Lending, loan covenants and EBITDA-MRI calculations – takeaways from our meeting on decarbonisation costs

The NHF hosted a meeting to discuss the social housing sector’s capacity to invest in decarbonising and improving the energy efficiency of their stock. The meeting was attended by lenders, valuers, four NHF members, and representatives from the trade association for banking and financial services, UK Finance. This followed an initial meeting in February and was intended to agree on actions to take forward.

The conversation was centred on the interaction between housing associations’ decarbonisation costs and lending covenants arranged with banks. There is a worry that these covenants could delay the sector’s progress in achieving its net zero targets because of embedded Earnings Before Interest, Tax, Depreciation, Amortisation, Major Repairs Included (EBITDA-MRI) calculations.

We discussed the potential for greater allowances in current covenants to allow for higher levels of expenditure, for decarbonisation grants to be included in the calculations, and for reviewing the sector valuation methodology through lotting and a reduced discount rate. The lenders present at the meeting recognised these as options to pursue and that there will need to be a give and take between them and housing associations. They were keen to emphasise however, that it will be difficult to make blanket provisions as each organisation is different and requires different arrangements.

Housing associations are assessing their business plans for the next five to 10 years to establish the extent to which they are able to carry out necessary works on their stock. It is becoming clear that a barrier to achieving these goals in this timeframe is the interest cover covenant used by some lenders.

Members will only be able to capitalise a small proportion of the major works on their homes as components, and hold these assets on their balance sheets, in accordance with the accounting principles as prescribed by FRS102 and the Housing SORP. When housing associations report EBITDA-MRI to lenders, decarbonisation works will be added back to the revenue expenditure, thus reducing the earnings, and by extension, the reported interest cover calculation.

The impact of this could be distinct. If housing associations’ business plans come within a set margin of breaching the EBITDA-MRI interest covenant, boards will question the decisions that led to this outcome. Any negative outcome over the next five to 10 year period will be a consequence of a number of factors. The speed members are able to deliver decarbonisation and energy efficiency, and also the government guidance that is issued – for example, on the need to reach an EPC rating of C.

Significant investment would add value to the future salability and quality of the stock which all lenders already hold as security. The sector is a strong credit and is attractive to long term funders. This stability is something that housing associations are striving to sustain and protect.

Housing associations’ investment in energy improvement will be key to mobilising the national supply chain and enabling the delivery of the government agenda on carbon reduction across all households in the UK. There was a clear consensus in our latest meeting that we must act as soon as possible and cannot expect this supply chain to develop overnight.

We are working hard to move forward on this issue in order to support the decarbonisation of social housing while maintaining lender confidence. Some actions from our latest meeting were:

1. To review the terms of grants to enable them to be brought into EBITDA-MRI calculations.
2. To explore the options of lotting and reducing the discount rate with sector valuers.
3. To reconvene later in the year to discuss progress on this issue.