U.K.-Based Social Housing Association Catalyst Housing Ltd. Assigned #A+# Outlook Negative

Stocks and Financial Services Press Releases Monday October 16, 2017 17:38
LONDON--16 Oct--S&P Global Ratings

LONDON (S&P Global Ratings) Oct. 16, 2017--S&P Global Ratings said today that it had assigned its 'A+' long-term issuer credit rating to U.K. social housing provider Catalyst Housing Ltd (Catalyst). The outlook is negative.

Our rating on Catalyst is one notch higher than the 'a' stand-alone credit profile (SACP), based on the moderately high likelihood of extraordinary support from the U.K. government, if needed. The SACP is primarily supported by Catalyst's very strong enterprise profile, thanks to solid economic fundamentals where Catalyst operates and low industry risk. Furthermore, modest leverage, sufficient interest cover, and robust liquidity buttress the financial profile. That said, adequate EBITDA margins and development-for-sale activities constrain the rating and expose the association to more-cyclical revenue sources.

The traditional social housing industry continues to exhibit low risk on a global scale; based on limited exposure to business cycles and lower competition from other non-government-related providers. The industry continues to enjoy strong demand and is normally high on the agenda of political manifestos. That said, Catalyst engages not only in traditional social housing activities but also in non-traditional activities, such as shared ownership and open market sales. These activities are more exposed to market volatility and, in particular, to potential adverse changes in the U.K. property market (such as sharp falls in property valuations).

Much of Catalyst's stock has an attractive location in terms of demand--64% of units are in London and the rest are located across southeast England--in commuter areas such as Reading and Oxford. These areas exhibit very strong economic fundamentals as population growth is estimated to slightly exceed 1%, and weighted-average social rent to market rent is expected to remain below 50%, indicating continued high demand for Catalyst's services. In addition, the Elizabeth line is set to be fully operational in December 2019. The opening of this new transport link could make its operating areas even more attractive to commuters. On the other hand, 22% of Catalyst's revenue in the financial year (FY) ending 2017 came from high-risk, non-traditional activities, specifically, outright sales and first-tranche shared ownership sales. Our base-case estimates suggest that revenues from such sources will reach 45% by FY2020. These activities exhibit riskier fundamentals, and could be particularly prone to an acute drop in valuations during a housing downturn.

We consider the quality of Catalyst's housing assets as a rating strength. Its stock portfolio has a moderate average age of 32 years, in line with similarly rated peers. That said, arrears are starting to increase, largely as a result of the roll-out of welfare reforms (in particular, Universal Credit), and asset restructuring. Although voids increased marginally to 1.4% in 2017 from 1.0% in 2016, they have remained stable overall since 2015, when they represented 1.3% of revenues. Catalyst's average time to re-let a property is 54 days, at the higher end of rated peers. Recently, following the tragedy at the Grenfell Tower, housing associations have initiated a check of high-rise tower blocks for aluminum composite material (ACM) cladding. Catalyst owns one tower that uses the ACM cladding. Although this tower is currently being reviewed for fire safety, it accounts for less than 1% of Catalyst's housing stock. Therefore, we expect to see limited contingent liabilities.

Catalyst's revenues came under pressure in FY2017, dropping by 25% to £169.7 million (compared with £227.4 million last year). We attribute the dip to Catalyst reaching the low point in its development cycle and to delays in handovers and sales at the end of 2016. Delays in development are caused by structural issues affecting the construction and social housing sector, including the shortage of construction skills in the labor force.

At the same time, adjusted EBITDA margins rose to 35% in FY2017, compared with 29% in the previous year. We expect this to be temporary and forecast that margins will decrease over the coming years, while remaining modestly above 30%. In our view, the housing market is currently stagnating, especially in London and the southeast, and the rise in cost inflation affects housing associations' margins during the rent control period.

In FY2017, Catalyst sold 41 units in the open market. In contrast, Catalyst sold 135 market sale units in FY2016, and 160 units in FY2015. We note that the market sale program can be volatile, however, we expect Catalyst will sell about 160 units annually, on average, between 2018 and 2020. Catalyst plans to develop a total of around 600-700 units annually until 2020, with a target mix of 25% to be sold in the open market, and a further 35% to be shared ownership units. The rest will be used for social rent. The contracted development plan is fully funded until 2020, with undrawn committed facilities and cash generated from operations.

Catalyst has improved its governance and controls since last year, when an impropriety was discovered in its sales and marketing division. The board and the regulator were promptly notified, leading the Homes and Communities Agency (HCA) to lower its assessment of Catalyst's governance to G2. Catalyst has since undertaken a substantial review of the situation and implemented corrective measures to ensure it does not recur. Following an in-depth review of the HCA's new procedures, Catalyst received the highest governance assessment of G1. The swift resolution of the matter demonstrates that Catalyst has a strong and experienced management team. In addition, we note that management has been successful in increasing revenues while maintaining stable costs over the past two years.

Catalyst will maintain a modest debt profile over the next two years, in our view. As of FY2017, its total drawn debt stood at about £610 million (including operating lease adjustment). Of this debt, 85% is at fixed rates, with an average interest rate of 4.6% and an average life of 17 years. We anticipate that debt will reach about £860 million by FY2020, and debt to EBITDA will average 10.5x over our five-year base-case period. Total housing properties, net of depreciation, are valued at £1.9 billion, of which £971 million is unencumbered (on EUV-SH basis). This supports our very strong debt position assessment. The group exhibits sufficient general EBITDA interest cover of 2.3x, on average, has a smooth maturity profile, and no exposure to derivatives. We note that the group can also cover interest cost from social housing lettings income over our five-year base case.

We consider Catalyst as a government-related entity (GRE) and assess the likelihood of it receiving extraordinary support from the U.K. government (AA/Negative/A-1+) through the HCA as moderately high, in the event of financial or operational distress.

Under our criteria for GREs, our view of a moderately high likelihood of extraordinary government support is based on our assessment of Catalyst's important role for the U.K. government and its public policy mandate. It is also based on Catalyst's strong link with the U.K. government, demonstrated by the government's track record of providing support historically.

The negative outlook reflects the outlook on the U.K. We could lower the rating if we were to lower our sovereign credit rating on the U.K. or if we revised downward our view of the likelihood of U.K. government support because, in both cases, the positive notch of support to the SACP would no longer apply.

We could also lower the rating if financial performance deteriorated, such that EBITDA falls structurally below 30% of revenues in our five-year base-case scenario and liquidity weakened below 1.75x.
We could revise the outlook to stable in the next two years if we revise the outlook on the sovereign to stable and, at the same time, Catalyst continues to perform in line with our base-case scenario.

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