Key Takeaways
- Our 41 rated U.K. social housing providers have been increasing their investments in their existing homes over the past few years.
- This has tightened their ratings headroom, although the average rating remains 'A'.
- We believe that these providers' capacity to keep increasing their investments in their existing assets and new homes has reduced.
- Even a modest rise in investments compared to our base case could result in lower stand-alone creditworthiness.
According to our sensitivity analysis, if investments in existing and new homes were to increase modestly above expectations, interest coverage for nearly 70% of our U.K. rated social housing providers could drop to a level that is no longer commensurate with the current ratings. In this case, many of the ratings could migrate toward the lower end of the 'A' category.
However, whether pressure from rising investments would translate into rating actions outside our sensitivity analysis would primarily depend on management's response to the financial pressure.
Social Housing Providers' Investments Have Weakened Their Stand-Alone Creditworthiness
While the average rating on our 41 rated social housing providers remains 'A', their stand-alone credit profiles (SACPs), our measure of intrinsic creditworthiness, have weakened over the past 12 months (see chart 1). This is largely the result of the sector increasing investments in its existing assets.
There is a more pronounced movement in SACPs than in ratings because we apply notching uplift to account for government-related support in some instances. Because one of the priorities of U.K. regulators is to maintain lender confidence and low funding costs across the sector, we think it is likely that they would try to prevent a default in the sector. In our view, social housing providers would receive timely extraordinary support from the U.K. government in the event of financial distress. This is the key reason why the average rating on the 41 rated providers remains 'A' despite the downward migration in SACPs.
Chart 1
Our Base-Case Interest Coverage Ratio Will Recover More Slowly Than We Had Anticipated
We see a steep increase in planned investments in existing properties for most of our rated U.K. social housing providers as compared to our previous expectation. This rapid increase in investments will delay the financial performance improvement from rent increases outpacing cost inflation and lower interest rates.
Our updated base case that runs to the end of fiscal 2026 (ending March 31) indicates a greater weakening in nonsales-adjusted EBITDA interest coverage and a delay in its recovery. However, we estimate that interest coverage will remain above 1.1x on average for the portfolio (see chart 2).
Chart 2
The Need To Invest In Existing Homes Is A Big Challenge, Particularly For The Large London-Based Providers
Many social housing providers increased their investments in their existing homes by an average of about 17% over fiscal 2024, as the sector focuses increasingly on improving housing quality.
The large London-based social housing providers--those with more than 40,000 homes--are more exposed to fire-safety remediation works as they have more high-rise and complex buildings in their housing portfolios. Moreover, the cost of capitalized repairs per unit for these providers is on average about 13% higher than for the rest of our rated portfolio (see chart 3). For these reasons, the ratings on the large London-based providers are lower on average than the ratings on the rest of the portfolio.
Chart 3
Higher costs year on year for all providers also reflect inflation, which rose significantly in fiscal 2023 and fiscal 2024. Going forward however, we forecast that average inflation will decelerate and drop below 3% in fiscal 2025.
We anticipate that the sector will keep increasing investments in existing homes as it focuses on meeting regulatory requirements for housing quality. At the same time, we believe that more grants could become available to social housing providers--for example, from the Warm Homes: Social Housing Fund and the Building Safety Fund--and that these could cover some of the increase in investments.
Larger Investments Than We Forecast Pose A Risk To Our Base-Case Scenario
The sector's need to improve the quality of its existing homes mainly arises from stricter regulation and the push toward decarbonization, while the development of new homes is necessary to meet the U.K.'s housing needs. Against this backdrop, we tested larger investments in both new and existing homes in the following three scenarios:
- Scenario 1: Our base-case assumptions, combined with a 10% increase in capital expenditure for development in fiscal 2025 and a 15% increase in fiscal 2026.
- Scenario 2: Our base-case assumptions, combined with a 10% increase in capitalized repairs in fiscal 2025 and a 15% increase in fiscal 2026.
- Scenario 3: A combination of scenarios 1 and 2.
In our base-case scenario, we forecast that our 41 rated social housing providers would have capacity to deliver approximately 27,000 new units per year in fiscal 2025 and fiscal 2026. We observe that a large London-based provider would deliver on average roughly double the units per year compared to a provider in the rest of the portfolio. Scenarios 1 and 3 increase delivery capacity by approximately 7,000 units over the same period for the total rated portfolio.
Our scenario testing focuses on increasing social housing providers' planned level of capitalized repairs, although we acknowledge that their operating expenditure is also rising.
In all three scenarios, we assume that about 80% of the social housing providers' existing debt is at a fixed rate, with the average cost of debt remaining above 5% until fiscal 2026. We incorporate this assumption of higher-for-longer interest rates to test the social housing providers' interest rate sensitivity. This contrasts with our base-case that follows our macroeconomic forecast of lower funding costs for U.K. issuers (see "U.K. Economic Outlook Q4 2024: Disinflation And Rate Cuts Will Stimulate Growth," published Sept. 23, 2024).
Social housing providers' nonsales-adjusted EBITDA interest coverage would remain weaker for longer if they undertook larger investments
The average interest coverage ratio for the 41 rated entities would continue weakening, although it still recovers modestly toward the end of our forecast periods in all scenarios. The average interest coverage ratio for the portfolio in all scenarios is around 1x (see chart 4). It would therefore be challenging for our rated social housing providers to maintain their current SACPs if any of the scenarios were to materialize.
Chart 4
In addition, the average nonsales-adjusted EBITDA interest coverage ratio weakens across all SACPs in all three scenarios. The scenarios have a particularly material effect on providers with a 'bbb' SACP, because their average interest coverage would migrate well below 1x. This is the average interest coverage ratio of providers with a 'bbb-' SACP, the lowest SACP category in the portfolio.
Chart 5
Mitigating Factors That Could Support Providers' Ratings
Overall, rating headroom has diminished compared to our prior forecasts from last year. We observe that our rated social housing providers are sensitive to higher investment spend and that even a modest increase in capitalized repairs and/or development could strain creditworthiness. However, these are hypothetical scenarios, and we acknowledge that the actual performance of the housing provider depends on its management priorities and risk appetite. Some social housing providers still have rating headroom and are carrying out mitigating strategies to ease financial pressure. Also, additional grant availability from the government could balance these investment needs.
Related Research
- Non-U.S. Social Housing Providers Ratings Risk Indicators: Ratings Pressure Has Eased, Oct. 31, 2024
- Non-U.S. Social Housing Providers Ratings History: October 2024, Oct. 31, 2024
- United Kingdom 'AA/A-1+' Ratings Affirmed; Outlook Stable, Oct. 18, 2024
- U.K. Economic Outlook Q4 2024: Disinflation And Rate Cuts Will Stimulate Growth, Sept. 23, 2024
- U.K. Social Housing Borrowing 2024: Borrowing capacity remains constrained, March 6, 2024
- European Housing Markets: Forecast Brightens Amid Ongoing Correction, Jan. 25, 2024
- Non-U.S. Social Housing Sector Outlook 2024: At A Turning Point?, Nov. 29, 2023
- Regulatory Framework Assessment: Social Housing Providers In The U.K. Benefit From Strong Regulatory Frameworks, Oct. 23, 2023
- U.K. Social Housing Providers' Credit Headroom Could Tighten If The Operating Environment Deteriorates, Oct. 4, 2023
This report does not constitute a rating action.
| Primary Credit Analyst: | Abril A Canizares, London + 44 20 7176 0161; abril.canizares@spglobal.com |
| Secondary Contacts: | Felix Ejgel, London + 44 20 7176 6780; felix.ejgel@spglobal.com |
| Colleen Sheridan, London +44-20-7176-0561; colleen.sheridan@spglobal.com | |
| Tim Chow, CFA, London +44 2071760684; tim.chow@spglobal.com |
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