Housing Associations and the Unencumbered Asset Test Ratio
Registered Providers have historically been considered a very low credit risk for lenders, due in a large part to the entrenched regulatory framework under which they are governed. RPs are also an appealing category of borrower, as they boast long-term stable cash flows, and many have secured a 'sub-sovereign’/quasi-public status by ratings agencies. As such, social housing finance is typically a 'no default' sector and the continued lender confidence in the sector alongside the burgeoning impact investment market and growth of for-profit RPs has paved the way for new lenders and investors to join the market.
Traditionally financing is secured against an RP’s portfolio of social housing units; and the market has streamlined the charging process through the use of security trusts where multiple lenders (or agents in the case of syndicated loans) can join as beneficiaries under the same trust, with charged properties capable of being allocated between beneficiaries without the need to release and recharge.
Some of (relatively) new lenders to the sector are offering unsecured lending, doing away with security trusts, property due diligence and managing property allocations; and established high street lenders are now also offering tranches of unsecured lending (alongside secured lending). Much of this unsecured lending may be taken out by RPs on a "just in case" basis to plug a liquidity gap in obtaining or refinancing long term debt via the capital markets.
Typically, under any unsecured lending arrangements, an RP is required to keep a specified number of assets free of security (known as "unencumbered assets"), which forms for the basis of a new financial covenant known as an "Unencumbered Asset Cover Ratio".
Cover ratios require RPs to maintain assets which are not subject to fixed security in favour of any other lender at a minimum level which is measured as a ratio against the amount of the debt provided by that lender.
Below are some of the commercial principles to consider when negotiating an unencumbered asset test:
- What restrictions are there on the type of assets which can be included as part of the unencumbered assets? Will a lender permit shared ownership units to be included in the calculation or include a maximum threshold? Can the RP include commercial property such as its head office; or commercial units within residential estates? What about non property assets such as cash collateral?
- Is the calculation of unsecured debt limited to the amount of all drawn loans or should it include committed but undrawn facilities? Given the volume of unused liquidity in the sector, this could have a significant impact on the amount an RP can draw under a facility with an unencumbered assets test.
- Should the calculation of unsecured debt include any mark to market exposures? For RPs with fixed rate loans and embedded swaps, the impact of including the mark to market exposure in the financial covenant should be considered.
- Should the unencumbered asset value be calculated on the existing use value of an RP's social housing units (EUV-SH), or will the lender permit units to be valued (or revalued) on the higher market value basis? Uncertain market conditions, rising volatility and increasing pricing no doubt have the potential to cause a shift in the current trends. The flexibility afforded by unsecured lending may well become more popular for borrowers; and represent an opportunity to differentiate for funders seeking to increase their market share across the sector.