing in both the bank market and the bond market (through group borrowing vehicles such as THFC). However, without the presence of a strong regulator and revenue support from Government we would expect both the bank and the bond market to differentiate between housing associations much more and smaller, less sophisticated housing associations will suffer much higher debt costs and/or struggle to secure private finance at all.

Jessica Castle

Managing Director Vice President

Debt Capital Markets Debt Capital Markets

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